Auditor industry specialization and corporate risk-taking

Jamie L. Hoelscher and Scott E. Seavey

Managerial Auditing Journal, 2014, vol. 29, issue 7, 596-620

Abstract: Purpose - – The purpose of this study is to examine the effects of higher-quality auditors on corporate risk-taking. Design/methodology/approach - – Agency theory suggests that managers have incentives to avoid risk in the interests of perquisite consumption and self-preservation, while investors prefer that managers invest in all projects with a positive net present value, i.e. projects that generally increase corporate risk. Empirical literature finds that managerial risk-aversion is mitigated (and firm value enhanced) when investor protection is higher. The authors examine whether higher-quality auditing is one such mechanism to encourage shareholder-focused corporate risk-taking. They model measures of corporate risk as a function of whether a firm is audited by an industry specialist or not, controlling specifically for accounting quality. They then examine the incremental effect of higher-quality audits on other forms of external monitoring (analyst coverage and institutional holdings) for corporate risk. Findings - – Using a sample from 2003 to 2007, the authors document a positive relationship between local-level audit industry specialization and both the standard deviation of annual stock returns and research and development expenditures (their measures of corporate risk-taking). They then find the effect is mitigated when firms have alternative external monitoring, in the form of either higher analyst coverage or greater institutional holdings. Research limitations/implications - – Given the nature of the question the authors ask, particularly in the context of the auditor–client relationship, a potential limitation is the difficulty in assigning causation. Nonetheless, this study underscores the importance of auditors as an effective mechanism for monitoring corporate managers. Originality/value - – This study provides novel evidence that auditors affect managerial decision making beyond a simple effect on financial statements, and should be of interest to boards of directors, regulators and investors.

Keywords: Monitoring; Audit; Corporate risk; Industry specialists; M42; G32 (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:eme:majpps:maj-02-2014-1000

DOI: 10.1108/MAJ-02-2014-1000

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