Auditor Hiring Control: Implications for Auditor and Preparer Behavior During the Audit

The Sarbanes-Oxley Act sought to improve auditors’ objectivity and influence by requiring that audit committees, rather than management, hire and oversee the external auditor. However, extant literature, as well as data I report in this paper, suggest that management remains involved in auditor hiring and it is unclear whether this affects reporting behaviors. In separate experiments with highly experienced auditors and preparers, I examine how variation in auditor hiring control impacts auditors’ constraint of earnings management and preparers’ reporting aggressiveness. I posit that management control of auditor hiring establishes a tone of asymmetric power among the corporate governance parties. Accordingly, I find that when management controls hiring, auditors and preparers view management as more powerful. Surprisingly, increased perceptions of management power are associated with auditors being more willing to challenge management. This paper provides a new perspective on the effects of management involvement in the auditor hiring process and novel insights into the effects of power in a governance setting.