Captured by Mutual Funds: Do Cross-Audits Undermine Auditor Independence?

67 Pages Posted: 9 Jul 2019 Last revised: 28 Aug 2020

See all articles by Yangyang Chen

Yangyang Chen

City University of Hong Kong (CityUHK) - Department of Accountancy

Jun Huang

Shanghai University of Finance and Economics

Ting Li

Shanghai University of International Business and Economics

Jeffrey Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Date Written: August 27, 2020

Abstract

We analyze the impact of cross-audits between companies and mutual funds on auditors’ reporting decisions. We document that companies are more likely to receive favorable audit opinions when they appoint the same auditor as their mutual fund blockholders. In cross-sectional evidence consistent with expectations, we find that the role that cross-audits play is concentrated where the mutual fund has stronger incentives to orchestrate stock price manipulation and the auditor is more likely to be captured by the mutual fund. We further show that investors fail to detect the impact of cross-audits on audit opinions in the short-term, which enables mutual funds to exploit this temporary mispricing through stock trading. In compensation, shared auditors captured by mutual funds benefit from higher audit fees and more audit business. Our evidence suggesting that market irregularities accompany cross-audits has major implications for stock market regulators.

Keywords: Cross-audit; Audit opinion; Mutual fund

JEL Classification: M40, G23, G32

Suggested Citation

Chen, Yangyang and Huang, Jun and Li, Ting and Pittman, Jeffrey A., Captured by Mutual Funds: Do Cross-Audits Undermine Auditor Independence? (August 27, 2020). Available at SSRN: https://ssrn.com/abstract=3415843 or http://dx.doi.org/10.2139/ssrn.3415843

Yangyang Chen

City University of Hong Kong (CityUHK) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China

Jun Huang

Shanghai University of Finance and Economics ( email )

No. 777 Guoding Road, Shanghai
Shanghai, 200433
China

Ting Li

Shanghai University of International Business and Economics ( email )

No. 1900, Wenxiang Road
Shanghai, 201620
China

Jeffrey A. Pittman (Contact Author)

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

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