Working Paper: Auditors are Known by the Companies They Keep

Paper Authors: Jonathan A. Cook, Karla Johnstone, Zachary T. Kowaleski, Michael Minnis, and Andrew Sutherland

Abstract: We study the role of client reputation in auditor-client matching. Using 1.2 million employment records from US broker-dealers, we find that broker-dealer clients of the same auditor have very similar financial adviser misconduct profiles. Misconduct is approximately half as important as client size in explaining auditor-client matches, and misconduct unrelated to misreporting or fraud risk is relevant to this matching. We link these matching patterns to auditors’ heterogeneous preferences for client reputation. An auditor’s track record for accepting high misconduct clients predicts future client misconduct, even after controlling for the client’s misconduct record and characteristics. Additional results reveal that auditor-client reputation matching is widespread and generalizable to firms outside the investment industry. We interpret our results within a positive assortative matching framework and conclude that auditors’ differential reputation concerns relate to their client acceptance and continuance decisions.