Industry specialization and discretionary accruals for Big 4 and non-Big 4 auditors

This paper examines the effect of industry specialization in local markets on the quality of audits provided by non-Big 4 auditors, and how the quality of audits provided by non-Big 4 auditors that are industry specialists in local markets compares to the audit quality of Big 4 non-specialist auditors. Prior research has used size (Big N vs. non-Big N) and industry specialization among Big N auditors as proxies for audit quality. However, industry specialization has generally been based on national market shares. Recent research has focused on local markets to identify industry specialist auditors. Such research has continued to focus on Big N market shares and has generally ignored market shares controlled by non-Big N auditors. This paper compares the quality of audits provided by Big 4, second-tier, and third-tier auditors that are industry specialists in local markets with the quality of audits provided by non-specialists of all sizes. Results based on a data set comprised of firms with auditors located in California and Florida for the period from 2003 to 2006 indicate that clients of second-tier and third-tier auditors that are industry specialists in local markets report lower levels of absolute discretionary accruals than do clients of Big 4 non-specialist auditors. Results also indicate that clients of third-tier auditors that are industry specialists in local markets report lower levels of absolute discretionary accruals than do clients of second-tier non-specialist auditors. Based on these results, the use of size (Big 4 vs. non-Big 4) as a proxy for audit quality may need to be revised to consider industry specialization in local markets in auditing research.;Keywords: Auditor industry specialization, audit quality, Big 4 auditors, non-Big 4 auditors, discretionary accruals...