Interlocked Audit Partners and Board Directors: An Examination of Financial Reporting Quality

Abstract

We examine the role of interlocking connections among board directors and external auditors on financial reporting quality. Following agency, social network, and resource dependence theoretical perspectives, we form different expectations according to directors' role on the board and in the financial reporting process. When such interlocks involve executive directors, we expect that they reduce auditors’ independence and decrease financial reporting quality. On the contrary, when audit committee non-executive directors are involved, such interlocks represent an effective channel to reinforce their co-operation and information sharing with auditors towards ensuring higher financial reporting quality. Investigating a sample of 794 companies listed in France, Germany, and the UK throughout 2009-2017, we find support for both our expectations. On the one hand, firms with executive-auditor interlocks have less reliable accruals and lower reporting conservatism. On the other hand, when experienced but not too busy, audit committee directors interlocked with auditors are associated with more reliable accruals and a lower likelihood of beating earnings benchmarks. We also show that these findings vary by country according to the strength of legal and governance traditions.