Does Regulator Selection of Auditors Improve Audit Quality? Evidence from Auditor Designation in Korea

Abstract

Although the hiring and firing of auditors by clients is believed to create a fundamental conflict of interest, there is little research on the issue except for experimental evidence in Mayhew and Pike (2004). To provide evidence on the issue, in this paper we exploit the setting in Korea, known as auditor designation, wherein regulators selectively and episodically selected auditors for certain client firms. We fail to find that audit quality proxied by absolute discretionary accruals, audit hours, modified opinions, and the tendency to meet or beat benchmarks, is higher for designated auditors. Our results therefore question whether hiring and firing of auditors by clients is a threat to auditor independence.