The Importance of Business Development Incentives to Audit Partner Independence: Evidence from The Propensity to Issue Modified Opinions to Group-affiliated Audit Clients
Posted: 16 Jul 2020 Last revised: 5 Feb 2021
Date Written: February 5, 2021
We analyze a unique auditor independence threat stemming from audit partners’ incentives to secure new revenue streams using the context of audit clients belonging to business groups. Since a partner who issues a modified audit opinion (MAO) to a group-affiliated client risks losing not only that client, but also the opportunity to extend their audit services to other member companies, this incentive to attract future business may induce partners to compromise their independence. Consistent with expectations, we document that partners are less likely to issue MAOs to group-affiliated clients when other group members are relatively large (i.e., representing lucrative potential clients for the partners) than other group-affiliated clients, and this relation intensifies when the incumbent group-affiliated clients themselves are economically less important. We also find that partners who issue MAOs to group-affiliated clients underperform in attracting new clients from the same business group. Further, investors perceive that audit quality is higher in these partners’ non-group clients, reflecting that reputation protection forces discipline partners to resist the temptation to issue unwarranted clean opinions.
Keywords: Auditor independence; future business potential; modified audit opinions; business group-affiliated audit clients
JEL Classification: M42
Suggested Citation: Suggested Citation