Inter-Industry Synergy and Audit Firms’ Industry Specialization Decision

59 Pages Posted: 18 Jan 2019

See all articles by Wenfeng Wang

Wenfeng Wang

City University of Hong Kong

Date Written: December 1, 2018

Abstract

Audit firms are organized along industry lines and industry specialization is a prominent feature of the audit market. Yet, we know little about how audit firms make their industry portfolio decisions, i.e., how audit firms decide which set of industries to specialize in. In this study, I examine how the linkages between industries in the product space affect audit firms’ industry portfolio choice. Using text-based product space measures to capture these industry linkages, I find that both Big 4 and small audit firms tend to specialize in industry-pairs that 1) are close to each other in the product space (i.e., have more similar product language) and 2) have a greater number of “between industries” in the product space (i.e., have a greater number of industries with product language that is similar to both industries in the pair). Consistent with the basic tradeoff between specialization and coordination, these results suggest that specializing in industries that have more similar product language and more linkages to other industries in the product space allow audit firms greater flexibility to transfer industry-specific expertise across industries as well as greater mobility in the product space. Additional analysis using the collapse of Arthur Andersen as an exogenous supply shock in the audit market finds consistent results. Taken together, the findings suggest that industry linkages in the product space play an important role in shaping the audit market structure.

Keywords: Audit Market Structure, Audit Specialization, Audit Fee

Suggested Citation

Wang, Wenfeng, Inter-Industry Synergy and Audit Firms’ Industry Specialization Decision (December 1, 2018). Available at SSRN: https://ssrn.com/abstract=3318229

Wenfeng Wang (Contact Author)

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

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