The Effect of Sharing a Common Auditor with Customers on Accounting Restatements by Supplier Firms

We examine whether firms that share an auditor with at least one of their major customers are less likely to make accounting restatements compared to firms that do not have such links with their customers. Based on a sample of 4,808 firm-year observations during the period over 20002009, we find evidence supporting this prediction. We also show that this common auditor effect is mainly driven by firms with lower institutional ownership or fewer analysts following, firms whose auditors have shorter tenure and cases where common auditors come from the same practice office or from offices located in close geographic proximity. Furthermore, this common auditor effect is more pronounced when suppliers have greater bargaining power over their customers. Interestingly, we find no significant difference in the common auditor effect between restatements involving accounting irregularities and those related to errors. Lastly, the common auditor effect does not merely reflect enhanced industry wide knowledge from auditing the supplier and the major customer from the same industry. Overall our study highlights an important channel through which auditors obtain useful information in improving the quality of an audit.