The Investment Opportunity Set and Industry Specialization by Auditors
By
Steven F. Cahan,
Jayne M. Godfrey ,
Jane Hamilton , and Debra C. Jeter
ABSTRACT
While auditor industry specialization has attracted widespread interest in the academic literature, one of the most fundamental questions remains unanswered: Why do some industries lend themselves to more intensive auditor specialization than others? In this study, we posit that IOS plays an important role in determining whether an industry is an attractive target for auditor specialization. We argue that when industry-specific IOS is high, auditors must make costly industry-specific investments that allow them to offer a differentiated product and create entry barriers for other audit firms. However, when a large component of IOS is unique to specific firms within an industry (i.e., IOS is highly variable within the industry), this creates unique knowledge requirements for the firm’s auditor, and it is more difficult to transfer knowledge and spread costs across clients in that industry. Using two different measures of IOS and three alternative industry classification schemes, we present evidence that auditor specialization is increasing in industry IOS levels and decreasing in within-industry IOS variability.
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