The Effect of Supply Chain Common Auditor on Audit Quality

Client-specific knowledge is essential for auditors to plan audits effectively, to assess related audit risks and to interpret audit evidence properly. One of the important sources of such knowledge is information about the client’s major customers that contribute significant proportions of revenues and operating profits. Thus, auditors with privileged access to information about the client’s major customers can provide higher-quality audits than those without such access. This paper investigates whether auditors who audit both supplier firms and their major customer firms at the same time, which we refer to as supply chain common (SCC) auditors, exhibit higher audit quality than non-SCC auditors. We find that SCC auditors are better able to constrain opportunistic earnings management using accruals and thereby provide high audit quality. SCC auditors also reduce the possibility that their clients restate financial statements in the future to correct previously inflated earnings. Our results are robust even after controlling for possible endogeneity with respect to SCC auditor choice. The finding suggests that auditing along the supply chain allows auditors to accumulate client-specific knowledge, which in turn helps them to provide high-quality audit service.