Heterogeneity in Expertise in a Credence Goods Setting: Evidence from Audit Partners
58 Pages Posted: 19 Sep 2016 Last revised: 2 Aug 2019
Date Written: July 31, 2019
We focus on heterogeneity of expert types in a credence goods setting. In our analytical model, clients are ex ante uncertain about how much effort an expert needs to provide to solve their problem, which can be simple or difficult. Clients can choose among experts with varying degrees of expertise. The less qualified experts are less effective at solving difficult problems, but are equally qualified to solve simple problems. We find that clients pay a fee premium to more qualified experts even when their problem is simple. The premium increases with the ex ante probability that the client has a more difficult problem. We empirically test these predictions in the context of partner industry expertise for the U.S. operations of the Big 4 audit firms, and find results consistent with the model. Using proprietary data, we find a positive association between partner industry specialization and audit fees, even for lower risk clients, but a negative association between partner specialization and the client’s probability of restatements only for high risk clients. Consistent with credence good agency issues, our results for lower risk clients are mitigated when the audit committee has more accounting expertise and information asymmetry between client and auditor is likely lower, and the industry specialization premium is higher in industries with more risky clients.
Keywords: Audit Engagement Partner, Audit Quality, Audit Fees, Industry Specialization, Expert-Client Agency Costs, Disclosure
JEL Classification: M42, D82, L14, L22
Suggested Citation: Suggested Citation