Audit Quality and Audit Partner Ownership of Non-Audit Businesses: Evidence from China

ABSTRACT

We examine whether audit partners’ ownership stakes in affiliated non-audit businesses are related to audit quality. We argue that non-audit ownership is a relatively sharp measure of auditor-client economic bonding, which can impair auditor independence. Using a unique setting in China where we observe partners’ equity stakes in both audit and non-audit businesses, we find that audit adjustments are significantly smaller when engagement partners hold larger ownership stakes in non-audit businesses. Audit adjustments are further reduced when the entire audit partnership holds greater ownership in affiliated non-audit businesses, suggesting that non-audit ownership matters at the audit firm level as well. Additional analyses suggest that these results are driven by impaired independence, rather than partner distraction or endogenous partner-client matching. Our study informs ongoing policy debates on the structuring of audit and non-audit businesses as well as the investments of non-audit entities in accounting practices.

Data Availability: The authors have nondisclosure and confidentiality agreements for their use of proprietary data, which were provided to the authors for independent academic research only. Nonproprietary data are available from sources identified in the text.

JEL Classifications: M41; M42; M48; M52.