Audit Committee Auditor-Director Interlocking, Audit Pricing and Industry Specialization

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Author Information : Xiaolu Xu (University of Massachusetts, Boston)

Susan Albring (Syracuse University, Whitman School of Management)

Year of Publication : International Journal of Corporate Governance (2018)

Summary of Findings : Using a sample of S&P1500 firms in the U.S. during the years 2004-2014, we find a positive relation between audit committee director-auditor interlocking and audit fees only for firms that select industry specialist auditors.

Research Questions : Audit committee director-auditor interlocking is associated with audit fees for firms that select non-industry specialist auditors.

Audit committee director-auditor interlocking is associated with audit fees for firms that select industry specialist auditors.

What we know : While there is considerable research on auditor independence from the perspective of client managers and audit committee member independence, relatively scant studies focus on the relationship between interlocking audit committee directors and external auditors (Chen et al., 2014; Fan, 2015). Furthermore, studies on the consequences of audit committee director-auditor interlocking provide mixed evidence. For example, Chen et al. (2014) find that audit committee director-auditor interlocking positively affects perceived earnings quality. On the contrary, Fan (2015) finds that auditor dismissal is less likely for AC-auditor interlocking firms when the audit quality is low. Hossain et al. (2016) show that fee dependence in the network created from audit committee member-auditor partner interlocking negatively affects audit quality. This study is motivated by the inconclusive consequences of audit committee director-auditor interlocking.

Novel Findings : First, we contribute to the research on audit committees by examining an important but less investigated aspect of audit committees, i.e. AC director-auditor interlocking. Audit committee director-auditor interlocking reflects a social network aspect of audit committees. There is extensive research on audit committee characteristics, e.g., audit committee size, independence, financial expertise (Abbott and Parker, 2000; Carcello and Neal, 2000; Klein, 2002; Abbott et al., 2003; Krishnan and Visvanathan, 2008). One characteristic of audit committees, AC director-auditor interlocking, did not receive much attention until recent years. Different from the studies which examine output-based measures of audit quality, we focus on an input-based measure, audit fees, and examine the association between AC director-auditor interlocking and audit fees.

Second, we contribute to the literature on board interlocking. We add to this line of research by showing that interlocking audit committees could affect auditing process, specifically, audit quality as well as the auditor-client relationship, and as a result audit fees in the U.S. (Johansen and Pettersson, 2013; Hossain et al., 2016). More importantly, we find that this effect varies depending on the type of auditors selected.

Full Citations : Xiaolu Xu and Susan Albring. 2018. Audit Committee Auditor-Director Interlocking, Audit Pricing and Industry Specialization. International Journal of Corporate Governance. Vol 9 (4), pp. 428-461.

Abstract : This study examines the relation between audit committee director-auditor interlocking and audit fees, as well as the effect of auditor industry specialization on this relation. Using a sample of S&P1500 firms in the U.S. during the years 2004-2014, we find a positive relation between audit committee director-auditor interlocking and audit fees only for firms that select industry specialist auditors. Firms that select non-industry specialist auditors pay lower audit fees compared to the control firms which do not have either interlocked audit committees or interlocked audit committees through director-auditor links. The findings are robust after controlling for sample selection bias and unobserved omitted variables and using alternative measures of audit committee director-auditor interlocking. Additional analyses show that firms with audit committee director-auditor interlocking are more likely to select industry specialist auditors. These results indicate that audit committees with director-auditor interlocking demand high quality audits and extensive audit coverage due to reputation effects only when the selected auditors have higher reputational cost and more bargaining power.

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Using a sample of S&P1500 firms in the U.S. during the years 2004-2014, we find a positive relation between audit committee director-auditor interlocking and audit fees only for firms that select industry specialist auditors.

Susan Albring

Professor Albring is an associate professor of accounting. Her research is focused on the effect of repatriation of foreign earnings on firm capital structure decisions.
Susan Albring
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