The impact of revealing auditor partner quality: evidence from a long panel

Abstract

We examine whether the revelation of individual audit partner reputation affects client firms’ external financing choice. Specifically, we investigate whether a firm switches its financing choices once its auditor partner is perceived to be a low-quality partner, captured by whether one of the audit partner’s other clients is sanctioned for financial misreporting. We identify firms audited by a low-quality partner as the treatment firms and designate firms audited by other audit partners from the same audit office as the control firms. Using a long panel of data with audit partner identity, we find that, on average, the treatment firm switches from equity financing to credit financing after the discovery of individual audit partner quality. In addition, reduced equity financing is primarily concentrated among firms that choose to keep low-quality partners. By building an implicit link between the non-sanctioned firm and the sanctioned firm through a common audit partner, we show that investors can infer the quality of external audits using the auditor-level information, thus empirically supporting to the new PCAOB rule that requires disclosure of the partner-level information.