The consequences of private relationship between audit partners and their clients*

Abstract

Abstract A private partner–client relation is revealed when sometimes signing audit partners and their clients switch to new audit firms but the audit partners continue to sign on audit reports for these clients in the new audit firms. In this study, we examine the economic consequences associated with such a private relation between audit partners and their clients. Using data from China, where the names of signing audit partners are identified in audit reports, we find that clients with private partner–client relationship tend to have higher costs of equity capital, lower firm values, and poorer future stock and accounting performances than their counterparts with no private partner–client relationship. Additional analyses show that the unfavorable consequences are not mitigated after the enforcement of mandatory audit partner rotation requirement in China. The findings imply that impaired independence at the audit partner level adversely affects clients and that more actions need to be taken to sever the private bond between audit partners and their clients.