Auditor Information Spillovers and Company Operating Performance: Evidence from Targeted Auditor Switches

Abstract

This study examines whether companies realize operational benefits from making “targeted auditor switches” (i.e., engaging a new auditor recently dismissed by a competitor company). While prior work suggests that companies perceive auditor information spillovers to be costly, there is sparse extant evidence as to whether auditors actually do transfer operational information across companies. Using a novel setting, I find that companies that switch to a competitor’s former auditor realize significant subsequent improvements in operating performance and that this association varies predictably with several cross-sectional factors. I also find that these operational improvements are driven by increases in operating margins as opposed to revenue increases and that the outcomes of targeted switches are influenced by certain operational characteristics of the competitor companies whose former auditors are targeted. In sum, my findings suggest that operational information can be transferred across companies via external auditors. More broadly, my findings suggest that the value of an audit (auditor) is associated with the auditor’s informational capital and extends beyond that which is traditionally considered by capital market participants.

Keywords: Auditor information spillovers; operating performance; auditor selection; operational value of auditor knowledge.

JEL Classification: M40, M41, M42