Audit Risk and the Benefits of Employing Specialist Auditors: Evidence from Firms with Major Government Customers

Abstract

This paper examines auditor specialization benefits in the context of government contractors, which are subject to complex rules and regulations. While governmental oversight may reduce agency costs, it may also increase audit risk. Supporting the latter argument, firms with major government customers (MGCs) have more idiosyncratic risk disclosures and thus pay higher audit fees than control firms without MGCs. To possibly mitigate risk and signal audit quality, firms with MGCs are more likely to employ specialist auditors than control firms. However, employing traditional, city-industry specialists does not yield audit efficiency or quality benefits for firms with MGCs, while employing industry-government specialists does. When an industry-government specialist is employed, there is no audit fee premium linked to higher sales made to MGCs and the likelihood of revenue- or expense-related restatements is lower. These findings highlight the positive implications of having auditors with expertise in auditing government contractors in a particular industry.

Keywords: audit risk, auditor specialization, audit quality, government contractors, major customers

JEL Classification: M42