Auditors are Known by the Companies They Keep

63 Pages Posted: 19 Feb 2019 Last revised: 15 Mar 2019

See all articles by Jonathan Aaron Cook

Jonathan Aaron Cook

Public Company Accounting Oversight Board

Zachary T Kowaleski

University of Notre Dame - Department of Accountancy

Michael Minnis

University of Chicago - Booth School of Business

Andrew Sutherland

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems

Date Written: March 8, 2019

Abstract

We study the role of reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have very similar financial adviser misconduct profiles. Our estimates indicate that variation in misconduct reputation is roughly half as important as variation in size in explaining matches and auditor preferences, not just client preferences, help explain these matching patterns. Moreover, auditors appear to screen clients based on misconduct unrelated to fraud risk or the financial reporting process. An auditor’s track record of accepting high misconduct clients predicts their new clients’ future misconduct. Additional results reveal that auditor-client reputation matching is widespread and generalizable to firms outside the investment industry. We conclude that heterogeneity in auditors’ reputation concerns relate to their client acceptance and continuance decisions, which in turn are an indicator of future client misconduct.

Keywords: auditing, audit market structure, broker-dealers, financial advisers, financial intermediation, assortative matching, financial misconduct, consumer finance, organizational culture

JEL Classification: M21, M41, M42, G24, G28, D14, D18

Suggested Citation

Cook, Jonathan Aaron and Kowaleski, Zach and Minnis, Michael and Sutherland, Andrew and Zehms, Karla M., Auditors are Known by the Companies They Keep (March 8, 2019). Chicago Booth Research Paper No. 19-12. Available at SSRN: https://ssrn.com/abstract=3326595 or http://dx.doi.org/10.2139/ssrn.3326595

Jonathan Aaron Cook

Public Company Accounting Oversight Board ( email )

1666 K Street, NW
Washington, DC 20006-2
United States

Zach Kowaleski

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

Michael Minnis (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

Andrew Sutherland

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street

Karla M. Zehms

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States
608-234-1052 (Phone)
608-265-5031 (Fax)

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