Auditor Industry Specialization and Earnings Quality

TLDR

Auditor brand name has been used as a proxy for audit quality, and recent research suggests that auditor industry specialization may also enhance audit quality. This study investigates the relationship between earnings quality indicators and auditor industry specialization. The authors compare discretionary accruals and earnings response coefficients for firms audited by industry specialists versus non‑specialists, limiting the sample to Big 6/5 auditors and employing multiple proxies for specialization. After controlling for established variables, they find that clients of industry specialists exhibit lower discretionary accruals and higher earnings response coefficients, indicating superior earnings quality.

Abstract

This study examines the association between measures of earnings quality and auditor industry specialization. Prior work has examined the association between auditor brand name and earnings quality, using auditor brand name to proxy for audit quality. Recent work has hypothesized that auditor industry specialization also contributes to audit quality. Extending this literature, we compare the absolute level of discretionary accruals (DAC) and earnings response coefficients (ERC) of firms audited by industry specialists with those of firms not audited by industry specialists. We restrict our study to clients of Big 6 (and later Big 5) auditors to control for brand name. Because industry specialization is unobservable, we use multiple proxies for it. After controlling for variables established in prior work to be related to DAC and the ERC, we find clients of industry specialist auditors have lower DAC and higher ERC than clients of nonspecialist auditors. This finding is consistent with clients of industry specialists having higher earnings quality than clients of nonspecialists.