The Severity of a Client’s Negative Environmental, Social, and Governance Reputation Affect Audit Effort and Audit Quality

Document Type : Original Article

Authors

1 Ferdowsi University of Mashhad

2 PhD Student in Accounting, Ferdowsi University of Mashhad, Mashhad, Iran

Abstract

In recent years, investors have evaluated the organizations through environmental, social and governance criteria and assessing firms. However, environmental, social, and governance (ESG) risks affect business processes and controls, increase financial risk, and threaten the firm's survival. This paper examines whether the employer's negative environmental, social, and governance reputation is related to audit effort and quality. For this purpose, data from 107 firms is collected from 2015 to 2020. The analyses show a positive and significant relationship between ESG criteria and delays in the audit report; auditors increase audit efforts by spending long days auditing financial statements in response to poor ESG credits. Because auditors work harder, the financial statements of such firms are less likely to be reviewed. There is a positive and significant relationship between ESG criteria and the restatement of financial statements: the greater the negative reputation resulting from ESG criteria, the greater the likelihood of financial statement restatement and the higher the quality of the audit due to the auditors' scrutiny. Furthermore, there is no significant relationship between ESG criteria and financial statement reform. The paper also studies the interactive effect of the negative clients’ ESG reputation and the delay of the audit report. The results show that delays in the audit report have a significant inverse effect on the relationship between ESG criteria and the presentation of financial statements and adjustment of financial statements.

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