Captured by Mutual Funds: Do Cross-Audits Undermine Auditor Independence?

We analyse the impact of cross-audits between companies and mutual funds on auditors’ reporting decisions. We document that companies are more likely to receive favourable audit opinions when they appoint the same auditor as their mutual fund blockholders. In cross-sectional evidence consistent with expectations, we find that the role that cross-audits play is concentrated where the mutual fund has stronger incentives to orchestrate stock price manipulation and the auditor is more likely to be captured by the mutual fund. We further show that investors fail to detect the impact of cross-audits on audit opinions in the short-term, which enables mutual funds to exploit this temporary mispricing through stock trading. In compensation, shared auditors captured by mutual funds benefit from higher audit fees and more audit business. Our evidence suggesting that market irregularities accompany cross-audits has major implications for stock market regulators.

Yangyang Chen:

Yangyang Chen joined Hong Kong Polytechnic University in 2015. He received his PhD from University of Melbourne and worked at Monash University from 2011 to 2015. His research interests are in corporate finance and financial accounting, including management compensation, corporate innovation, audit quality and pricing, earnings management, stock price crash risk and so on. His works have been published or accepted in The Accounting Review, Journal of Financial Economics, Journal of Financial and Quantitative Analysis, Contemporary Accounting Research, Review of Accounting Studies etc.

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