The Impact of Board Interlocks on Auditor Choice and Audit Fees

Abstract

Manuscript Type Empirical Research Question/Issue This paper uses unique Danish data to examine whether non‐executive directors draw on both direct and indirect ties in the network of interlocking directorates to impact auditor choice, and whether this impact has consequences for audit fees. Research Findings/Insight The paper finds clear evidence that non‐executive directors draw on their networks to impact auditor choice, and evidence that clients pay an audit fee premium when non‐executive directors are connected to audit firms outside the focal company. The relationship between non‐executive directors and auditors is well established in Denmark and exhibits features that currently emerge in international debates and regulations. Therefore, the national context offers an interesting setting for empirical evidence of whether international aspirations are likely to be realized. Theoretical/Academic Implications Audit‐related corporate governance research has predominantly adopted the agency theory paradigm and has only drawn on alternative theoretical perspectives to a limited extent. We draw on the literature about board interlocks and social network theory in order to develop a study that aims to increase our understanding of the non‐executive director–auditor relationship and the role that board networks have in governing auditor choice decisions. The study identifies interlocks as an infrastructure for differentiation in the audit market and determines that such differentiation is associated with an audit fee premium for audit firms. The findings indicate that personal experiences with auditors are shared among non‐executive directors and that audit attributes other than low cost audit, auditor size, and industry specialism, are important in the audit market. Practitioner/Policy Implications Our findings support continued efforts to strengthen the relationship between non‐executive directors and auditors. Our findings also indicate that board interlocks may constitute a mechanism that mitigates the audit market failure that arises because of a lack of auditor differentiation.

The reputation driven interplay of relationships between clients and auditors in an auditor selection process: A multilevel network approach

“…Initially, this study confirmed that interlocks impact auditor selection (Davison et al, 1984;Johansen & Pettersson, 2013), but also that Danish interlocks have a strong tendency to form complex, closure-like network configurations, which might enable information flow and managing decisions across the alliances. In respect to other studies on strategies for establishing interlocking directorships (Mizruchi & Stearns, 1988;Stokman et al, 1985;Pfeffer & Salanc, 1978;Useem, 1982) and reasons for auditor selection and change (Beattie & Fearnley, 1995;Magri & Baldacchino, 2004;Woo & Koh, 2001), the findings showed that, in both contexts, relationships tend to either exist between those that are reputable, or to emerge towards those that are reputable.…”

“…In an Australian context, Davison et al (1984) found that links between companies audited by the same audit firm can, to a considerable extent, be explained by links between those same companies when they have a director in common. On the other hand, by focusing on an experience-based demand mechanism, Johansen and Pettersson (2013) found that interlocks in Denmark have a strong impact on the selection of auditors and audit fees. The gap found in previously proposed framework urges bridging the seemingly disparate bodies of theory by discussing the question of how two reputation-driven demands are mutually negotiated through mechanisms of interlocking directorships and auditor selection.…”

The Complexity of Social Capital: The Influence of Board and Ownership Interlocks on Implied Cost of Capital in an Emerging Market

“…This is because there is a whole range of studies that deal with the board and director interlock [15,[22][23][24][25][26] and ownership interlock [27][28][29], but there are few studies that consider these two types of relationship jointly [30], especially in emerging markets like Brazil.…”

Busyness of audit committee directors and quality of financial information in India

“…In this arrangement of extended interlocking, the promoters, who have substantial control over firm executives, may appoint their favorite audit committee members on the multiple firms in the business group, and their social ties gets further fillip with the inclusion of auditors of their choice. Johansen and Pettersson (2013) find that in the interlocked relationship audit committee members and promotors generally employ the same audit firm in the business group firms. The increasing familiarity between the participants of the extended interlocking can result in lesser monitoring of managerial actions and diminishing credibility of audit quality, which can result in lower financial reporting quality.…”

“…However, there are several other types of services that audit firms can still do for their client firms. In the extended interlocking relationship, the audit committee members, and promotors often employ the same auditor in various firms in the business group (Johansen and Pettersson, 2013). The audit committees, executive directors and promoters of the client firms may prefer their audit firms to do the NAS too.…”