The Spillover Effect of Public Firm Audit Regulation on Private Firm Auditing: Evidence from Common Partners

Abstract

We study a regulatory spillover in which audit regulations for public firms can affect auditing practices for private firms through the channel of common partners—partners who audit both public and private firm clients. We exploit a regulation in China that applies only to public firm auditing and aims to enhance transparency and rigor in audit procedures. We find that audit partners are more inclined to issue modified opinions for private firm clients following the implementation of the regulation. We explore two potential mechanisms through which common partners may treat private clients less leniently after the public audit regulation: knowledge transfer and increased professional skepticism. We find suggestive evidence consistent with both mechanisms. Collectively, our results demonstrate that public audit regulations can have a positive spillover on private firm clients through audit partners.

Keywords: Audit partner, knowledge transfer, professional skepticism, spillover effects of regulation.

JEL Classification: D83, G3, M42, M48.