Auditor Partnership Network And Audit Quality

The report of the 20 th National Congress of the Communist Party of China points out that it is necessary to “improve the function of the capital market” and “give full play to the decisive role of the market in the allocation of resources”.As an important information intermediary in the capital market,auditors are supposed to continuously improve the credibility of the CPA industry,realize sustainable and healthy development,and play a functional role in promoting the quality of national economic information and maintaining market economic order.However,in recent years,audit failure cases involving huge amount of money and of vile nature,such as Tongjitang,ST Xinyi,Kangmei Pharmaceutical,Kangdexin,etc.,are still incessant in the market,which keeps the topic of audit quality always in the spotlight of researchers and practitioners.Focusing on audit quality,prior studies have explored the various factors affecting auditor independence and professional competence from the perspectives of institutional background,regulatory environment,client-auditor relationship,and characteristics of accounting firms and auditors.Along with the continuous expansion of researches in the field of audit quality,the audit research based on the perspective of auditor’s informal network has gradually gained in importance.In this branch of literature,the auditor is not only an“economic man”,but also a “social person”.The relevant theoretical analysis and research design have considered the social attributes of auditing behavior.Among those studies,casebased research shows that some typical network characteristics exist within the informal teams of auditors,such as “group job-hopping” and “team maintenance of client resources”.Researchers have also verified the significant impact of the informal network of auditors on the auditor behavior combining the research background of mandatory audit rotation and disclosure of key audit matters.In addition,based on the signature records of audit reports of listed companies,it is not uncommon to find in reality that auditors who have failed in audits and have been punished administratively come from the same “interpersonal circle”.Based on the above realistic background and existing academic findings,this thesis identifies auditors’ informal network and intends to further explore the influence of auditors’ informal network on audit quality.The purpose of the thesis is to clarify the factors of audit quality from the perspective of social networks and to provide references for the sound development of the CPA profession.How do informal network of auditors affects audit quality? Sociological theories have provided some research clues.Social network theory suggests that informal networks shape the attitudes,perceptions,and behaviors of network members by facilitating the diffusion of information and transmitting social influence.In the auditing research scenario,the informal network in which the auditor is embedded not only provides him/her with access to information and resources,but also integrates network members that can be imitated and learned from into his/her social and work circles.Therefore,on the one hand,the auditor who belongs to an advantaged network or takes an advantaged position in the network will have easier access to the information resources needed to conduct audit services,and his/her professional competence and audit quality may be enhanced;on the other hand,the auditor who belongs to a “low-quality” network may be affected by the high-risk audit behaviors of others,and the contagion effect of audit quality may occur.Based on the above theoretical conjectures,this thesis,using research data during 2007-2021,carries out the following research work in order: First,using social network analysis techniques,and based on the audit signature information of listed companies’ annual report,this thesis identifies the informal network of auditors,i.e.,the auditor partnership network,and obtain the relevant network characteristics;Second,the thesis reviews and summarizes the social network theory,systematically analyze the possible channels and mechanisms of how auditor partnership network may affect audit quality,explores the potential economic consequences,and builds a theoretical analysis framework;Third,the thesis systematically describes the characteristics and distribution of auditor partnership network,and explores the relationship between the structural characteristics of auditor partnership network,the positional characteristics of the individual auditor in the auditor partnership network and audit quality;Fourth,considering a research scenario in which punished low-quality auditors exist in the auditor partnership network,the thesis empirically test whether there is a contagion effect of audit quality;Fifth,integrating the research scenario of auditor cross-firm job-hopping,the thesis explores whether there is a cross-firm contagion effect of audit quality or a cross-firm spillover effect of punishment;Lastly,tracking whether the auditor partnership network further influences the stock liquidity of listed companies by affecting audit quality.The main findings of this thesis include:(1)with regard to the basic knowledge about auditor partnership network,in general the annual growth trend of audit partnership networks in accounting firms is consistent with the annual growth trend of branch offices.But the concept of auditor partnership network is different from accounting office: the same firm branch office usually contains multiple auditor partnership networks,and the same auditor partnership network may contain auditors from multiple offices of a certain accounting firm;in terms of the real-world connotation,the structural characteristics of auditor partnership networks are significantly associated with auditor’s gender,age,and signing experience,etc.However,these observable auditor characteristics in turn are possibly not able to represent the complete meaning of those auditor partnership network structural characteristics.(2)The structural characteristics of the auditor partnership network significantly affect audit quality,corroborating the information effect of the auditor partnership network.The findings of the thesis indicate that the higher the density,the smaller the size,the shorter the average distance,and the higher the centralization of auditor partnership network,the higher the audit quality of the members of the network;at the same time,the centrality of auditor in auditor partnership network is significantly and positively related to audit quality.It is verified that certain structural characteristics of a particular auditor partnership network or certain positional characteristics of the individual auditor in the auditor partnership network can be helpful for auditors to acquire knowledge and accumulate experiences required for engagements,which enhances the audit quality.Those research findings support the mechanism of the information effect of the auditor partnership network in affecting audit quality.In the robustness tests of replacing the independent variables,redefining the auditor partnership network,and considering company fixed effects,the above findings remain largely consistent.In further tests,the thesis also finds that the size of the accounting firm and the auditor’s industry expertise significantly and negatively moderates the relationship between the structural characteristics of the auditor partnership network and audit quality.This suggests that when accounting firms are of small size or auditors do not have industry expertise,the positive impact of the structural characteristics of the auditor partnership network on audit quality is more significant;when accounting firms are large or auditors have industry expertise,the negative impact of disadvantaged network structural characteristics that obstructing information transfer within the auditor partnership network on audit quality is mitigated.In addition,the business complexity of the client company positively moderates the relationship between auditor partnership network structural characteristics and audit quality,implying that the advantaged auditor partnership network structural characteristics contribute more significantly to audit quality when the business complexity of the client is high.(3)The contagion effect of audit quality exists at the level of auditor partnership network,and the “defective” qualitative characteristics of auditor partnership network have a significant negative impact on the audit quality of auditors in the network,demonstrating that members of the auditor partnership network have significant social influence on each other.Using the CSRC’s administrative punishments to identify low-quality auditors in the auditor partnership network,this thesis reveals that the audit quality of auditors who used to have partnership network ties with punished auditors is significantly lower than that of other auditors,demonstrating that the auditor partnership network influences audit quality by transmitting social influence.After performing a series of robustness tests of propensity score matching,instrumental variables,change analysis,company fixed effects,and redefining independent and dependent variables,these findings remain robust and validate the accounting-firm-level audit quality contagion effect as distinct from accounting firm-level quality control deficiencies and homophily of auditors.The thesis also examines three diffusion channels of low-quality audit behavior,i.e.,“social geodesic distance with the punished auditors in the network”,“centrality of the punished auditors in the network”,and“percentage weight of the punished auditor in the network”.The impact of the contagion effect of audit quality is significant only when the signing auditor is close to the punished auditor,when the network centrality of the punished auditor is high,and when there is high percentage of punished auditors in the auditor partnership network.In further tests,it is found that the larger the size of the auditor partnership network,the more it helps to mitigate the contagion effect of audit quality.This is because the larger the size of the network,the more difficult it is to coordinate the network as a whole,which will weaken the interactions between auditor members within the auditor partnership network and amplify the heterogeneity among network members.At the same time,the higher the density of the auditor partnership network,the more it enhances the contagion effect of audit quality.The reason lies in that higher density of auditor partnership network helps to consolidate the established social norms and hinders the absorption of external corrective information and knowledge by network members.In addition,after the auditors are punished or investigated by the CRSC,the audit quality of auditors who had network ties with them is not significantly different from those who had no network tie with them,which suggests that the occurrence of CRSC administrative punishments can serve as a deterrent fact and warning for auditors who have not been not punished,and thus curb the negative impacts of the contagion effect of audit quality.(4)There is cross-firm spillover effect of administrative punishment at the auditor partnership network level,and the “defective” qualitative characteristic of auditor partnership networks significantly improves the audit quality of job-hopping auditors,which supports the social influence mechanism of auditor partnership networks in affecting audit quality.Still using CRSC administrative punishments to identify low-quality auditors in the auditor partnership network,it is revealed that the audit quality of job-hopping auditors is significantly higher than that of other job-hopping auditors if they used to have network ties with the punished low-quality auditor and if the relevant punishments have already been announced in the first year after the inter-firm job-hopping.The cross-firm spillover effect of administrative punishments identified in this thesis remains robust after using propensity score matching,instrumental variables approach,controlling for pre-post-firm fixed effects,company fixed effects,and replacing the measurement of dependent and independent variables,which once again validates the social influence mechanism of auditor partnership network in affecting audit quality.In the cross-sectional analysis,the thesis reveals that the higher the integration level of the “new firm” of the job-hopping auditors,the more stringent the quality control procedures will be received by the jumped auditor who had network ties with the punished auditor,and the stronger the cross-firm spillover effect of administrative punishment;middle-aged auditors are more capable of learning from their punished colleagues and have stronger desire to maintain and enhance their professional reputation,therefore the cross-firm spillover effect of administrative punishments is most pronounced among middle-aged auditors;in addition,the shorter the network geodesic distance between the jumped auditors and the punished auditors,and the more severe the punishments imposed by the CRSC on punished auditors,the higher the audit quality of jumped auditors who used to have network ties with punished auditors.With regard to the mechanisms of the cross-firm spillover effect of administrative punishment,the stringent quality control procedure of accounting firm is one of the major mechanism,as the thesis finds that accounting firms tend to allocate partners who have undertaken more engagements or who have greater industry expertise to jumped auditors who used to share network ties with the punished auditors;at the same time,the social learning of jumped auditors from the punished auditors is the other mechanism for the cross-firm spillover effect of administrative punishments,as the audit quality is still higher for auditors who used to have network ties with the punished auditor even if the accounting firms have not conducted more stringent quality control procedures.Further,measuring the external regulatory risk of clients by media attention and litigation risk,it is also demonstrated that the higher the external regulatory risk of the audit client,the stronger the cross-firm spillover effect of administrative punishment;moreover,the punishments prior to the jump do not have a long-term impact on the auditors who used to have network ties with those punished auditors,nor does the “new firm” maintain a long-term stringent supervision on those jumped auditors.The dynamic effect test shows that the impact of administrative punishment spillover effect sustains about three years.(5)The auditor partnership network significantly impacts the cost of stock trading of client companies by affecting audit quality.Using a two-stage estimation model,the thesis finds that audit quality that can be explained by auditor partnership network characteristics is significantly and positively related to client companies’ stock liquidity,provided that the structural characteristics of the auditor partnership network(e.g.,density,size,etc.)as well as the qualitative characteristics of the auditor partnership network(i.e.,whether or not it contains any punished auditor members)significantly affect auditor quality.The positive(negative)effect of auditor partnership network characteristics on audit quality significantly enhances(impairs)client companies’ stock liquidity.The above findings remain robust after controlling for company fixed effects,redefining the independent variables in terms of unadjusted auditor partnership network,and replacing the estimation period of the dependent variables.This suggests that specific structural or qualitative characteristics of the auditor partnership networks do contribute to improving the information environment of listed companies and enhancing the trading efficiency of listed companies’ stocks.Further tests find that,first,the more readable a listed company’s annual report is,the smaller the effect of the auditor partnership network on the liquidity of that company’s stock through audit quality.The textual information of listed companies’ annual reports can play a supplementary and explanatory role to the financial information,and the easy-to-understand textual information of the annual reports can enhance investors’ understanding of the company’s financial status and development strategy,narrow the information gap between external investors and informed traders,and reduce investors’ reliance on audit quality.Second,the effect of auditor partnership networks on stock liquidity is relatively insignificant in the sample of state-owned companies.State-owned companies enjoy more advantages in tax deduction,financial subsidies,etc.,face relatively lower market access thresholds,and enjoy higher certainty in intrinsic value;at the same time,subject to the dual regulation of government and market,the information disadvantage perceived by investors in state-owned companies is relatively insignificant,which leads to a more significant impact of the auditor partnership network on stock liquidity in the sample of private companies.Third,the industry competition amplifies the sensitivity of stock liquidity to the change of the characteristics of the auditor partnership network.The reason lies in that the higher the degree of industrial competition,the higher the pressure on companies’ survival and their operational uncertainty,and the more sensitive market participants are to changes in audit quality.Finally,a high level of analyst attention also helps to mitigate the impact of the auditor partnership networks on stock liquidity through audit quality.Functioning as capital market information intermediary and external governance of listed companies,analysts directly facilitate information exchange among market participants and indirectly improves the disclosure of information by the listed companies,both of which reduce market participants’ reliance on audited financial information.To summarize,this thesis identifies the auditor partnership networks formed by auditors in accounting firms,explores the impact of the structural and qualitative characteristics of the auditor partnership network on audit quality,and analyzes the economic consequences of auditor partnership network from the perspective of the capital market efficiency.The contributions of this thesis include: firstly,under the special cultural and institutional background of China,the auditor partnership network is a self-organized informal network established on common interests,values or benefits of auditors.However,the research focus on the network is still confined to limited research scenarios or using a single set of measurements.This thesis explores the effects,paths and consequences of the structural and qualitative characteristics of auditor partnership networks on audit quality based on two mechanisms: information effect and social influence,which enriches the empirical findings of auditor informal network and audit quality with more complete research framework and more coherent research logic.Second,the contagion effect of audit quality and the spillover effect of administrative punishment have always been the hot research topic,but the quality controls at the accounting firm level alone are not sufficient to explain the mechanism of either the contagion effect of audit quality or the spillover effect of administrative punishment,and the researches based on the perspective of the formal auditing team only can only reveal a small part of the contagion effect of audit quality or the spillover effect of administrative punishment.This thesis revisits the research topic of audit quality contagion effect and administrative punishment spillover effect,and improves the theoretical framework of the two types of effects from the perspective of informal network.Third,the role of auditors as information intermediaries in the capital market has attracted much academic attention.From the perspective of auditor informal network,the thesis enriches the empirical evidence on auditors’ role as information intermediaries in the capital market affecting stock transaction costs by exploring whether the auditor partnership network affects the stock liquidity of audit clients through audit quality.The above findings provide new enlightenment for accounting firms to improve their internal governance,provide empirical references to optimize the regulatory efficiency of the audit profession,and are also instructive for improving investors’ trading decision models.