Out of Sight, Out of Mind: Does Audit Partner Proximity to Clients Matter?

Abstract

We examine if the geographic proximity of audit partners to their clients is associated with audit quality. We use newly mandated PCAOB disclosures of engagement partners and find that more than one quarter of clients have non-local partners, which are defined as partners with home locations at least 100 kilometers from their clients’ headquarters. We build on an extensive literature examining the effects of proximity between economic agents to predict that audit quality is lower when a lead engagement partner is located farther from the client. Our findings are consistent with this prediction. Clients’ audited earnings are of lower quality when the lead engagement partner is non-local. Inconsistent with prior research, which did not have the benefit of partner-level data, we find that there is no association between audit office proximity and the quality of clients’ audited earnings, once partner proximity is held constant. Our findings are consistent across several alternative measures of audit quality and robust to a battery of sensitivity tests, including model specifications designed to rule out potential alternative explanations. In cross-sectional analyses, we show that the adverse effect of partner distance is less severe for Big 4 partners, and for audit partners with easy access to a direct flight to their clients’ headquarters. Finally, we find that extended audit firm tenure increases the odds that a client will have a non-local partner. We suggest this association is caused at least in part by mandatory audit partner rotation, which, combined with our primary findings, point to a potential unintended negative consequence of mandatory rotation policies.

Keywords: Audit Partners, Geographic Proximity, Audit Quality

JEL Classification: M42