Auditor Involvement in Clients’ Financial Reporting and Audit Quality
Abstract
This paper analyzes how auditor involvement in clients’ financial reporting processes affects audit quality. Auditor involvement could place auditors in a position to gain more insights in clients’ financial reporting, which could allow them to better detect misstatements. However, more auditor involvement also means a closer collaboration and leads to self-audits, which could impair auditor independence and lower the likelihood that auditors report misstatements. Based on U.S. data of auditors and their clients between 1995 and 2022, I find that auditor involvement is negatively associated with SEC enforcement actions. Consistently, I find some evidence that the likelihood of modified audit opinions increases for clients with more involved auditors. Supporting a casual interpretation, these results are robust to using the collapse of Arthur Andersen as an plausibly exogenous shock to auditor-client matching. Collectively, my results suggest that auditor involvement can mitigate agency issues and facilitate compliance with financial reporting standards.