The Association between Partnership Financial Integration and Risky Audit Client Portfolios

Abstract

This study examines whether profit-sharing arrangements within accounting firms are associated with the riskiness of their client portfolios. Our results use unique data about the profit-sharing arrangements of the Big 8 firms during the period 1985 to 1994. We investigate whether there is a correlation between profit-sharing and risky clients. Firms consist of the financially integrated firms, i.e., those that share their profits across a large pool of partners across the country and the financially independent firms that share their profits in a small pool on a local office basis. The large-pool firms provide more incentive for partners to cooperate to audit high-risk clients than the small-pool firms. Our results show that the large-pool firms are associated with riskier client portfolios; this is indicated by a higher proportion of fees from clients that later suffer from bankruptcies. In contrast, a smaller proportion of the clients of the small-pool firms go bankrupt. Tests using financial distress as alternative measures of client risk confirm this result.