（2007）Does Auditor Industry Specialization Matter？Evidence from Market Reaction to Auditor Switches.pdfVIP

AUDITING: A JOURNAL OF PRACTICE THEORY Vol. 26, No. 1 May 2007 pp. 19–45 Does Auditor Industry Specialization Matter? Evidence from Market Reaction to Auditor Switches W. Robert Knechel, Vic Naiker, and Gail Pacheco SUMMARY: Numerous capital market studies have investigated the stock market’s reaction to firms switching to and from brand name auditors (Big 8/6/5/4 auditors). However, audit firm brand name is only one possible indication of the quality of an auditor. This study contributes to the existing literature on auditor switching, by ex- amining how the market reacts to auditor switches to or from audit firms that are considered to be industry specialists. Consistent with our hypotheses, we find that firms switching between Big 4 auditors experience significant positive abnormal returns when the successor auditor is an industry specialist, and they experience significant negative abnormal returns when the successor auditor is not a specialist. We also find that these market reactions are more likely to be due to changes in perceived audit quality rather than differential costs of using specialist auditors. In supplemental anal- ysis of switches involving non-Big 4 auditors, we find that firms that switch from a specialist Big 4 auditor to a non-Big 4 auditor suffer the largest negative market re- action. Surprisingly, we also observe that the market reacts most positively when a company switches from a non-Big 4 auditor to a Big 4 auditor who is not a specialist. These results suggest that the market does perceive audit quality differences based on industry specialization to be relevant to the valuation of a company’s market value. Keywords: industry specialist auditors; auditor switching