The Effect of Networked Clients' Economic Importance on Audit Quality

Abstract

SUMMARYIn this study, we examine the association between audit quality and networked clients' economic importance. We consider networks of clients that result from audit committee member-audit partner interlocks. These interlocks occur when an audit committee member of a company is also an audit committee member of other companies that are audited by a common audit firm and audit partner. The audit partner may perceive that future fee income from the network of interlocked companies may be affected by disputes with the management of an interlocked client company. These economic ties have the potential to erode auditor independence and, as a consequence, reduce audit quality. The test variables include measures of network fee dependence based on the audit partner's fees generated from the networked clients created by audit committee member-audit partner interlocks. Audit quality is proxied by the likelihood of issuing a first-time going-concern modified audit report and the absolute value of discretionary accruals. Regressions on unrestricted and propensity score matched samples provide consistent evidence that audit partner dependence on fees from other companies in the network reduce audit quality.JEL Classifications: G34; M41; M42.Data Availability: All data used in this paper are publicly available.