Opening Up the ‘Black Box’ of Audit Firms: The Effects of Audit Partner Ownership on Audit Adjustments

Abstract

Audit firms face conflicting incentives. On one hand, they are motivated to provide high quality audits in order to protect their reputations and avoid regulatory sanctions but, on the other hand, they also need to please their clients in order to increase their revenues. We argue that these conflicting incentives become apparent when comparing the partners who conduct audits (i.e., ‘engagement partners’) and the partners who are responsible for monitoring audit quality (i.e., ‘review partners’). Given their different responsibilities within the audit firm, we predict that review partners monitor audit quality more closely when they are motivated to work harder, whereas engagement partners tend to work harder by trying to please their clients. Consistent with these predictions we find that the associations between audit adjustments and partner ownership are: 1) significantly positive for review partners, 2) significantly negative or insignificant for engagement partners, and 3) significantly more positive for review partners than engagement partners. Our findings suggest that larger ownership stakes motivate review partners to monitor audit quality more closely, while larger ownership stakes do not motivate engagement partners to deliver higher quality audits.

Keywords: Audit adjustments, Audit partner ownership, Review partners, Engagement partners

JEL Classification: M41