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.

Keywords: information spillovers, audit quality, auditor specialization, audit fees, PCAOB regulation

JEL Classification: C72, D80, D83, L22, M42, M48