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  • The Auditing Section
    Academic Instruction as a Determinant of Judgment...
    research summary posted May 7, 2012 by The Auditing Section, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 09.0 Auditor Judgment, 09.10 Prior Dispositions/Biases/Auditor state of mind, 11.0 Audit Quality and Quality Control, 11.05 Training and General Experience 
    Title:
    Academic Instruction as a Determinant of Judgment Performance
    Practical Implications:

    The results of this study are important for audit firms to consider providing decision aids and/or on job training. The results suggest that considerable practical experience is necessary to achieve good judgment performance. In addition, the evidence indicates that auditing firms may wish to concentrate their training earlier to more quickly create a basis for high-quality auditor judgments.

    Citation:

    Wright, William F. 2007.  Academic Instruction as a Determinant of Judgment Performance. Behavioral Research in Accounting 19: 247-259.

    Keywords:
    Audit judgment; instruction; experience;
    Purpose of the Study:

    Knowledge and personal involvement are important factors that affect auditor judgment quality. It is generally believed that sufficient knowledge can lead to good auditor judgment.  Two sources of relevant knowledge are academic instruction and practical experience. Yet the relative benefits of the two sources remain unclear. The primary purpose of the study is to test for the benefit of task-specific academic instruction and practice relative to task-specific CPA training and experience in making auditor judgments. 

    Design/Method/ Approach:

    The research evidence is collected during 1991. Three groups of people participated in the experiment: (1) graduate business students, (2) inexperienced financial institution audit seniors, and (3) experienced financial institution auditors (managers, senior managers, and junior partners). Participants were asked to complete a simulated case involving evaluating the collectability of commercial loans to a fictitious manufacturer of microcomputers.

    Findings:
    • The author finds that, compared to the inexperienced audit seniors, the graduate students who completed an elective course in credit analysis made more accurate and less biased judgments.
    • The author finds that, the graduate students who completed an elective course in credit analysis made judgment similar to that of the experience auditors.
    Category:
    Audit Team Composition, Auditor Judgment, Audit Quality & Quality Control
    Sub-category:
    Industry Expertise – Firm and Individual, Prior Dispositions/Biases/Auditor state of mind, Training & General Experience
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  • Jennifer M Mueller-Phillips
    Audit Firms’ Client Acceptance Decisions: Does P...
    research summary posted July 18, 2016 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter?
    Practical Implications:

     This paper contributes to the literature on auditor industry expertise in many ways. First, it extends previous studies on this topic to examine whether industry specialists demonstrate different risk preferences in client acceptance decisions. The finding that partner-level industry specialists are more likely to accept less risky clients may partly explain why industry specialists have better quality clients.

    Citation:

    Hsieh, Y., and Lin C. 2016. Audit Firms’ Client Acceptance Decisions: Does Partner-Level Industry Expertise Matter? Auditing: A Journal of Practice and Theory 35 (2): 97-120.

    Keywords:
    partner-level industry specialization, client acceptance decision, and Big N auditors
    Purpose of the Study:

    Recently, audit firms have paid more attention to client acceptance decisions due to increased litigation risk. As a result more and more studies have investigated what goes into making this important decision. However, most prior studies examine whether auditors evaluate client risk characteristics when making client portfolio management decisions and whether auditors change their portfolio management strategies in response to changed in response to changes in litigation liability. Few studies have examined the impact of auditor characteristics other than accounting firm size. Auditors with different attributes could have different risk considerations in making client portfolio management decisions. In fact, previous studies have suggested that auditors use industry experience as a risk management strategy to mitigate risk on client portfolio management decisions because industry specialists provide high-quality audits and thus decrease litigation risk and reflect a good client-auditor match. Audit firms make large investments in specialized industries, so specialist auditors have an incentive to shed risky clients to avoid litigation risk and protect their reputation; hence, whether audit firms use industry expertise as a risk management strategy to mitigate the effect of risk is an empirical issue. The authors of this paper hope to explore whether industry specialization affects the association between risk considerations and client acceptance decisions. 

    Design/Method/ Approach:

    The sample is restricted to Taiwanese listed companies audited by Big N audit firms from 1999 to 2010. The final sample contains 9,337 observations. A Client Acceptance Decision Model was created to examine the effect of auditor industry expertise on firms’ risk consideration when making client acceptance decisions. 

    Findings:
    • The authors find that auditors are less likely to accept clients with audit risk higher than that of existing clients.
    • The authors find that firm-level industry expertise has no significant effect on the association between risk consideration and client acceptance decisions.
    • The authors find that partner-level industry specialists alone are less likely to accept clients with higher financial risk or higher audit risk, which supports the hypothesis that partner-level industry specialization affects the association between risk factors and client acceptance decisions. No evidence is found that firm-level industry expertise alone affects risk considerations in client acceptance decisions. 
    Category:
    Audit Team Composition, Client Acceptance and Continuance
    Sub-category:
    Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Audit quality and the market value of cash holdings: the...
    research summary posted July 30, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 11.0 Audit Quality and Quality Control, 11.04 Industry Experience 
    Title:
    Audit quality and the market value of cash holdings: the case of office-level auditor industry specialization.
    Practical Implications:

    While theoretical literature has extensively examined the link between audit quality and firm value, very little empirical evidence has been provided as to the potential channels in which high-quality audits enhance firm value. This study extends and complements the existing line of research by providing useful insights into the role of audit quality in constraining managerial diversion or misuse of corporate cash resources. The results of this study are useful in assessing the effects of audit quality on firm value, specifically the market value of cash holdings.

    Citation:

    Kim, J. B., J. J. Lee, and J. C. Park. 2015. Audit Quality and the Market Value of Cash Holdings: The Case of Office-Level Auditor Industry Specialization. AUDITING: A Journal of Practice & Theory 34 (2): 27-57.

    Keywords:
    audit quality, auditor industry specialization, capital expenditures, cash holdings, cash management efficiency
    Purpose of the Study:

    In the past, research has been conducted in regards to the impact of managerial cash expenditures on the market value of cash holdings within corporations. Specifically, the misuse of corporate cash resources by management has been shown to result in investors discounting the value of cash holdings. This study investigates the monitoring role of high-quality auditors defined as office-level industry specialists in the stock market valuation of cash assets. The authors pose the idea that high-quality audits facilitate external discipline, thereby preventing potential misuse of cash holding and the associated destruction of cash values.  The study aims to provide large-sample, systematic evidence on whether higher-quality audits contribute to an increase in the market value of cash holdings.

    Design/Method/ Approach:

    Once problematic data were excluded, the sample consisted of 14,688 Big 4 client-year observations for publicly traded U.S. companies over the sample period of 20032011. The relation between audit quality and the market value of cash holdings was investigated by applying a regression model developed in previous research. The authors controlled for certain factors that have been previously shown to affect the market value of cash, including audit financial reporting quality and corporate governance.

    Findings:

    Overall, the results of the study support the idea that higher-quality audits contribute to an increase in the market value of cash holdings. Specifically:

    • The market value of cash is significantly higher for firms audited by local practice offices with both national and city-specific industry specialization.
    • The marginal value of cash is 34 cents higher for the client of a joint industry specialist at both the national and city levels than for the client of a non-specialist.
    • The positive association between joint-industry specialization and the value of cash holdings is more significant than those of national-only or city-only industry specialization.
    • When the auditor has joint-industry specialization, cash holdings are more closely associated with capital investment, and the market value of capital expenditures is significantly higher.
    • The market value of cash holdings increases significantly following the change of auditors to joint-industry specialists.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual, Industry Experience
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization and Evidence of Cost...
    research summary posted October 21, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 10.0 Engagement Management, 10.06 Audit Fees and Fee Negotiations 
    Title:
    Auditor Industry Specialization and Evidence of Cost Efficiencies in Homogenous Industries.
    Practical Implications:

    The results of this study are important to audit firm clients, audit firms, and audit regulators as they evaluate the benefits and costs of industry specialization. For auditors and their clients, the evidence indicates that specialist auditors in homogenous industries, even when complex accounting is involved, achieve economies of scale that are passed on to clients. Clients in homogenous industries appear to benefit from a lower cost audit without a decrease in audit quality. Moreover, audit firms may benefit from increased client retention in these industries because of their expertise and competitive price. And, though audit regulators have expressed concern about concentration in the audit market, the results indicate that concentration can improve audit firms’ economies of scale in homogenous and complex industries without reducing audit quality. As audit clients, audit firms, and audit regulators consider industry specialization, this paper provides support for auditor specialization in homogenous industries.

    Citation:

    Bills, K. L., D. C. Jeter, and S. E. Stein. 2015. Auditor industry specialization and evidence of cost efficiencies in homogenous industries. The Accounting Review 90 (5): 1721-1754.

    Keywords:
    auditor industry specialization, audit fees, economies of scale, homogenous industries, complex industries
    Purpose of the Study:

    Audit firms specialize in certain industries hoping to enhance audit quality and achieve lower costs through knowledge transfer across clients. There has been mixed evidence to date regarding audit pricing for firms in specialized industries; most studies indicate that auditors charge a premium on their services, while others indicate that auditors discount their services due to achieved economies of scale. This paper examines the audit pricing effects of auditor industry specialization based on specific industry characteristics. Specifically, the authors:

    • Investigate whether the specialist auditor’s pricing behavior varies based on industry characteristics, like an industry’s similarity (homogeneity) of operations and complex accounting requirements.
    • Investigate whether the pricing decisions by the specialist auditor in industries where auditors achieve economies of scale depend on client bargaining power.
    Design/Method/ Approach:

    The authors collected audit firm market share data, operating expense data for each industry, information about AICPA audit and accounting guides, as well as data necessary to calculate control variables on companies with data available in the Audit Analytics database and Compustat. The information collected on these companies was for years 2004-2009.

    Findings:
    • The authors find that industry specialist auditors serving client firms in non-homogenous industries charge a fee premium. However, audit fees are incrementally lower for client firms in homogenous industries and client firms in homogenous and complex industries. This indicates that specialist auditors achieve cost efficiencies that are passed to clients who operate in homogenous industries. Additionally, when the client firm displays a relatively high degree of bargaining power, specialist auditors exhibit significantly lower fees.
    • The authors find that non-specialist auditors can also realize cost savings in homogenous industries, but charge higher fees to client firms in complex industries. Specialist auditors charge incrementally higher fees than non-specialists to client firms in complex, but not homogenous, industries. 
    • The authors find that audit quality provided by industry-specialist auditors in homogenous, or homogenous and complex, industries are not significantly different from other industries. These results support that specialist auditors generate production efficiencies without sacrificing audit quality. 
       
    Category:
    Audit Team Composition, Engagement Management
    Sub-category:
    Audit Fees & Fee Negotiations, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Auditor Industry Specialization, Service Bundling, and...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 04.0 Independence and Ethics, 04.03 Non-Audit Services, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City.
    Practical Implications:

    The authors contribute by providing some of the first evidence of service bundling in the economics of auditing literature. In doing so, they broaden the notion that strategic pricing occurs around audit switches. This study contributes to prior mixed findings of the existence of industry specialist premiums in the small-client segment, suggesting an additional reason why these mixed findings might occur. Where opportunities to package services are attractive, auditors may strategically price and discount audits with bundling premiums in mind. Where potential for such bundling opportunities is less attractive, it is possible the auditor may instead seek to generate premiums in the audit service.

    Citation:

    Ferguson, A., G. Pündrich, and A. Raftery. 2014. Auditor Industry Specialization, Service Bundling, and Partner Effects in a Mining-Dominated City. Auditing: A Journal of Practice & Theory 33 (3): 153-180.

    Keywords:
    audit fees, industry specialization, mining industry, non-audit services, second-tier firms, service bundling
    Purpose of the Study:

    This study examines auditor industry specialization effects in Perth, a remote mining town in Australia characterized by a large number of small, homogeneous firms. In this study, the authors consider whether an auditor industry specialist may strategically price a bundle of services in the small-client segment. They argue that the small company sector is a good environment to consider the existence of service bundling. The setting is the mining development stage entity (MDSE) market in Perth, the biggest industry and city in Australia by client numbers. This market is characterized by small (high-growth) firms where auditing is arguably of less importance to the client compared to tax advisory, the other primary service provided to them. Further, the firms are relatively homogeneous, an appealing feature of industry studies. Thus, the authors have arguably an attractive setting to observe service bundling by an industry specialist.

    First, the authors examine whether industry specialist auditors earn audit fee premiums in the Perth MDSE segment. To do this, an audit pricing model is developed and includes controls likely to impact on audit fees in a mining industry context. Second, the authors redefine the dependent variable to consider the pricing implications of the bundle of services provided by industry specialists.

    Design/Method/ Approach:

    The authors utilize an OLS regression model to test for audit fee premiums with respect to brand name and industry leadership. A sample of 1,799 firms listed on the ASX as of December 31, 2009 is obtained. Of the 1,799 listed entities nationally, 668 (37.13 percent) are domiciled in Perth, making it the largest city-level market by client numbers in Australia. At the city-level, the market share of non-Big 4 firms is 70.1 percent in Perth.

    Findings:

    The authors find no evidence of auditor industry leadership audit fee premiums accruing to either Big 4 (EY) or non-Big 4 (BDO) leaders. However, when the dependent variable is redefined to include non-audit services (NAS), the industry leader, BDO, obtains a total fee premium. This finding is of added interest given that the industry leader is a second-tier firm, implying that strategic audit pricing, such as service bundling, is not confined to Big 4 auditors. Nor is it confined to merely one location, since bundling premiums are observed at the national level. The authors argue MDSEs have little in the way of financial statement complexity, so they do not value specialist audits, but rather are willing to pay more for NAS. Last, in supplementary analysis, the authors find some evidence of partner-scale effects.

    Category:
    Audit Team Composition, Client Acceptance and Continuance, Independence & Ethics
    Sub-category:
    Audit Fee Decisions, Industry Expertise – Firm and Individual, Non-audit Services
  • Jennifer M Mueller-Phillips
    Auditor Style and Financial Statement Comparability.
    research summary posted July 17, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size 
    Title:
    Auditor Style and Financial Statement Comparability.
    Practical Implications:

    The authors find support for the idea that auditors develop in-house rules to facilitate comparability within their clientele. These auditor style effects also appear to reduce comparability between clients audited by different auditors. Big 4 accounting firms may have an effect on another earnings attribute that has not previously been investigated, namely, accounting comparability. The authors find that firms audited by Big 4 auditors have greater accounting comparability than firms audited by non-Big 4 auditors, which suggests another dimension in which the two auditor groups differ. It is also the case that each Big 4 audit firm has its own style, which affects accounting comparability and is therefore another source of variation within the Big 4 group of auditors.

    Citation:

    Francis, J. R., Pinnuck, M. L., & Watanabe, O. 2014. Auditor Style and Financial Statement Comparability. Accounting Review 89 (2): 605-633.

    Keywords:
    big 4 accounting firms, comparability, earnings, expertise
    Purpose of the Study:

    Comparability is defined by the Financial Accounting Standards Board (FASB) as the quality of information that enables users to identify similarities and differences in the financial performance of two firms. The FASB states that comparability in financial reporting is the primary reason for developing accounting standards, and the centrality of comparability is stressed in accounting textbooks, particularly financial statement analysis texts accounting standards on their own do not fully determine financial reporting outcomes; economic agents and institutional incentives also play an important role.

    This motivates the investigation of the role that auditors play in the implementation of comparability in the United States. For the purpose of this study the authors define accounting comparability as the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms. In the empirical context, this means that firm-pairs in the same industry and fiscal year, and therefore subject to the same general economic shocks, are expected to have a similar accruals and earnings structure, all things being equal. The study focuses on the role of the auditor, the authors argue that each Big 4 audit firm has its own unique set of internal working rules that guide and standardize the auditor’s application of auditing and accounting standards.

    Design/Method/ Approach:

    The authors use a regression model to examine the relation between accounting comparability and auditor style. The primary tests are based on pairs of firm-year observations from Compustat in the same industry-year for the period 1987 to 2011.

    Findings:

    The authors find that two firms in the same industry-year and audited by the same Big 4 auditor have more comparable earnings than two firms audited by two different Big 4 auditors. Pairs of firms in the same industry-year with the same Big 4 auditor have more similar total and abnormal accruals; firm-pairs with the same Big 4 auditor have a higher covariation in earnings over time; and auditor fixed effects are a statistically significant determinant of accruals.  Big 4 auditors have a greater effect on accounting comparability than non-Big 4 auditors.

    A single set of uniform accounting standards is often advocated as a means to increase comparability of financial statements, reflecting the rationale for the FASB-IASB convergence project. This study documents that the role of an economic agent, the auditor, is also important in facilitating the production of accounting comparability. The authors argue that the Big 4 style effect arises from each audit firm having its own unique set of in-house rules with respect to the interpretation and implementation of GAAS (auditing standards) and the interpretation and enforcement of GAAP (accounting standards).

    Category:
    Audit Team Composition
    Sub-category:
    Impact of Office Size, Industry Expertise – Firm and Individual
  • Jennifer M Mueller-Phillips
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality...
    research summary posted March 4, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 03.0 Auditor Selection and Auditor Changes, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 05.08 Impact of Office Size, 14.0 Corporate Matters 
    Title:
    Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics?
    Practical Implications:

    The fact that the Big 4 effect is generally insignificant indirectly supports the argument that the Big 4 distinction may reflect client and not auditor characteristics. The results suggest that differences in these proxies between Big 4 and non-Big 4 auditors largely reflect client characteristics and, more specifically, client size. The study has not resolved the question, although it encourages other researchers to explore alternative methodologies that separate client characteristics from audit-quality effects.

    For more information on this study, please contact Alastair Lawrence.

    Citation:

    Lawrence, A., M. Minutti-Meza, and P. Zhang. 2011. Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics? The Accounting Review 86 (1): 259-286. 

    Keywords:
    Big 4 versus non-Big 4 audit quality; discretionary accruals; ex ante cost-of-equity capital; analyst forecast accuracy; propensity-score matching; attribute-based matching
    Purpose of the Study:

    This study examines whether differences in proxies for audit quality between Big 4 and non-Big 4 audit firms could be a reflection of their respective clients’ characteristics.

    The question of Big 4 superiority is important, given that many studies rely on the Big 4 versus non-Big 4 distinction as an audit-quality proxy. Hence, it is prudent to confirm that this distinction does not simply reflect client characteristics. Furthermore, incorrectly classifying Big 4 auditors as superior to non-Big 4 auditors has unnecessary negative ramifications for smaller auditors, such as audit committee’s auditor selection bias and discriminatory clauses in loan and underwriting agreements, which could result in a loss of current and future clients.

    Design/Method/ Approach:

    In the research, the authors use three audit-quality proxies – discretionary accruals, the ex ante cost-of-equity capital, and analyst forecast accuracy – and employ propensity-score and attribute-based matching models in attempt to control for differences in client characteristics between the two auditor groups while estimating the audit-quality effects. Also, they use propensity-score matching models in an attempt to control for differences in client characteristics between the two auditor groups while estimating auditor treatment effects.

    Findings:

    Using the matching models and full samples, the authors find that the treatment effects of Big 4 auditors are insignificantly different from those of non-Big 4 auditors with respect to our three audit-quality proxies.

    Category:
    Audit Team Composition, Auditor Selection and Auditor Changes, Client Acceptance and Continuance, Corporate Matters
    Sub-category:
    Audit Fee Decisions, Impact of Office Size, Industry Expertise – Firm and Individual
  • The Auditing Section
    Differences in Industry Specialist Knowledge and Business...
    research summary posted May 7, 2012 by The Auditing Section, tagged 02.0 Client Acceptance and Continuance, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity, 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual, 06.0 Risk and Risk Management, Including Fraud Risk, 06.05 Assessing Risk of Material Misstatement 
    Title:
    Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation
    Practical Implications:

    The findings in this study are not intended to undermine the benefits of specialization in generic industries. Rather, they serve to highlight the importance and impact that specializing across differing industries has on auditor knowledge and experience.  From a
    practical perspective, the results of this study provide audit firms insights into the possible effects experience from industries of varying complexity has on auditors’ abilities to evaluate audit risks.  The results highlight the challenges in simply grouping industry specialists homogeneously, as the benefits accruing to specialists may vary depending on the nature and complexity of the industry.

    Citation:

    Moroney, R., and R. Simnett. 2009.  Differences in Industry Specialist Knowledge and Business Risk Identification and Evaluation.  Behavioral Research in Accounting 21(2): 73-89.

    Keywords:
    Behavioral decision theory; industry specialization; business risks
    Purpose of the Study:

    Prior literature has reported that auditors who are considered industry specialists outperform non-specialists on tasks within their area of expertise.  Noting that not all industries are the same, the authors build on this prior literature to examine the relative performance gains between auditors specializing in a complex (pension fund) industry vs. generic (manufacturing) industry.  Below are the primary objectives that the authors address in their study: 

    • The authors argue that the nature of a complex industry causes a specialist to possess a more developed sub-specialty knowledge base compared to his/her counterpart specializing in a generic industry.  In response, it is believed that the complex industry specialist will outperform the generic industry specialist in identifying appropriate business risks, within their respective industries.
    • The authors additionally examine information-gathering attributes. Specifically, they argue that complex industry specialists will 1) list more appropriate information sources, 2) list more appropriate evidence gathering processes, and 3) will list more appropriate accounts and related assertions when compared to generic industry specialist auditors.
    Design/Method/ Approach:

    An experiment, which uses Big 4 auditors ranging in experience from 2 to 27 years, is conducted. The average experience levels of the auditors are 5.2 and 4.6 years, respectively, for the complex and generic industry specialists. This data was collected in Australia, prior to 2009. Two expert panels of Big 4 industry specialists (one from each industry) were involved in the development of the experimental materials.  

    Findings:
    • Complex industry specialists (i.e., pension fund auditors) were able to list relatively more business risks when working in their industry than generic industry specialists (i.e., manufacturing auditors) were able to in their respective industry.
    • Complex industry specialists, working in their industry, were able to list a greater number of appropriate information sources and appropriate evidence gathering processes, compared to their generic industry peers. However, they were not able to list a greater number of accounts or related assertions.
    Category:
    Client Acceptance and Continuance, Audit Team Composition, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Business Risk Assessment (e.g. industry - IPO - complexity), Industry Expertise – Firm and Individual, Assessing Risk of Material Misstatement
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  • The Auditing Section
    Does Auditor Industry Specialization Matter? Evidence from...
    research summary posted April 16, 2012 by The Auditing Section, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Does Auditor Industry Specialization Matter? Evidence from Market Reaction to Auditor Switches
    Practical Implications:

    This study offers an important implication for audit firms that industry specialization, in addition to brand name, is perceived as valuable by investors. The results are also useful for regulators when examining auditor switching by firms. Finally, the results are useful to investors in that they show significant market reactions to various types of auditor switching.

    Citation:

    :  Knechel, R. W., V. Naiker, and G. Pacheco. 2007. Does Auditor Industry Specialization Matter? Evidence from Market Reaction to Auditor Switches.  Auditing: A Journal of Practice and Theory 26 (1):  19-45. 

    Keywords:
    Industry specialist auditors, auditor switching, market reaction, financial reporting quality, auditor selection and auditor change.
    Purpose of the Study:

    Accounting regulators are interested in auditor switching by client companies because of a concern over opinion shopping. However, companies may also switch auditors in order to search for a higher-quality level of assurance provided by the audit. Prior research indicates that auditor brand name represents an audit quality differentiation and that investors recognize this  differentiation, as reflected in market reactions to changes to or from a brand name auditor. 

    Knowledge of a client's industry is one of the essential components of auditor expertise. Besides brand name, audit firms employ industry specialization as a method to differentiate their services and structure themselves along industry lines. This study examines whether: 

    • auditor industry expertise, in addition to brand name, reflects a form of service differentiation that is considered valuable by capital market investors. 
    • investor reactions, if any, are caused by changes in the market perception of audit quality or changes in the perceived costs of hiring auditors with varying levels of audit quality.
    Design/Method/ Approach:

    The authors use data on publicly-traded companies from 2000 to 2003 to investigate the market reaction to firms switching to (from) industry specialist auditors.

    Findings:
    • Switching within the Big 4 group of auditors -  the authors document that firms switching to an industry specialist experience a positive market reaction while those switching to a non-industry specialist experience a negative market reaction. The authors find that the observed market reactions are more likely to be caused by changes in perceived audit quality rather than the differential costs of using specialist auditors.  
    • Switching from a Big 4 to a non-Big 4 auditor - investors react most negatively when a company switches from a specialist Big 4 auditor to a non-Big 4 auditor. This suggests that the market is concerned with the reduction in perceived audit quality represented by brand name and industry expertise.  
    • Switching from a non-Big 4 to a Big 4 auditor - the market reacts most positively when a company switches from a non-Big 4 auditor to a Big 4 auditor who is not a specialist. However, there is no significant reaction for a switch from a non-Big 4 auditor to a Big 4 auditor who is a specialist. The authors speculate that the absence of a significant positive market reaction to the latter switch may be caused by increases in the perceived costs of using specialist auditors.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)
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  • The Auditing Section
    Does Industry Expertise Improve the Efficiency of Audit...
    research summary posted April 16, 2012 by The Auditing Section, tagged 05.0 Audit Team Composition, 05.02 Industry Expertise – Firm and Individual 
    Title:
    Does Industry Expertise Improve the Efficiency of Audit Judgment?
    Practical Implications:

    The results of this study are important for potential clients to consider when selecting an auditor.  The results are also important for auditors considering tradeoffs between efficiency and effectiveness, and considering how to staff their current and future client engagements.  The evidence indicates that specialists are more effective auditors within their specialty and are more efficient in certain decision making processes.  Also, auditors are more effective when they spend more time and iterations reviewing audit information.

    Citation:

    Moroney, R. 2007. Does Industry Expertise Improve the Efficiency of Audit Judgment? Auditing: A Journal of Practice and Theory 26 (2): 69-94.

    Keywords:
    Behavioral decision theory, expertise paradigm, industry specialization
    Purpose of the Study:

    Industry specialization is used to differentiate audit firms, and prior research has demonstrated that industry specialists are more effective when working within their specialization.  Prior research also assumes that specialist auditors are more efficient within their specialty industry.  However, no prior studies have demonstrated that specialist auditors are more efficient than non-specialists when working within their specialty industry.  This paper addresses this concern by investigating whether audit judgment efficiency at each of three stages of the decision making process (pre-information search, information search, and decision processing) is influenced by auditor specialization.  The paper also links efficiency to effectiveness by investigating whether higher efficiency increases effectiveness within specialty. 

    The author motivates their expectations based on the literature that shows that expertise influences performance.  Specifically, specialist auditors are experts in their specialty industry and are expected to be more efficient when making decisions because of their prior knowledge and experience, which streamline the process of understanding the problem (pre-information search), acquiring knowledge (information search), and making decisions (decision processing) about a new case within their industry.  Finally, because of the learning opportunities afforded by repeatedly working with clients in the same industry, specialist auditors are expected to be more efficient and more effective when working within specialty.

    Design/Method/ Approach:

    The experimental data was collected prior to February 2006. The author used manufacturing and pension fund specialists from Big 4 firms to complete two simulated audit cases.  The cases involved reading the case materials, selecting and reviewing pertinent accounting and auditing standards (audit cues), and making an audit decision for a manufacturing client and a pension fund client.  The author then compared efficiency between the two specialist types. The author also examined the relation between efficiency and effectiveness

    Findings:
    • The author finds mixed evidence that industry specialists are more efficient in the pre-information search stage of decision making.
      • Specialists spend less time reading the case that is within their specialty.
      • Manufacturing specialists read the manufacturing case more often than the pension fund case, which is contrary to expectations. 
    • The author finds mixed evidence that industry specialists are more efficient in the information search stage of decision making.
      • Specialists spend less time reading the cues when working within their specialty.
      •  Only pension specialists selected fewer cues to review when working within their specialty.
    • The results do not support the hypothesis that specialists are more efficient in the decision processing stage of decision making.

    Contrary to the hypothesis that efficiency increases effectiveness, the author finds that auditors are more effective when they spend more time reading and reviewing case materials regardless of whether they are working within or outside their specialty.

    Category:
    Audit Team Composition
    Sub-category:
    Industry Expertise – Firm and Individual
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