The Role of Director and Executive Interlocks in Mitigating Uncertainty in Auditor Hiring Decisions

• In Event: Corporate Governance / Auditor Response to Corruption Culture

Abstract

Choosing a new auditor imposes uncertainty because a company does not know for sure whether the new auditor will turn out to be a good choice. This uncertainty can be reduced when directors and executives choose an auditor with whom they are better acquainted. We therefore expect that familiarity with a prospective audit firm increases the likelihood that the company selects the firm as its new auditor. To measure a company’s familiarity with prospective auditors we identify directors and executives who have positions at other companies that employ a prospective auditor (hereafter “interlocks”). We have three main findings. First, companies tend to select audit firms with whom directors and executives are better acquainted through their service at other companies. Second, the length of tenure with the new auditor is longer when directors and executives are better acquainted with the new auditor. Third, audit quality is higher when companies select audit firms with whom directors and executives are better acquainted. Overall, we conclude that interlocks help companies make more informed and therefore better auditor appointment decisions.

Authors

• Clive Lennox, University of Southern California

• Yingri Julia Yu, Nanyang Technological University