Shredded Reputation: The Cost of Audit Failure

TLDR

The article investigates how the Enron audit failure affected Arthur Andersen’s reputation. The study analyzes stock market reactions of Andersen’s clients around key dates when audit procedures and independence were questioned. The authors find that following the shredding announcement, Andersen’s clients suffered statistically negative abnormal returns—especially those served by the Houston office—and that non‑audit fees did not appear to influence perceptions of independence.

Abstract

In this article we investigate the impact of the Enron audit failure on auditor reputation. Specifically, we examine Arthur Andersen’s clients’ stock market impact surrounding various dates on which Andersen’s audit procedures and independence were under severe scrutiny. On the three days following Andersen’s admission that a significant number of documents had been shredded, we find that Andersen’s other clients experienced a statistically negative market reaction, suggesting that investors downgraded the quality of the audits performed by Andersen. We also find that audits performed by Andersen’s Houston office suffered a more severe decline in abnormal returns on this date. We are not able to show that Andersen’s independence was questioned by the amount of non–audit fees charged to its clients.