Captured by Mutual Funds: Do Cross-Audits Undermine Auditor Independence?
67 Pages Posted: 9 Jul 2019 Last revised: 28 Aug 2020
Date Written: August 27, 2020
We analyze the impact of cross-audits between companies and mutual funds on auditors’ reporting decisions. We document that companies are more likely to receive favorable 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.
Keywords: Cross-audit; Audit opinion; Mutual fund
JEL Classification: M40, G23, G32
Suggested Citation: Suggested Citation