Does Contamination Cross borders? Reputational Spillovers and Market Consequences in the GNP Sector

Auditing is the cornerstone of accounting firms’ business. Yet audit quality as a credence good is difficult to evaluate, incentivizing auditors to rely on their reputations to sustain client relationships and secure future revenue. Little is known about the role of auditor reputation beyond public client sectors. My study examines whether reputational damage from public client audit spills over to a structurally distinct client sector, the government and nonprofit (GNP) audit market. Specifically, I test whether audit offices lose market share in the GNP sector after being associated with public client restatements. Using 267,630 client-auditor-year observations from 2003 to 2023, I find that audit offices associated with public client restatements (“contamination”) lose market share in the GNP sector through both lower client retention and reduced new client acquisition. These lost clients are economically meaningful, reflected by the total revenue of the office’s GNP clients. The effect is stronger for offices with greater reputational capital and for those operating in more competitive markets. At the client level, contamination increases the likelihood of auditor change, which is higher for clients that auditors previously assessed as high risk, but lower for larger clients and those classified as special entities. Taken together, my findings demonstrate that reputation built through the core public audit practice generates spillover effects that shape outcomes in other client segments, revealing a broader scope and economic significance of auditor reputation than previously recognized.