The Impact of Economic Bonding on Audit Quality: Evidence from Audit Working Papers
Posted: 30 Jan 2015
Date Written: January 21, 2015
Abstract
In this study we examine the effect of auditor economic bonding (financial dependency on a client) on audit quality. We consider financial dependency as either abnormally high fees in relation to expected hours or vice versa. We consider audits to have credence goods properties where the client has limited ways to assess audit quality that is (likely to be) delivered. This setting provides opportunities for different auditor business strategies. We base our results on a unique, proprietary dataset of audit fees, audit hours, materiality, risk assessments, error detection and auditor reporting decisions taken from the working papers of 681 audit engagements with 2,209 engagement-year observations over the period 2006 to 2011. First, we predict and find that high effort audit engagements (i.e., abnormal high audit hours) are associated with a higher probability of detecting audit differences than low effort audit engagements. Simultaneously, we predict and find that financial dependency on a client lowers the audit quality achieved by high effort as reflected by waiving proposed audit differences. Moreover, our results suggest that auditors facing high independence threats are more highly associated with overstated earnings than when independence threats are low. Consequently, the findings suggest that the negative effects of financial dependency, i.e. economic bonding threats, are a result of the auditors’ business relationship with a given client and how the auditor responds to competitive markets.
Keywords: Audit Quality, Auditor Business Strategy, Audit Partner, Audit Working Papers
JEL Classification: M40, M41, M42, M48
Suggested Citation: Suggested Citation