Related Party Transactions and Audit Quality: Evidence on the Efficacy of Auditing Standard No. 18

SUMMARY We provide evidence on the efficacy of Auditing Standard No. 18 (AS18) for auditing-related party transactions (RPTs). We measure audit quality using general restatements and RPT-related restatements. Using a sample of S&P 1500 firms from 2011 through 2018, we find that RPT firms are significantly less likely to report a general restatement compared with non-RPT firms after AS18. We also classify RPTs into business RPTs and nonbusiness RPTs based on the type of transactions and the transacting party. We find that business RPT firms are (1) less likely to have general restatements after AS18 relative to non-RPT firms and (2) less likely to have RPT-related restatements relative to nonbusiness RPT firms. AS18 does not have any effects on nonbusiness RPTs. Our results are driven by S&P MidCap 400 and S&P SmallCap 600 firms. Overall, our findings suggest that AS18 has enhanced the quality of business RPT auditing. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; M42.