CEO-executive connections and auditor resignations

Abstract

ABSTRACT This article examines the impact of connections between the Chief Executive Officer (CEO) and other executives on auditor resignations. Prior literature documents both the positive and negative effects of CEO-executive connections on financial disclosure quality. However, there remains a lack of understanding regarding whether auditors perceive CEO-executive connections as a factor that potentially increases or decreases audit risk. To address the gap, this study investigates the association between CEO-executive connections and the likelihood of auditor resignations. The results based on 19,452 firm-year observations of S&P 1500 firms from 2004 to 2015 show that CEO-executive connections, especially visible connections, are positively associated with auditor resignations. Moreover, the association is more pronounced for firms with poor oversight over the financial reporting process and management. This suggests that CEO-executive connections are an audit risk factor that heightens the inherent and control risks of the firm, which can be mitigated through effective oversight mechanisms. This study contributes to the auditing literature by investigating an unexplored determinant of audit risk, that is, CEO-executive connections, and highlights the need to evaluate the management-related factors that could potentially heighten risks for auditors and regulators.