Auditor Industry Specialists and the Ability of Accruals to Predict Future Cash Flows

Abstract

We examine the relation between auditor industry specialization and the ability of accruals to predict future cash flows, a key attribute of informative accounting. We find that, on average, client firms of industry specialist auditors have a weaker relation between accruals and future cash flows, suggesting a negative relation between auditor industry specialization and the predictive ability of accruals. In cross-sectional tests, we find that these results are concentrated in settings where auditor industry-specific knowledge is likely less useful. Specifically, the results are driven by firms in less homogeneous industries, firms that differ more from their industry peers, and firms with greater idiosyncratic risk. Our results are robust to employing various techniques to control for client differences between specialist and non-specialist auditors. Overall, our results provide novel and more granular evidence on the role of auditor industry specialization for financial reporting.

Keywords: Auditor Industry Specialization, Cash Flow Prediction, Accrual Informativeness, Earnings Quality

JEL Classification: M41, M42, M48