The reputation driven interplay of relationships between clients and auditors in an auditor selection process: A multilevel network approach

Abstract

Abstract:This study investigates the reputation-based interplay between auditor selection and interlocking directorships from a multilevel network perspective. The aim of this article is to explore how and under what conditions reputation influences patterns of social selection processes in an assurance service context. To empirically determine the impact of reputation on establishing relational ties, this study applies exponential random graph models (ERGMs) for multilevel networks. The case study was carried out in the Danish field of mandatory audits, and findings here make a valuable contribution to the literature on auditor selection. A total of 774 annual reports were collected from 145 -165 Danish public listed companies, and the relational data of companies was assembled, as comprised of the members of supervisory boards and partners who signed audit reports during the five-year period from 2010 to 2014. In this study, mechanisms for auditor selection were controlled by mechanisms for interlocking directorships in order to obtain a broader picture of the conditions under which board members have tendencies to select reputable auditors. The findings suggest that reputation has a significant impact on both observed processes, however, results reveal that reputation has a compensatory nature, as it drives both mechanisms of social selection but never simultaneously.

Auditor Selection Process: An Interplay of Demand Mechanisms – A Multilevel Network Approach

“…The purpose of this paper is to identify whether, and how, the co-existence of recommendation and reputation-based demand side mechanisms in corporate governance system influences audit partner selection. The research question aims at challenging earlier theoretical assumptions on demand side mechanisms that assist buyers in differentiating experience goods (Davis & Robbins, 2004;Granovetter, 1973;Nelson, 1970;Podolny, 2001;Powell, 1990;Saxton, 1997), in which the previous studies argued that demand preferences are driven by either one of the two mechanisms (Beattie & Fearnley, 1998;Magri & Baldacchino, 2004;Woo & Koh, 2001;Neveling, 2006;Kacanski, 2017;Johansen & Pettersson, 2013). Arguably, taking into account such a perspective, the studies disregarded reflections on the potential synergetic effect of the two epistemologically detached theoretical standpoints on auditor choices.…”

“…However, such a duality of standpoints has only been implicitly addressed in the literature, as researchers considered either mechanism merely as a precondition to the development of theoretical argumentations. As a result, the exclusiveness of the operationalization of the either of them from empirical observations led toward dissemination of relevant but, at the same time, potentially conflicting results (Beattie & Fearnley, 1998;Magri & Baldacchino, 2004;Woo & Koh, 2001;Neveling, 2006;Kacanski, 2017;Johansen & Pettersson, 2013). In particular, different studies revealed that within the same research context both of the mechanisms have significant influence on general propensity of auditor selection, but under the implicit assumption that the effects of the alternative mechanism are not present in the same model of observation (e.g.…”

“…In particular, different studies revealed that within the same research context both of the mechanisms have significant influence on general propensity of auditor selection, but under the implicit assumption that the effects of the alternative mechanism are not present in the same model of observation (e.g. Kacanski, 2017;Johansen & Pettersson, 2013). Consequently, such a misalignment between theoretical assumptions on potential mutual exclusiveness and the presence of the significances of both of them, raises the dilemma of whether those mechanisms, in fact, are mutually exclusive, or they are potentially interdependent .…”

“…At the theoretical level, we mobilize the literature on cross-board relations as a mechanism of diffusion of corporate decisions (e.g. Davis & Greve, 1997;Larcker et al, 2005;Ortiz-de-Mandojana et al, 2012;Johansen & Pettersson, 2013), and reputation driven incentives for social selection (Saito and Takeda, 2014;Kacanski, 2017) to develop hypotheses. Following the literature and conditioning the argument on the assumption of the existence of interdependency , we assert that, it is, in fact, possible to argue that both mechanisms could potentially be taken into consideration by corporate boards during the process of auditor selection.…”

“…We use Danish data because partner-level data are available, but also because there is a long tradition of strong relations between members of supervisory boards and external auditors, both legally and in practice. Also, the network of interlocking directors in Denmark is extensive, meaning that each board, on average, has 1.2 interlocking directors (Kacanski et al, 2017). On this basis, we assume that it is, in fact, possible to expect that individuals representing multiple boards play an important role in auditor choice at all the boards they represent.…”