Do Shared Auditors Facilitate Follow-on Innovation?

Key Takeaways

• Research Question: Do shared auditors help public companies identify and use valuable knowledge from other clients’ inventions?
• Data: The study combines U.S. patent, audit, and financial data from 2000 to 2018, covering 1,568,167 directional company-pair-year observations and 162,483 unique company pairs.
• Method: The authors examine whether companies cite more of one another’s patents when they share the same local audit office. They also use the collapse of Arthur Andersen in 2002, which forced clients to change auditors and unexpectedly created new shared-auditor relationships.
• Findings:
  • Companies sharing the same audit office cite 6.6% more of one another’s patents. Newly connected companies affected by the Arthur Andersen collapse increase their cross-citations by 6.0%.
  • The effect is larger among innovation-intensive companies and for recent patents and knowledge that outsiders can more readily use.
  • Broader audit-office information sets also associate with more and higher-quality subsequent patents.
• Implications: Public disclosure alone does not ensure that companies can identify which inventions are worth building on. Shared auditors may support cumulative innovation by helping clients assess the commercial relevance of public patent knowledge, revealing an information-intermediary role for auditors beyond financial reporting.

Background

A patent explains how an invention works. It says much less about whether the invention will work commercially. Companies seeking to build on an existing patent must assess whether the underlying technology fits their operations, can be developed profitably, and is likely to generate future cash flows. These questions are especially difficult for recent inventions with limited commercial track records. Public disclosure therefore makes knowledge accessible without necessarily making it easy to evaluate.

Auditors may help bridge this gap. Through their work with management, boards, and audit committees, they acquire knowledge about clients’ markets, operations, investments, and financial prospects. Experience across engagements may help them provide useful commercial context when another client considers a publicly disclosed technology.

This possibility is far from certain. Auditors may lack detailed technical expertise, innovation may be highly company-specific, and confidentiality obligations constrain communication across clients. This paper examines whether companies nevertheless make greater use of one another’s inventions when they share an auditor.

Data & Methodology

The study combines patent records from PatentsView, audit-office information from Audit Analytics, and company data from Compustat and CRSP. The sample contains 1,568,167 directional company-pair-year observations involving 162,483 unique pairs from 2000 to 2018. Each direction is analyzed separately because Company A may build on Company B’s patents even when knowledge does not flow in the opposite direction.

The authors examine whether one company cites more patents belonging to another when both employ the same local audit office. The analysis accounts for annual changes in the citing company’s overall citation activity and in the visibility of the cited company’s patent portfolio. It also controls for other connections between the companies, including common analysts, alliances, inventors, investors, technological similarity.

Companies with similar technologies or business models may independently select the same auditor and cite one another more frequently. To strengthen identification, the authors use the collapse of Arthur Andersen in 2002. Andersen’s clients were forced to appoint new auditors, unexpectedly causing some previously unconnected company pairs to begin sharing an audit office. The study compares changes in citations among these newly connected pairs with changes among pairs that continued to use different auditors.

The paper also examines whether clients subsequently innovate more when their audit office has a broader information set, measured by the number of public companies it audits.

Findings & Discussion

Shared audit offices increase patent citations between clients

Companies sharing the same local audit office cite one another’s patents 6.6% more frequently than otherwise comparable company pairs. The relationship remains after accounting for technological similarity, geographic proximity, common ownership, board connections, and other channels through which companies may learn about one another’s inventions.

The effect is concentrated among clients of the same local office, rather than merely clients of the same audit firm. This pattern matters because audit offices develop distinct industry expertise and client portfolios, making the local office the level at which commercially relevant knowledge is most likely to accumulate.

The evidence does not imply that auditors transmit confidential technical information. Patents are already public. Instead, it is consistent with shared auditors helping clients recognize which disclosed inventions are relevant and commercially valuable, thereby directing attention toward knowledge that can support follow-on innovation.

Forced auditor switches provide stronger causal evidence

Arthur Andersen’s collapse forced its clients to appoint new auditors, creating shared-office relationships that companies had not deliberately chosen. This setting helps separate the effect of sharing an auditor from similarities that may lead companies both to select the same audit office and to cite one another’s patents.

Company pairs that began sharing a local audit office because of these forced switches increased citations to one another’s patents by 6.0% relative to pairs that continued using different offices. The two groups followed similar citation trends before Andersen’s collapse. The increase appeared only after the new auditors had spent time working with their clients.

This delayed response is consistent with auditors gradually acquiring knowledge about clients’ businesses and helping other clients identify relevant inventions. Although the study cannot observe the information exchanged, the forced-switch evidence makes deliberate auditor selection a less plausible explanation for the citation increase.

Shared auditors help clients evaluate external knowledge

The effect is stronger when auditors have potentially useful knowledge to connect and clients have the capacity to use it. When both clients are innovation-intensive, sharing a local audit office increases citations between them by 8.6%. These companies generate more innovation-related information and are better equipped to incorporate ideas developed elsewhere.

Shared auditors also have a larger effect on citations to recent patents. Because new inventions have shorter track records, their technical relevance and commercial potential are harder to assess. Auditors’ knowledge of clients’ businesses may be especially valuable in helping companies identify which new ideas merit attention.

The effect is also stronger for patents that can be more readily applied outside the originating company. This pattern points to the evaluation of publicly disclosed, transferable knowledge — not the transmission of confidential technical details — as the likely intermediary role.

The benefits may extend beyond citations between specific client pairs. A one-standard-deviation increase in the information available within an audit office is associated with 1.5% more patent applications and 2.3% more citations per patent among its clients in the following year. Their subsequent patents also have broader scope and greater originality and novelty. These estimates are associational, but they suggest that access to a richer audit-office knowledge base is linked to both more innovation and higher-impact innovation.

Implications

The study expands the economic role of auditors beyond financial-statement assurance. Knowledge accumulated across engagements may help clients evaluate markets, business applications, and the commercial prospects of existing technologies.

This role can help explain why innovative companies sometimes share auditors with other companies, including competitors, despite concerns about information leakage. A shared auditor may provide access to industry experience that helps a company recognize useful ideas and assess whether they are worth developing.

The results also highlight a limit of disclosure-based innovation policy. Making patents public improves access to technical knowledge, but disclosure alone cannot resolve uncertainty about commercial value. Professional intermediaries can complement public disclosure by helping companies interpret and apply the information it contains.