Auditor Specialization and Information Spillovers

Abstract

We study the determinants of auditor industry specialization, the impact of specialization on fees and audit quality, and a regulator's optimal choice of audit standards in the presence of specialization. In industries with correlated firm values, a specialist auditor enjoys synergies from information spillovers between clients. These spillovers, however, only induce a specialist to decrease audit effort when the cost of effort and the prior precision of the firms' values are low. We derive empirical predictions about the determinants of specialization, and show that specialization benefits firms through lower expected fees and higher audit reporting quality, but only enhances the usefulness of reports to investors when the specialist exerts high audit effort. In a regulated setting, a stricter audit standard affects fees through its impact on specialization. We provide conditions under which standards that maximize firm value will be more strict and less strict when a regulator recognizes synergies.

The Impacts of Characteristics of Hometown Connectedness Between Auditors and Executives on Audit Quality: Evidence From China

“…First of all, from the perspective of pressure, auditors conniving or even helping enterprises cover up mistakes can be exchanged for financial or emotional returns given by managers, thus helping to relieve their own economic and emotional pressure (Brozovsky & Richardson, 1998). Secondly, the degree of specialization in audit business is high, and the errors in financial reports can easily be concealed, so auditors have opportunities to commit fraud without being discovered or getting away with punishment (Bhattacharjee et al, 2012;Petrov & Stocken, 2022). Finally, helping managers with hometown connectedness pull through difficult times can easily become an important excuse to be accepted or be highly spoken to by everyone from the same hometown.…”