Common Auditors and Relationship-Specific Investment in Supplier-Customer Relationships

Theory suggests that information asymmetry between supplier and customer firms exacerbates the holdup problem. We investigate if an auditor common to the supplier and customer firm improves information flows leading to reduction in the holdup problem. Consistent with this notion, we find that shared auditors enhance relationship-specific investments in supplier-customer relationships. This positive relation is more pronounced in product market environments more prone to holdup problems between suppliers and customers are more prevalent. In contrast, we document no relation in a placebo sample of randomly matched supplier-customer pairs, supporting a causal linkage. Finally, we Arthur Andersen's failure as an exogenous shock to show that supplier-customer pairs that shared Andersen prior to its failure are more likely to share an auditor post-failure in environments where relationship-specific investments are important. Overall, we demonstrate that common auditors mitigate the investment inefficiency in relationship-specific assets