Auditor-Client Interdependence and Audit Quality: Partner-Level Evidence

Abstract

In this study, we argue that an increased economic bonding may develop between the auditor and the clients when an auditor will switch to a new audit firm because the turnover auditor's better payoff expected from switching to the new firm (e.g., promotion, larger share of firm profits, more perks, more authority and peer respect) are often enhanced by the number of clients he can bring to the new firm. The auditor and the client can use audit quality as a bargaining tool to divide the incremental payoff generated from the joint auditor-client switch. We thus hypothesize that the turnover partners treat follower clients more favorably (by making less downward audit adjustments to pre-audit earnings or allowing greater discretionary accruals) than they treat other clients around the joint auditor-client turnover. Using the data in China where engagement-specific audit partner information is available, we find evidence supporting our hypothesis under the condition that both the former engagement and review auditors later switch to the same successor audit firm to perform the audits for the follower clients. Our partner-level evidence is consistent with the widespread concern that audit quality is lower when there is a greater level of auditor-client bonding.

Keywords: auditor-client bonding, audit quality, client following behavior, bargaining