Do industry specialists and business risk auditors enhance audit reporting accuracy?.

Abstract

A number of prior studies have examined audit reporting quality using size (Big 8/6/5/4) as a proxy for quality (i.e. Lennox, 1999b; Francis and Krishnan, 1999; Weber and Willenborg, 2003). In this paper we move beyond the traditional definition of a high quality auditor, and investigate whether enhanced industry knowledge or an increased focus on business risk auditing methodologies improve audit reporting accuracy. In addition, we examine whether industry specialists and business risk auditors have a comparative advantage in judging the adequacy of mitigating management actions implemented by financially distressed companies. Using a sample of US companies from manufacturing industries (SIC 20-39) that went bankrupt between 1998-2001, we do not find evidence supporting that specialist auditors are more likely to issue a going concern opinion for companies that subsequently go bankrupt. However, our evidence does indicate that specialists are not fooled by operating initiatives (whereas non-specialists are). Interestingly and counter to our expectations, we find that audit firms using a business risk methodology are less likely to issue a going–concern opinion for a firm that subsequently goes bankrupt. Further, our evidence also suggests that business risk auditors may be 'fooled' by short term operating efforts to reduce financial distress. Finally, we also find very strong evidence that auditors, irrespective of their type, are 'fooled' into not issuing a going concern opinion for clients that subsequently go bankrupt when the client is planning on raising cash in the short term.Behavior; Control; Cost; Exchange; Information; Negotiations; Performance; Power; Research; Theory; Law; Effects; Trade; Flows; Country; Intensity; Imports; Import; United States; Trade liberalization; Industry; Industries; Business; Risk; Reporting; Studies; Quality; Size; Knowledge; Auditing; Comparative advantage; Management; Companies; Manufacturing; Firms; Planning;