Auditor-client compatibility and corporate governance effectiveness: an empirical analysis Online publication date: Fri, 10-Apr-2015
by Ahmed M. Abdel-Meguid
International Journal of Corporate Governance (IJCG), Vol. 3, No. 1, 2012
Abstract: This paper examines a new facet of the auditor-client relationship, the extent to which the auditor's portfolio of audited clients' industries matches its client's portfolio of business segments which I refer to as the auditor-client compatibility. The paper examines how compatibility affects audit quality and consequently the auditor's governance effectiveness. Using a sample of clients of big auditing firms, I empirically examine the effect of compatibility on earnings quality proxied by absolute discretionary accruals as a manifestation of audit quality and in turn corporate governance effectiveness. I document a negative relation between compatibility and discretionary accruals suggesting that compatibility contributes to effective governance. This result holds for several robustness checks. The study introduces a new measure of industry specialisation: compatibility. It also highlights how the multi-segment nature of companies has auditing and governance implications, a dimension that has been relatively ignored in the auditing and corporate governance literatures.
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