Information sharing between mutual funds and auditors

Abstract

This paper examines whether there is information sharing between mutual funds and their auditors about the auditors’ other listed firm clients. Using data from the Chinese market, we find that mutual funds earn higher profits from trading in firms that share the same auditors. The effects are more pronounced when firms have a more opaque information environment and when the audit partners for the fund and the partners for the listed firm share school ties. The evidence is consistent with information flowing from auditors to mutual funds, providing mutual funds with an information advantage in firms that share the same auditors. Our findings are robust to the use of audit‐firm mergers and acquisitions (M&As) as exogenous shocks and several other robustness checks. We further find that auditors benefit by charging higher audit fees for mutual fund clients and by improving their audit quality for listed firm clients. Our study provides evidence of bi‐directional information sharing between two important market intermediaries.

Auditor‐client reciprocity: Evidence from forecast‐issuing brokerage houses and forecasted companies sharing the same auditor

“…This information may provide relevant inputs to the production of earnings forecasts by security analysts affiliated with the brokerage house. This is consistent with recent evidence supporting that auditor‐client networks are a conduit for information transmission (Cai et al, 2016; Z. Chen et al, 2020; Dhaliwal et al, 2016; Hope et al, 2023). To the extent that the brokerage house clients and the BC‐shared auditor perceive that the benefits of sharing private information exceed the costs, we expect brokerage houses with a BC‐shared auditor to enjoy an information advantage over the covered listed companies that share the auditor, which, in turn, would translate into these brokerage houses issuing more accurate forecasts.…”

“…An emerging research stream suggests that shared common auditors play an integral role in narrowing information asymmetry between related clients in (M&A) transactions (Cai et al, 2016; Dhaliwal et al, 2016), supply chains (Johnstone et al, 2014), and mutual funds' investments (Hope et al, 2023). However, Dhaliwal et al (2016) report evidence implying that the private information leaked by common auditors largely benefits the acquirer at the expense of target shareholders, stressing that this information sharing may translate into common auditors favoring some clients to the detriment of others.…”

“…Given that audit firms provide audit services to multiple clients, recent research has begun to examine auditor effects on certain common client characteristics (Francis et al, 2014; Francis & Michas, 2013; Fung et al, 2017). One stream of the literature documents that information may be transferred between clients that share the same auditor (Cai et al, 2016; Z. Chen et al, 2020; Dhaliwal et al, 2016; Fang et al, 2022; Hope et al, 2023). This paper focuses on an unexplored setting in which the auditor of a brokerage house also audits listed companies covered by the brokerage house (hereafter, a BC‐shared auditor).…”

“…Fourth, our results contribute to research on cross‐audits as well as the wider literature on shared common auditors. Although prior work on common auditors predominantly examines an average effect on certain client characteristics or audit quality for clients sharing a common auditor (Cai et al, 2016; Z. Chen et al, 2020; Dhaliwal et al, 2016; Fang et al, 2022; Hope et al, 2023), we focus on whether auditors favor one group of clients (i.e., brokerage houses) over another (i.e., listed companies). Given the prevalence of cross‐audits, our evidence may alert regulators that the information role played by shared auditors might benefit a particular group of clients at the expense of others.…”

“…One stream of the literature documents that information may be transferred between clients that share the same auditor (Cai et al, 2016;Z. Chen et al, 2020;Dhaliwal et al, 2016;Fang et al, 2022;Hope et al, 2023). This paper focuses on an unexplored setting in which the auditor of a brokerage house also audits listed companies covered by the brokerage house (hereafter, a BC-shared auditor).…”