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    The Effect of Networked Clients’ Economic Importance on A...
    research summary posted January 12, 2017 by Jennifer M Mueller-Phillips, tagged 10.0 Engagement Management, 10.05 Interactions with Audit Committee Members, 11.0 Audit Quality and Quality Control 
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    Title:
    The Effect of Networked Clients’ Economic Importance on Audit Quality.
    Practical Implications:

    Relationships between an auditor and the client have the capacity to impair auditor independence, which may have a negative impact on financial reporting quality. As such, research that examines issues that have the potential to impair audit quality should be important to the auditing profession. Furthermore, audit committees play a critical role in ensuring auditor independence and audit quality; therefore, it is important to consider the potential impact of the auditor’s economic dependence created by interlocking on audit quality. 

    Citation:

    Hossain, S., G. S. Monroe, M. Wilson, and C. Jubb. 2016. The Effect of Networked Clients’ Economic Importance on Audit Quality. Auditing: A Journal of Practice and Theory 35 (4): 79 – 103.

    Keywords:
    audit committee-audit partner interlocks, audit quality, client importance, fee dependence, going-concern opinions, and discretionary accruals.
    Purpose of the Study:

    The authors examine the association between audit quality and the economic importance of client networks that are created by audit committee member-audit partner interlocks, which occur when an audit committee member of a company is also an audit committee member of other companies that are audited by a common audit firm and engagement audit partner. When an audit partner audits several companies that have audit committee members in common, there is potential for a self-interest threat to auditor independence. The interlocked audit partner may perceive that disputes with the management of a particular client within the network may threaten future fee income from the other companies in the network; thus, these economic ties have the have the potential to erode auditor independence and, as a consequence, reduce audit quality.  

    Design/Method/ Approach:

    The authors test the association between each audit-quality proxy and each client network fee dependence measure using regressions based on unrestricted samples and samples of clients matched on their inherent propensity to be associated with an audit committee-audit partner interlock. 

    Findings:
    • The authors find that network fee dependence is significantly associated with lower audit quality as measured by each of their audit-quality proxies, suggesting that the economic dependence created by such links may reduce the likelihood of an auditor issuing a first-time going-concern opinion and may increase the extent to which reported earnings are biased away from the level at which a neutral application of GAAP would precipitate.
    • Collectively, the authors’ findings provide support for the contention that audit partner dependence on fees from other companies in the network created by audit committee member-audit partner interlocks erodes audit quality in economically significant client firms. 
    Category:
    Audit Quality & Quality Control, Engagement Management
    Sub-category:
    Interactions with Audit Committee Members