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    Auditor industry expertise and cost of equity
    research summary posted March 10, 2015 by Jennifer M Mueller-Phillips, tagged 03.0 Auditor Selection and Auditor Changes, 03.01 Auditor Qualifications 
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    Title:
    Auditor industry expertise and cost of equity
    Practical Implications:

    The results of this study should be of interest to policymakers. An August 2011 Public Company Accounting Oversight Board (PCAOB 2011) concept release asked for comments on the advisability of using mandatory auditor rotation to enhance auditor independence. It aroused concerns from commenters that such rotation could adversely affect clients benefiting from auditor industry specialization. Although these comments did not elaborate on the nature of the benefits from industry specialization, this study’s evidence that equity investors value industry-expert auditors is relevant to the debate about the desirability of mandatory auditor rotation

    For more information on this study, please contact Jagan Krishnan.

    Citation:

    Krishnan, J., C. Li, and Q. Wang. 2013. Auditor industry expertise and cost of equity. Accounting Horizons 27(4): 667-691.

    Keywords:
    audit quality; cost of equity; auditor expertise; auditor change.
    Purpose of the Study:

    The study examines (1) the association between auditors’ industry expertise and their clients’ cost of equity capital, and (2) the change in cost of equity capital when companies switch from industry non-expert (expert) auditors to industry-expert (non-expert) auditors.

    Design/Method/ Approach:

    This study uses the city-national framework of auditor expertise, examine the effects of national-only, city-only, and joint city-national industry expertise on cost of equity.  The sample used in this study is derived from publicly traded companies employing Big N auditors. The period covers the years 2000 through 2008.     

    Findings:
    • Clients of city-only and joint city-national industry-expert auditors enjoy lower cost of equity capital. This is consistent with the assertion that investors’ positive perceptions about auditor reputation exist at the city level, either alone or jointly with national level.
    • Firms that move from non-experts to city-only and joint city-national industry experts experience a decline in cost of equity, and firms that switch from joint city-national experts to non-experts experience an increase in cost of equity. In addition, firms that switch from non-experts to experts issue more equity in the two years following the switch.
    • Further analyses suggest that, while the effects of national-only and city-only experts vary across some subsets of the sample, joint city-national experts enjoy lower cost of equity in the majority of subsamples.
    Category:
    Auditor Selection and Auditor Changes
    Sub-category:
    Auditor Qualifications (e.g. size - industry expertise)