Do alumni relationships between executive directors and auditors matter for financial reporting quality?

Abstract

ABSTRACT This paper examines the impact of executive director-auditor Guanxi on Chinese listed firms’ financial reporting quality from 2009 to 2019. We identify Guanxi-connected auditors as those who attend the same university as the client firm directors. Using a fixed-effect model, we provide consistent evidence that alumni ties between auditors and executive directors are positively related to corporate earnings management, indicating that auditors are more willing to trust clients and less likely to challenge their financial reporting decisions. Subsequently, client firms have more incentives to manipulate earnings, and financial reporting quality is reduced. Our study also finds that the positive impact of director-auditor ties on earnings management is greater among non-state-owned enterprises, firms that do not recruit big-four auditors, and those with fewer industry specialist auditors. Our study sheds new light on the impact of Guanxi-connected auditors on financial reporting quality, enhancing our understanding on the role of social ties. Highlights Alumni ties between auditors and executive directors are positively related to earnings management. Such a positive relationship is greater among non-state-owned enterprises. Such a positive relationship is more pronounced for firms that do not recruit big-four auditors. Such a positive relationship is more pronounced for firms with fewer industry specialist auditors.