Out of Sight, Out of Mind: Does Audit Partner Proximity to Clients Matter?

• In Event: Audit Partner

Abstract

Using newly mandated disclosures which reveal the identity of the lead engagement partner for publicly traded US firms, we examine whether audit partners’ geographic proximity to their clients affects the quality of the audits they perform. We find that nearly 30 percent of clients have non-local partners, defined as partners with “home” locations at least 100 kilometers away from their clients’ headquarters. We build on an extensive literature examining the effects of proximity between economic agents to predict that audit quality is lower when a lead engagement partner is located farther from her client. Our findings are consistent with this prediction. In our primary analysis, we find that clients’ audited earnings are of lower quality (i.e. discretionary accruals are more likely to significantly increase net income) when the lead engagement partner is non-local. Our findings are consistent across several alternative measures of audit quality and are robust to a battery of sensitivity tests, including alternative model specifications designed to rule out alternative explanations. In cross-sectional analysis, we show that the effect of partner distance is mitigated (partially) among Big 4 audit firms and (completely) for audit partners with easy access to a direct flight to their clients’ headquarters. Finally, we find that audit firm tenure increases the odds that a client will have a non-local partner. We suggest that this association is caused by mandatory audit partner rotations and, combined with our primary findings, points to a potential unintended (negative) consequence of such mandatory rotation policies.

Authors

• Nicholas Jennings Hallman, University of Texas at Austin

• Jere R Francis, University of Missouri-Columbia

• Nargess Golshan Mottaghi, University of Missouri - Columbia