Is Customer Dependency Associated with Supplierrs Misstatement Risk and Audit Fees?

Abstract

What are the implications of customer-base concentration, i.e., the degree of a supplier’s dependency on its major customers, for outside auditors? While prior research highlights the negatives of major customer dependency for client business risk, we find that suppliers with more concentrated customer bases spend less on audit fees. The negative association between audit fees and customer-base concentration holds after controlling for a wide array of firm characteristics, and is more pronounced when dependent suppliers and major customers share the same auditor. Our evidence is consistent with a negative link between audit effort and major customer dependency due to lower audit complexity. The audit fee discount identified, however, does not imply that audit quality declines with major customer dependency. Indeed, we find that suppliers with more concentrated customer bases are less likely to experience restatements of previously audited financial statements, which suggests a positive link between audit quality and major customer dependency. Overall, our study contributes to research in accounting and operations management on inter-organizational relationships by exploring the interplay of major customer dependency with client business risk and audit complexity. Taking the outside auditors’ perspective, our study provides new managerial insights on the costs and benefits of major customer relationships for supplier firms.