The impact of revealing auditor partner quality: evidence from a long panel
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The impact of revealing auditor partner quality: evidence from a long panel C. S. Agnes Cheng 1 & Kun Wang 2 & Yanping Xu 3 & Ning Zhang 4 # Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract We examine whether the revelation of individual audit partner reputation affects client firms’ external financing choice. Specifically, we investigate whether a firm switches its financing choices once its auditor partner is perceived to be a low-quality partner, captured by whether one of the audit partner’s other clients is sanctioned for financial misreporting. We identify firms audited by a low-quality partner as the treatment firms and designate firms audited by other audit partners from the same audit office as the control firms. Using a long panel of data with audit partner identity, we find that, on average, the treatment firm switches from equity financing to credit financing after the discovery of individual audit partner quality. In addition, reduced equity financing is primarily concentrated among firms that choose to keep low-quality partners. By building an implicit link between the non-sanctioned firm and the sanctioned firm through a common audit partner, we show that investors can infer the quality of external audits using the auditor-level information, thus empirically supporting to the new PCAOB rule that requires disclosure of the partner-level information. Keywords Audit . Individual audit partner . External financing . Equity investors
* Yanping Xu [email protected] * Ning Zhang [email protected] C. S. Agnes Cheng [email protected] Kun Wang [email protected] Extended author information available on the last page of the article
C. S. A. Cheng et al.
1 Introduction We examine whether the revelation of individual audit partner reputation affects client firms’ external financing choices. Specifically, we investigate whether a firm switches its financing choice once its auditor partner is perceived to be of poor quality, captured by whether one of the auditor partner’s other clients is sanctioned for financial misreporting. To the extent that external financing is essential for a firm’s growth and external financing is costly, when compared to using internally generated funds, our study highlights the impact of external audit partner quality on firms’ financing decisions. Our research question is motivated by the recent academic interest in understanding the capital market consequences of individual audit partner profiles. For example, Gul et al. (2013) document that, due to differences in individual-level characteristics, such as education, work experience, and so forth, individual audit partners exhibit considerable variation in audit quality. Li et al. (2017) show that the “contagion effect” of audit quality at the office level (e.g., at the city level) is due to the “individual effect” in that individual auditors carry over “individual fixed effects” between audit engagements. Studies generally focus on the stock market reactions at the partner level (Abodia
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