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    Does Auditor Industry Specialization Matter? Evidence from...
    research summary posted April 16, 2012 by The Auditing Section, last edited May 25, 2012, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications, 05.02 Industry Expertise – Firm and Individual 
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    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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