Does Regulator Selection of Auditors Improve Audit Quality?
Although the hiring and firing of auditors by clients is widely believed to create a conflict of interest, public policy around the world permits precisely this arrangement. We argue that auditor-client trust is also important for audit quality: auditors appointed by third parties have no conflict of interest, but such auditors and clients may not have the mutual trust necessary for high-quality audits. We provide evidence on the issue by exploiting the setting in Korea, known as auditor designation, wherein regulators selectively and episodically selected auditors for certain client companies. Using a difference-in-difference design we find that consistent with the importance of trust, audit quality proxied by performance matched discretionary accruals and restatements is lower for auditor-designated periods. Using pre-designation auditor’s tenure as a measure of trust, we find that companies having higher trust with their self-chosen auditor face a more severe decrease in audit quality with the designated auditor.
Index Terms - Trust, Auditor Designation, Audit Fees, Audit Quality