Common Auditors and Relationship-Specific Investment in Supplier-Customer Relationships

Abstract

Using a sample of key supplier-customer relationships, we investigate whether an auditor common to a supplier and customer firm reduces information asymmetry between the two parties, leading to an increase in relationship-specific investments. We find evidence that the presence of a common auditor is positively related to relationship-specific investments. In addition, we show that industry structure and financial constraints play a role in explaining this relation. Finally, we use Arthur Andersen’s failure as an exogenous shock to the information environment and show that supplier-customer pairs that shared Andersen prior to its failure are more likely to share an auditor post-failure. Moreover, this higher propensity to share an auditor post-failure is prevalent only in sub-sample of firms where relationship-specific investments are important. Overall, we demonstrate that common auditors in supplier-customer relationships reduce information asymmetry in the supply chain and mitigate the investment inefficiency in relationship-specific assets.