It's a Small World: The Importance of Social Connections with Auditors to Mutual Fund Managers' Portfolio Decisions.

Abstract

We examine the impact of social ties between mutual fund managers and auditors of public firms on mutual fund stockholdings. We find that mutual funds whose managers are socially connected with firm auditors hold more shares of these firms. In cross-sectional results consistent with expectations, we find that the effect of social connections on mutual fund stockholdings is more pronounced: when the social connections are stronger; for small audit firms; and for public firms with greater business opacity, stock price synchronicity, and systematic risk. We further document that mutual funds with socially connected auditors engage more in informed trading and generate superior portfolio returns. In compensation, connected auditors benefit from more audit business as well as higher audit and non-audit fees from both mutual funds and public firms. Our evidence implies information transfer from auditors to mutual fund managers through their social connections, which improves mutual fund portfolio decisions.