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Are Auditors Compromised by Auditing Clients' Major Customers?

Sat, January 19, 7:30 to 8:30am, TBA

Abstract

Our study examines whether there is lower audit quality when the same auditor is engaged by the client and the client’s major customer(s). We posit that in this setting that the auditor’s independence is compromised by the potential threat of losing not just one client but two or more clients. We employ two measures of revenue quality: discretionary revenues and the likelihood of meeting or beating analysts’ revenue forecasts. We find that revenue quality is negatively associated with the percentage of sales to major customers who employ the same auditor as the client supplier. This result is primarily driven by the client supplier employing the same office-level auditor as the major customer(s), when compared to the firm-level. For instance, median income-increasing discretionary revenue is materially greater (0.76 percent of sales revenues) for client firms who engage the same office-level auditor as their major customer(s) than for client firms do not engage the same auditor at the firm-level. Our findings provide evidence that auditors compromise independence when they have clients who are part of the same supply chain.

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