Financial Reporting Quality and Auditor Dismissal Decisions at Companies with Common Directors and Auditors

Posted: 12 Mar 2022

See all articles by Yangyang Fan

Yangyang Fan

Hong Kong Polytechnic University - School of Accounting and Finance

Joshua L. Gunn

University of Pittsburgh - Katz Graduate School of Business

Chan Li

University of Kansas

Jun Shao

Shanghai Lixin University of Accounting and Finance

Date Written: February 9, 2022

Abstract

We examine the effects of corporate networks involving common directors and auditors (i.e., connections creating single or double ties between companies) on two important monitoring roles: financial reporting quality and auditor dismissal decisions. We also investigate how shocks to the networks, in the form of the audit failing to detect misstatements, affect these networks’ structure. The investigations are important because these networks can have significant effects on firm governance and may have different effects when they overlap. We have three primary findings about double-tie networks: (i) there is no evidence that they improve overall financial reporting quality beyond the effect of single-tie networks; (ii) they lower directors’ willingness to dismiss the auditor, even when there is a signal of an audit failure within the network; and (iii) they allow audit-quality problems to spread between companies. Our results demonstrate the importance of investigating multiple types of networks and how shocks travel through them. Our findings also lend credence to concerns that “cozy” relationships between directors and auditors diminish the link between poor audit quality and market-imposed reputation penalties— specifically, auditor dismissals.

Keywords: financial reporting quality, auditor dismissal, director networks, auditor networks, auditor-director bonds, common auditor

Suggested Citation

Fan, Yangyang and Gunn, Joshua L. and Li, Chan and Shao, Jun, Financial Reporting Quality and Auditor Dismissal Decisions at Companies with Common Directors and Auditors (February 9, 2022). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4041340

Yangyang Fan

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Joshua L. Gunn

University of Pittsburgh - Katz Graduate School of Business ( email )

Pittsburgh, PA 15260
United States

Chan Li (Contact Author)

University of Kansas ( email )

Capitol Federal Hall
Lawrence, KS 66045
United States
7857661277 (Phone)
66045 (Fax)

Jun Shao

Shanghai Lixin University of Accounting and Finance ( email )

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