Engagement Partner Quality, Costs of Capital, and Valuation

• In Event: Auditing Engagement Partners

Abstract

We examine the theoretically predicted negative (positive) relationship between the engagement partner (EP) quality and costs of capital (value) of the clients. Employing five proxies for the EP quality (characterized by size and industry specialization), and analyzing 414-739 EPs from the United Kingdom, we find, consistent with the predictions, that the clients of high-quality EPs generally enjoy lower costs of capital and have higher values. The latter effect is due to the markets’ perception that high-quality EPs improve their clients’ accruals quality. The effect of EP quality on clients’ value is through the improvement in the prediction of future cash flows and reduction of discount factors. The results are robust to controls for the industry, year, client, and audit firm fixed effects, as well as alternative measurements of EP quality and clients’ value. Our results suggest that audit quality at the EP level benefit clients.

Authors

• Kose John, New York University

• Min Liu, Brooklyn College