Auditors are Known by the Companies They Keep

72 Pages Posted: 19 Feb 2019 Last revised: 4 Feb 2020

See all articles by Jonathan A Cook

Jonathan A 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: January 31, 2020

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 similar financial adviser misconduct profiles. Our estimates indicate that variation in client misconduct behavior is nearly half as important as variation in client size in explaining matches. Auditors adjust their portfolios when presented with new information about client behavior, and those with the most significant reputation concerns are least likely to deal with high misconduct clients. Finally, we find that an auditor’s reputation for accepting high misconduct clients predicts their new clients’ future misconduct. Together, our results present new evidence on how reputation affects audit relationships, and the consequences of auditors’ reputation concerns for client behavior. Our results also indicate an unintended consequence of audit mandates: non-discerning auditors emerge to serve clients with low endogenous demand for auditing.

Keywords: auditing, audit market structure, broker-dealers, financial advisers, financial intermediation, financial misconduct, reputation

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

Suggested Citation

Cook, Jonathan A and Kowaleski, Zach and Minnis, Michael and Sutherland, Andrew and Zehms, Karla M., Auditors are Known by the Companies They Keep (January 31, 2020). Available at SSRN: https://ssrn.com/abstract=3326595 or http://dx.doi.org/10.2139/ssrn.3326595

Jonathan A 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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