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February 24, 2021 12:42 PM

Saints or Sinners? Politically Connected Auditors and their Audit Quality

Location

ESSEC Business School
France
FR

Anastasios Elemes (ESSEC Business School), Jeff Zeyun Chen (Texas Christian University)

Auditors’ lobbying activities were until now generally assumed to take place exclusively through audit firms’ national offices. However, our recent article, published in the European Accounting Review, questions this assumption. In our study we retrieve for the first time the contributions of all politically connected Big 4 employees to members of the Senate and House of Representatives Committees that oversee the audit industry and compile a novel dataset of auditors’ political connections at the audit office level. We find strong evidence that, in addition to auditors’ political connections at the national level, auditors across local offices also engage in intense political activity.

There is a significant degree of overlap between auditors’ political connections at the national level and at the office level. Contributions from connected offices and the degree of overlap in supported politicians at the office level among the Big 4 firms peak in years of intense regulatory activities that significantly affect the audit industry, such as around the first implementation years of SOX as well as when the PCAOB imposed restrictions on auditors’ tax services and was deciding whether these restrictions should be expanded to include other non-audit services. We also find a spike of political contributions from connected offices in 2007 to support the presidential campaign of Chris Dodd, a long-time advocate of Big 4’s interests.

In our study we also examine the implications of auditors’ political connections for their audit quality. We find that politically connected auditors deliver superior audit quality. This finding is consistent with connected auditors having strong incentives to avoid audit failures in order to maintain credibility in their lobbying effort. However, we also find robust evidence that connected auditors are likely to compromise their independence for their politically connected clients. Specifically, we find that the positive relation between auditors’ political connections and their audit quality weakens for clients with political ties. Furthermore, we show evidence that connected clients are successful at contracting for less effort with their connected auditors when they want to engage in egregious forms of earnings management, i.e., precisely when high quality audit services are more important.

Our study is the very first to offer a unique exploration of auditors’ political connections at the audit office level and to examine the implications of auditors’ political connections for their audit quality. It is therefore relevant to various stakeholders and market participants such as investors, bankers, as well as financial analysts. It is additionally relevant to regulatory authorities, particularly in the light of growing concerns that auditors’ lobbying activities could pose a threat to their independence.

Read our full article here: https://www.tandfonline.com/doi/abs/10.1080/09638180.2020.1856163?journa...

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About Anastasios Elemes

ESSEC BUSINESS SCHOOL

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