Knowledge Transfer in Audit Firms

Abstract

We utilize the setting of the rapid audit market consolidation in China over the past twenty years to study knowledge transfer in audit firms. We employ a difference-indifference approach and examine whether industry-specific knowledge transfer occurs after a merger of two audit firms with different levels of expertise in a particular industry. For clients in an industry audited by both merging audit firms, those audited by the less competent audit firm in that industry belong to the treatment group, while all other clients belong to the control group. Consistent with the existence of knowledge transfer, we find an economically significant improvement in audit quality (as reflected in a reduction in misstatements and an increase in modified audit opinions) for the treatment group relative to the control group in the same merged audit firm.