Auditor tenure, auditor specialization, and information asymmetry

Abstract

PurposeThe purpose of this paper is to examine the relation between a company's bid‐ask spread, a proxy for information asymmetry, and auditor tenure and specialization.Design/methodology/approachThe tests use clustered regression for a sample of 31,689 company‐years from 1992 to 2001 and control for factors known to impact bid‐ask spread in cross‐section.FindingsThe findings suggest that the market's perception of disclosure quality is higher and private information search opportunities are fewer for companies engaging industry specialist auditors. In addition, the paper finds that information asymmetry has a U‐shaped relation to auditor tenure. This U‐shaped relation holds for both specialists and non‐specialists; however, the bid‐ask spread for specialists tends to fall below that of non‐specialists at all tenure intervals.Research limitations/implicationsThe findings may directly result from auditor tenure and specialization or it may be that those auditor‐related characteristics are a subset of concurrent choices made by the company that impacts disclosure quality.Practical implicationsCompanies have incentives to lower information asymmetry and the findings document that the choice of a specialist auditor and the length of the auditor relationship can potentially influence this objective.Originality/valueThe paper provides information to academics, regulators, companies, and auditors concerning the effect of auditor‐client relationships on the level of information asymmetry. In addition, it shows the importance of industry specialization and audit firm tenure on audit quality.