Do social ties between two signatory auditors affect audit quality and firm value?

Abstract

We explore the effects of social ties (including alumni relations, regional connections and employment affiliation) between the two signatory auditors (engagement and review auditors) on audit quality in China. We find that client firms with socially connected auditors have lower audit quality. The negative effect is more pronounced when the two signatory auditors are partners in their audit firms or when financial irregularities exist in their client firms. Conversely, this adverse effect is alleviated if the two auditors have attended elite schools or work for one of the Big 4 audit firms. We further find that social ties between the two auditors is negatively associated with firm value through impaired market confidence, while this negative relationship can be partially explained by impaired audit quality. Overall, our results indicate that the costs of the two signatory auditors’ social ties outweigh their benefits.