Recent research findings suggest that corporations engaging auditors with specialised expertise in their respective fields gain significant cost benefits and attain a more accurate financial overview, enhancing investor trust.
The research, led by Birendra Mishra and Theodore Mock from the School of Business at UC Riverside, delves into the impact of auditors’ industry-specific experience on the pricing and quality of audits. This study scrutinises over 32,000 auditing instances in India, a nation whose corporate financial regulations mirror those of the U.S., uncovering that auditors—termed “partners” in the study—who possess profound industry knowledge not only elevate the quality of audits but also reduce costs for clients during initial audits.
Mishra, an esteemed professor of accounting, underscores the significance of expertise in the auditing field by comparing skilled auditors to adept surgeons whose experience ensures swiftness and precision, subsequently benefiting clients through cost reductions. He emphasises that such expertise allows auditors to tackle complex issues more adeptly, ensuring high-quality audit outcomes.
Furthermore, the study advises against choosing auditors who initially undercharge—”low-balling”—to compensate for their lack of experience. This practice often increases fees in subsequent years as these auditors strive to offset initial discounts, resulting in escalated costs and diminished audit quality over time. Mishra highlights that auditors with ample industry experience do not need to resort to low-balling, as their efficiency enables them to offer competitive pricing initially without subsequent significant fee increases. He points out that focusing on cost recovery can detract from the primary goal of conducting thorough and accurate audits.
The research utilises a robust dataset from India, where auditing regulations require the disclosure of lead auditors in financial reports. This transparency has enabled the researchers to precisely track the industry-specific experience of individual auditors and develop a novel metric, “INDEXP_PTNR,” which quantifies an auditor’s cumulative years of industry experience. By employing sophisticated statistical models, the study assesses the influence of this experience on the pricing of initial-year audits, adjustments in fees in later years, and overall audit quality.
Mishra notes the close resemblance between Indian and U.S. auditing standards, which amplifies the study’s international relevance. He suggests that the insights gained could revolutionise how companies select their auditing partners and influence regulatory frameworks in the U.S. and other countries. Given that U.S. law mandates annual audits for publicly traded companies, which can be costly, enhancing audit processes could significantly impact a company’s financial transparency and, by extension, its market value.
Highlighting the broader implications of high-quality audits, Mishra points out that they strengthen the correlation between reported earnings and stock prices, thereby boosting investor confidence. The rigorous link established through reliable auditing practices can elevate a company’s stock valuation and market standing.
Mishra concludes by recommending that companies in the process of selecting an auditor prefer candidates with substantial industry-specific experience. These candidates are more likely to deliver superior results and maintain manageable audit costs over time, potentially enhancing the company’s stock performance.
More information: Naman Desai et al, The Effects of Audit Partner Industry Experience on Lowballing, Subsequent Audit Fees, and Audit Quality, Auditing A Journal of Practice & Theory. DOI: 10.2308/AJPT-2022-133
Journal information: Auditing A Journal of Practice & Theory Provided by University of California – Riverside
