Audit Firms as Networks of Offices

Abstract

SUMMARY Prior audit research suggests that most, if not all, audit quality can be explained at the office level. However, the question remains of whether office-level audit quality is contingent on how individual offices relate to the firm as a whole. Motivated by theories of knowledge management, organizational learning, and networks, we posit that individual offices are connected to their audit network through partner knowledge sharing and oversight, which impact office-level audit quality. We interview Big 4 audit partners and learn that knowledge sharing between partners in different offices is common and intended to aid in the provision of audit services. Using network connectedness to proxy for knowledge sharing and oversight between offices of the same firm, we document that more connected offices are associated with fewer client restatements and lower discretionary accruals. We additionally find that network effects are magnified when accounting treatments are more complex and require greater auditor judgement.

Collaborating with Competitors: How Do Small Firm Accounting Associations and Networks Successfully Manage Coopetitive Tensions?*

“…We focus on small firms with AAN membership in this study and, thus, exclude the networks of Big 4 and Second Tier firms. While the latter is the focus of much research attention (e.g., Brown et al 1996; DeFond and Zhang 2014; Downey and Westermann 2019; Seavey et al 2018), coopetition does not exist in the same way within these networks because each of these large firms operates in the United States as a single legal entity with multiple practice offices. In contrast, AANs comprising small accounting firms are multimember alliances (i.e., 40 US member firms on average as derived from PAR 2015) that collaborate to receive certain benefits but retain their independence and individual identity 4.…”

“…22Whereas each of the Big 4 and Second Tier firms operates as one legal entity with city‐based practice offices across the United States (Seavey et al 2018), small accounting firms only have offices in regionally based locations. The Big 4 and Second Tier firms are also members of international networks that use a common brand name worldwide; in contrast, smaller US firms with AAN membership seldom adopt the AAN brand in their firm name, and they also maintain their autonomy from other member firms.…”

The Impact of National Office Governance on Audit Quality

“…Audit firms have a decentralized organizational structure that operates through local, city-based offices (Seavey et al 2018;Beck et al 2019). The local offices operate with considerable autonomy with respect to client contracting and the delivery of assurance services (Wallman 1996;Francis, Maydew, and Sparks 1999;Reynolds and Francis 2000;Ferguson, Francis, and Stokes 2003;Reichelt and Wang 2010).…”

“…Audit firms are generally organized as partnerships, made up of local city-based offices that pool resources. While each local office has its own independent operating characteristics, they also connect with each other as a "unified corporate identity" (Seavey, Imhof, and Westfall 2018), sharing both profits and reputation. As the quality of audits is not easily observable, and heterogeneity in resources available in local offices exists, the decentralized structure of audit firms introduces problems related to moral hazard and resource constraints to local audit offices.…”

“…Much of the previous work has focused on the proximity between the auditor and external parties such as clients and regulators (Kedia and Rajgopal 2011;Choi et al 2012;Hanes 2013;Brooks and Yu 2013;Thammasiri 2014;Jensen, Kim, and Yi 2015). More recently, some of this literature extends the proximity analysis to a setting within audit firms and argues that the proximity between practice offices impacts knowledge and resource sharing, and therefore audit quality (Seavey et al 2018;Beck et al 2019). Our paper extends this literature not only by evaluating the role of geographical proximity in audit firms' governance of local practices, but also by pointing to a useful alternative measure to capture geographical proximity, the availability of direct flight routes.…”