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April 30, 2020 10:13 AM

Auditor Selection Process: An Interplay of Demand Mechanisms – A Multilevel Network Approach

In our recent article published in the European Accounting Review, Dean Lusher, Peng Wang and I studied auditor selection process. We assummed that client’s selection of the engagement partner is driven both by engagement partner’s reputation, and also recommendations that board of directors receive through interlocking board members.

Our study was inspired by the finding that major body of audit partner selection literature implicitly assumed that the demand side mechanism that assists buyers in differentiating experience goods is either driven by reputation or recommendation. This has resulted with the polarization of the arguments around one of the two mechanisms in the research of engagement partner selection. Interestingly, such a duality has mostly been implicitly addressed in the studies, which has been taken merely as a precondition for the development of arguments. As a consequence, this implicit assumption that the engagement partner selection is either driven by reputation or recommendation raised the dilemma of whether these two underlying processes are, actually, mutually exclusive – or, if not, are they interdependent/co-present.

In order to investigate the co-presence of the two demand side mechanisms in the engagement partner selection context we start off with the assumption that the co-presence is, in fact, possible. In order to build the argument, we made the reference to the concept of interdependency, which originates from the social network theory. By making the assumption that the nature of the partner selection is relational, and that the asymmetrical information might co-exist in a buyer-seller relationship, we conducted the relational analysis in order to measure the presence of the both demand side mechanisms in a particular research context.

 

We examined this co-presence by applying a cutting-edge network methodology – exponential random graph models (ERGMs) – on a dataset containing information on signing partners for publicly listed companies in Denmark in the period 2010-2014. ERGMs are tie-based models, which, besides to enabling the identification of the presence of the underlying processes that (both tie- and actor attribute-driven) create and sustain the network-based social system, also enabled us to account on interdependency between the mechanisms, and finally identify the presence of the interplay between them.

The results demonstrated that the characteristics of both mechanisms are identified in the network. This indicates that reputation and recommendation mechanisms, in fact, do create an interplay within the partner selection process, conditioning the study on the presence of interdependency between the two mechanisms. Moreover, the findings hint that the cross-board recommendation sharing and partner’s reputation have equally important impact on boards’ decisions, and the clients’ decisions are not solely polarized around either recommendation or reputation, but their combination.

We believe that our study provides with a significant contribution to the theory and practice at different levels. First, it brings the two theoretical polarities by mediating them with the concept of interdependency. Second, it breaks through the literature of auditing with the novel methodological approach. Finally, audit partners may better understand the importance of social positioning in the network in regards the likelihood for selection conducted by the clients.

 

You can find out more about our study at https://doi.org/10.1080/09638180.2020.1740755

To cite our article: Slobodan Kacanski, Dean Lusher & Peng Wang (2020): Auditor Selection Process: An Interplay of Demand Mechanisms – A Multilevel Network Approach, European Accounting Review, DOI: 10.1080/09638180.2020.1740755

 

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About Slobodan Kacanski

Roskilde University
Assistant Professor

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