Industry expertise in audits leads to cost savings, quality boost: Study

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Corporations that partner with auditors who specialize in the company's industry reap cost savings and get a better picture of their finances, which boosts investor confidence, a new study has found.

Co-authored by professors Birendra Mishra and Theodore Mock from UC Riverside's School of Business, the study examines how the industry experience of auditors can influence audit fees and quality.

The study, "The Effects of Audit Partner Industry Experience on Lowballing, Subsequent Audit Fees, and Audit Quality", was published in the journal Auditing: A Journal of Practice & Theory.

The findings are based on a comprehensive analysis of 32,000 audit engagements in India—which has corporate finance rules like those in the U.S. They reveal that audit partners with extensive industry experience deliver higher-quality audits while also offering cost savings to clients in their initial engagements. In the study, auditors are referred to as "partners" with their clients in the finance industry.

"Expertise matters. An experienced audit partner in your industry can navigate complexities more efficiently, saving costs while ensuring better quality," said Mishra, a professor of accounting. "Think of an audit partner like a skilled surgeon—the more experience they have, the quicker and more precise they are, and that efficiency translates to savings for clients."

The study also found that companies should avoid auditors who "low-ball" their fees to compensate for a lack of experience. These auditors offer low prices during the first year but then hike fees in subsequent years to make up for the earlier discounts. The companies then wind up with higher costs and lower-quality audits.

"Audit partners with more industry experience don't rely on low-balling," Mishra said. "Their efficiency allows them to offer competitive initial pricing without the need for large fee hikes later. Low-balling can compromise audit quality because the focus shifts to recovering costs rather than delivering a thorough and accurate audit."

The research utilized audit data from India, where regulations have long mandated the disclosure of lead auditors in financial reports. This dataset enabled researchers to track the industry-specific experience of individual auditors.

The team developed a novel metric, which they called "INDEXP_PTNR." It measures an auditor's cumulative years of industry experience. The researchers also employed statistical models to assess the impact of this experience on initial-year pricing, subsequent fee adjustments, and audit quality.

"The Indian auditing standards are remarkably similar to those in the U.S., making the findings highly applicable internationally," Mishra noted.

The study's insights could transform how companies select audit partners and reshape regulatory perspectives in the U.S. and beyond. In the U.S., publicly traded corporations are required by law to undergo annual audits that detail their costs, revenues, profits, and losses. Audit costs range from hundreds of thousands of dollars to tens of millions of dollars, depending on the size and type of company.

Good auditing can potentially boost a company's value. "High-quality audits strengthen the link between earnings and stock prices, boosting investor confidence in your company," Mishra said.

Mishra and Mock collaborated with researchers Naman Desai of the Indian Institute of Management in Ahmedabad, India, and Siddharth Purohit of University College in Dublin, Ireland.

"If you're selecting an auditor, go for someone with lots of industry-specific experience. They'll deliver better results and keep audit costs down over the long term, and are likely to give your stock a boost," Mishra said.

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 (2024). DOI: 10.2308/AJPT-2022-133

Provided by University of California - Riverside