The Pricing of Industry Specialization by Auditors in New Zealand

David Hay
University of Auckland
New Zealand

Debra Jeter
Vanderbilt University
United States of America

Abstract:
A number of recent research papers examine the impact of industry specialization by auditors on audit fees in a variety of contexts. Most propose that auditors who specialize in an industry are able to perform higher quality audits, which are recognized and valued by financial statement users and thus by managers to such an extent that higher audit fees are warranted and paid to such specialists. Evidence consistent with this proposition has been presented in some studies, while others have generated conflicting findings. To the extent that specialist premiums are supported, this result is a satisfying one for auditors, as it suggests that managers value high quality audits and view audit services as something other than a necessary evil. In this study, we partition New Zealand companies into various market segments to consider the possible benefits of hiring a specialist auditor, and whether (and when) such benefits justify higher audit fees. We find that there are premiums for specialisation at the city level but not at the national level. The issue of self-selection, whereby clients choose auditors based on the same variables that determine audit fees, does not appear to arise as far as specialisation premiums are concerned. Somewhat surprisingly, we find that audit premiums for specialization apply principally to larger client firms, and to non-issuers and to low-risk companies. These findings suggest that fee premiums in our setting are most likely to be paid not by those firms in greatest need of a signal of earnings quality, but rather by those firms who can most easily afford such a signal. This may occur because firms which do not have specialist expertise in an industry have to offer discounts to attract the most desirable clients, i.e. those that are large, those that are growing and those that are low risk. The results suggest that auditor specialist fee premiums involve a fairly complex interaction between demand and supply concerns.