Audit Quality, Alternative Monitoring Mechanisms, and Cost of Capital: An Empirical Analysis

43 Pages Posted: 23 Apr 2008 Last revised: 2 Sep 2008

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Stephanie J. Rasmussen

University of Texas at Arlington

Senyo Y. Tse

Texas A&M University - Lowry Mays College & Graduate School of Business

Date Written: August 2008

Abstract

Prior studies document that firms using a Big 4 auditor have a lower cost of capital than other firms. We extend this literature by examining whether using an industry specialist auditor reduces cost of capital for clients of Big 4 audit firms. We document that firms that use Big 4 auditors that are industry specialists have significantly lower cost of both equity and debt than firms that use non-specialist Big 4 auditors. We further investigate whether the benefits of using an industry specialist auditor vary with the strength of alternative monitoring mechanisms. We show that using an industry specialist auditor is especially important when alternative monitoring mechanisms, such as boards of directors or institutional shareholders, are relatively weak. In other words, the benefits of using an industry specialist auditor dissipate when alternative monitoring mechanisms are strong. This evidence suggests some degree of substitutability between audit quality and alternative monitoring mechanisms.

Keywords: Audit quality, Industry specialization, Financial reporting credibility, Cost of capital

JEL Classification: G12, G34, G38, M49

Suggested Citation

Ahmed, Anwer S. and Rasmussen, Stephanie J. and Tse, Senyo Y., Audit Quality, Alternative Monitoring Mechanisms, and Cost of Capital: An Empirical Analysis (August 2008). Available at SSRN: https://ssrn.com/abstract=1124082 or http://dx.doi.org/10.2139/ssrn.1124082

Anwer S. Ahmed (Contact Author)

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Stephanie J. Rasmussen

University of Texas at Arlington ( email )

Box 19468
Arlington, TX 76019-0468
United States

Senyo Y. Tse

Texas A&M University - Lowry Mays College & Graduate School of Business ( email )

Wehner 401Q, MS 4353
456C
College Station, TX 77843-4218
United States
979-845-3784 (Phone)

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