Auditor Specialization on Client Technology Space

Description

The recent Nobel laureate, Paul Romer, proposes that technology is the key input to a firm’s production function and key source of economic growth (Romer 1986; Romer 1990). His models explain how innovative technologies in the early 1990s such as computer code for word processor or the internet have given rise to increasing returns to scale in production and sustained exponential growth in the economy. Nowadays firms interact with each other to inspire innovations and knowledge spillovers, technology affinities have become increasingly important in firm growth and productivity (Jaffe, Trajtenberg, and Henderson 1993; Bloom, Schankerman, and Van Reenen 2013). In this innovation- and technology-based economy, it is crucially important for auditors to understand their clients’ technological position to make better auditing decisions and professional judgments. Furthermore, technology spillovers could occur beyond the traditional industry boundaries; client firms are therefore less likely to be concerned about potential leakage of proprietary information when they hire the same auditor as their close technology peers, compared to the situation where they appoint the same auditor as their product market competitors. Therefore, auditor expertise developed from client technological closeness should constitute a critical type of auditor specialization in addition to industry specialization. There is already a long series of literature showing that industry specialist auditors provide better audit quality and earn audit fee premia due to their greater knowledge of industry, business and accounting practices compared to non-specialists (Dopuch and Simunic 1982; Craswell, Francis, and Taylor 1995; Balsam, Krishnan, and Yang 2003; Ferguson, Francis, and Stokes 2003; Krishnan 2003; Mayhew and Wilkins 2003; Francis, Reichelt, and Wang 2005; Carson 2009; Reichelt and Wang 2010; Fung, Gul, and Krishnan 2012; Goodwin and Wu 2014). To the best of our knowledge, however, the literature has paid little attention to how client technological links could influence auditor specialization, which could accordingly affect audit quality and fee premiums. To fill this void in the literature, we examine whether auditors derive expertise from client technological proximity while controlling for the within-industry client product closeness. Such evidence will help to shed lights on whether auditors develop expertise from their client technological links beyond industry borders. We also intend to investigate whether auditors develop greater technological expertise when their client firms have a more intense and specific technology focus, when their client firms belong to a more concentrated industry, when these client firms are more opaque or less transparent.