The Importance of Clients' Social Ties to Audit Adjustments

Abstract

We extend prior research by exploring the importance of social ties among auditors’ clients to audit quality. On one hand, social ties foster communication among clients concerning how to deal with an auditor, helping clients negotiate against proposed audit adjustments. On the other hand, indications that an auditor provides a low-quality audit to one client are likely to become known to their other clients via social network channels, motivating auditors to impose stricter external monitoring to protect their valuable reputations. In examining audit adjustment data in China to shed light on which force dominates, we find that auditors require more adjustments to earnings for a client whose audit committee members are socially connected with audit committee members of other clients. In contrast, we do not find any perceptible impact of social connections stemming from top management on auditors’ decisions to book an adjustment, consistent with executives not always demanding accounting transparency. Additional mechanism analysis reveals that auditors expend more effort on engagements involving socially connected clients.

Keywords: Social Ties, Audit Adjustments, Audit Effort