The Impact of Board Interlocks on Auditor Choice and Audit Fees

Authors

  • Thomas Riise Johansen,

  • Kim Pettersson


Address for correspondence: Thomas Riise Johansen, Department of Accounting and Auditing, Copenhagen Business School, Solbjerg Plads 3, 2000 Frederiksberg, Denmark. Tel: +45-38152320; Fax: +45-38152321; E-mail: trj.acc@cbs.dk

Abstract

Manuscript Type

Empirical

Research Question/Issue

This paper uses unique Danish data to examine whether non-executive directors draw on both direct and indirect ties in the network of interlocking directorates to impact auditor choice, and whether this impact has consequences for audit fees.

Research Findings/Insight

The paper finds clear evidence that non-executive directors draw on their networks to impact auditor choice, and evidence that clients pay an audit fee premium when non-executive directors are connected to audit firms outside the focal company. The relationship between non-executive directors and auditors is well established in Denmark and exhibits features that currently emerge in international debates and regulations. Therefore, the national context offers an interesting setting for empirical evidence of whether international aspirations are likely to be realized.

Theoretical/Academic Implications

Audit-related corporate governance research has predominantly adopted the agency theory paradigm and has only drawn on alternative theoretical perspectives to a limited extent. We draw on the literature about board interlocks and social network theory in order to develop a study that aims to increase our understanding of the non-executive director–auditor relationship and the role that board networks have in governing auditor choice decisions. The study identifies interlocks as an infrastructure for differentiation in the audit market and determines that such differentiation is associated with an audit fee premium for audit firms. The findings indicate that personal experiences with auditors are shared among non-executive directors and that audit attributes other than low cost audit, auditor size, and industry specialism, are important in the audit market.

Practitioner/Policy Implications

Our findings support continued efforts to strengthen the relationship between non-executive directors and auditors. Our findings also indicate that board interlocks may constitute a mechanism that mitigates the audit market failure that arises because of a lack of auditor differentiation.

Ancillary