The ‘Big Three’ institutional investors—BlackRock, Vanguard, and State Street Global Advisors (SSGA)—have burgeoned into load-bearing pillars of the U.S. economy. With great power comes great responsibility, as well as a risk-averse investment strategy that favors common ownership—i.e. owning equity stakes in multiple companies within the same industry.
What all this means for the future of competition under capitalism remains to be seen. But Young Hoon Kim, assistant professor of accounting at Costello College of Business at George Mason University, recently published a solo-authored paper that examines a related issue: the governance practices that large asset managers (including but not limited to the ‘Big Three’) employ to monitor their portfolio companies.
The paper, forthcoming in Contemporary Accounting Research, identifies auditor-sharing as a key coordination tool. “If you think about this common ownership structure, there’s no consolidation process,” Kim says. “The companies are legally separate entities, with a shared investor, operating independently. But even so, would these commonly held investees be likely to engage the same audit firm, because of the benefits that would bring to the common owner?”
Kim analyzed stock market and audit information, as well as holdings reports from asset managers, related to U.S.-based companies during the period 2001-2021. He generated pairings of same-industry companies for each year under observation (totaling nearly five million company-pair-years).
Company pairings with at least one investor in common were 4.2 percent more likely to use the same auditor, a statistically significant result. As further confirmation, Kim examined the effects of BlackRock’s acquisition of Barclays Global Investors in 2009. He found that, after the merging of the two institutions, newly common-held companies were 7.9 percent more likely to share an audit firm with same-industry peers.
The likelihood of auditor-sharing was lower for companies with multiple co-owners, and for those with a lower combined market value of co-owned equity.
"Auditor sharing under common ownership can result in better audit outcomes by generating market-based discipline.”
—Young Hoon Kim, assistant professor of accounting at Costello College of Business at George Mason University
To develop the hypothesis, Kim first cites the well-known “contagion effect,” where issues in one company can ripple out to affect industry peers. Guilt by association means that “common owners, by holding multiple companies in the same industry, can suffer a lot more than another investor holding just one company’s shares,” says Kim.
This incentivizes co-owners to push for sharper and more consistent monitoring. Assigning a greater share of their portfolio to a single auditor raises the stakes for that auditor. Mistakes made with one company could lead to multiple client losses across the block.
“If you have multiple cars, would you go to the same repair shop or different shops? If you go to the same shop, and if this shop doesn’t do well for one of the cars, you have a power,” Kim says.
Indeed, Kim found that company pairs that shared both an investor and an auditor experienced fewer restatements, higher accruals quality, lower abnormal accruals, and less questionable earnings management—in short, higher audit quality.
Additional benefits of auditor-sharing may arise from enhanced financial reporting comparability, which helps investors assess the relative performance of portfolio companies. “If you have different committees evaluating different people, they will have different outcomes,” Kim says. “But if you use the same evaluating committee, then you can rely on consistent methodology.”
His comparability hypothesis was supported by evidence that co-owned companies based in the same city were more likely to use not just the same auditor but also the same audit office. Research suggests that comparability is driven more at the office level than by auditor choice per se. Also, economically distinct companies—for which apples-to-apples comparisons would be less appropriate—were less likely to share an auditor.
The paper, therefore, suggests that auditor-sharing reflects more than mere herd mentality. It is presumably adopted at the behest of investors seeking the above-mentioned benefits. The behind-the-scenes nature of the common owners’ interactions with portfolio companies makes it difficult to document exactly how investors influence auditor selection. However, the paper also finds that auditor-sharing is higher among companies that also share a board member, suggesting a potential channel.
While regulators and prior studies tend to focus on the negative effects of common ownership, such as anti-competitive concerns, Kim notes that “there is some evidence that it can be beneficial for the financial reporting side. Auditor sharing under common ownership can result in better audit outcomes by generating market-based discipline.”