The Insurance Hypothesis: The Case of KPMG's Audit Clients

30 Pages Posted: 10 Feb 2009

See all articles by Darryl Lee Brown

Darryl Lee Brown

Illinois State University

Susan Shu

Boston College - Carroll School of Management

Gregory M. Trompeter

Boston College

Date Written: December 1, 2008

Abstract

Although many have argued that independent audits implicitly provide clients with a form of insurance (the insurance hypothesis), there is limited empirical evidence to support the existence and magnitude of this function. In August of 2005, after months of intense negotiations and discussions, KPMG entered into a settlement agreement with the Department of Justice, which ended widespread speculation of an impending federal indictment against the audit firm and the notion that the firm would suffer the same fate as Arthur Andersen. We argue that the circumstances surrounding the settlement provide a natural setting to test the insurance value provided by auditors. Our results show that, while BIG 4 non-KPMG client firms earn insignificant abnormal returns, KPMG client firms earn significantly positive abnormal returns during the days surrounding news of the settlement. We show that these positive abnormal returns vary cross-sectionally, and are more pronounced for KPMG client firms in greater financial distress and for those subject to greater litigation risk.

JEL Classification: G12, G22, M49

Suggested Citation

Brown, Darryl Lee and Shu, Susan and Trompeter, Gregory M., The Insurance Hypothesis: The Case of KPMG's Audit Clients (December 1, 2008). Available at SSRN: https://ssrn.com/abstract=1339985 or http://dx.doi.org/10.2139/ssrn.1339985

Darryl Lee Brown

Illinois State University ( email )

Normal, IL 61790
United States

Susan Shu (Contact Author)

Boston College - Carroll School of Management ( email )

Boston College
140 Commonwealth Ave.
Chestnut Hill, MA 02167
United States
617-552-1759 (Phone)

Gregory M. Trompeter

Boston College ( email )

Carroll School of Management 140 Commonwealth Avenue
Chestnut Hill, MA 02167
United States
617-552-0878 (Phone)
617-552-2097 (Fax)

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