THE IMPACT OF TRADE SECRETS LAW ON AUDITOR SHARING AMONG PEER COMPANIES

Abstract

This study examines the impact of U.S. states’ staggered adoption of the inevitable disclosure doctrine (IDD) on rival companies’ auditor choice. I posit that, in states where the IDD limits employee mobility among rival companies, the IDD adoption exogenously increases the costs of disclosing proprietary information through other channels. I find that on average peer companies do not show any changes in the probability of audit office sharing after the companies’ headquarter states adopt the IDD. I also find that companies with trade secrets respond to IDD adoption by avoiding audits conducted by the same audit office as their competitors’ audit office, supporting the proprietary cost hypothesis. The results are robust not only in various levels of auditor sharing but also after I incorporate factors including Mergers and Acquisitions, SOX, and differentiations of IDD adoption and rejection. Cross-sectional results related to Big N auditors suggest that peer companies with trade secrets that hire Big N auditors increase audit office sharing because Big N auditors’ higher levels of reputation, higher litigation costs, and deep pockets alleviate concerns of potential information leakage through audit office sharing in the post IDD adoption periods. My cross-sectional results related to audit committee experts show that peer companies with trade secrets respond to IDD adoption by engaging in more frequent audit office sharing when they have industry experts and accounting financial experts on audit committees. Supervisory financial expertise on audit committees of peer companies with trade secrets does not seem to affect the probability of audit office sharing after the IDD adoption. To my knowledge, this study is the first to document the causal effect of proprietary information costs on audit office choices of U.S. companies with trade secrets.