Abstract
This paper examines the relation between auditor industry specialization and analysts’ beginning-of-the-year earnings forecast accuracy. It predicts that the higher industry specialization of the auditors will improve the quality of external financial reports and thus mitigates the analysts’ forecast error. It also predicts that higher audit quality will have a negative association with analyst forecast dispersion. The empirical test results on Australian listed firms from the year 2003 to 2012 does not find evidence of association between audit firm industry specialization and analysts’ beginning-of the year earnings forecast error. However, firms with higher analysts forecast error is associated with lower forecast dispersion among analysts, which is consistent with the prediction that analysts are consistent with predicting future earnings and analysts possess similar traits in terms of difference with the actual earnings. Additional analysis also finds that’s larger firms have less forecast errors compared to smaller firms. The findings contribute to the growing literature on auditing and financial reporting quality in Australian context.
Highlights
A high-quality auditor is believed to reduce information asymmetry and increase the quality of financial reporting
INDSP_MKT = an audit firm's industry market –share (MKT) is 1 if the ratio of audit fee paid to a firm in a specific industry relative to audit fee paid by all companies in that industry is greater than 30 percent for 2003-2012, 0 otherwise. = INDSP_POWER = an audit firms portfolio share (POWER) is 1 if total audit fee of the clients that an auditor services in a specific industry-year divided by the sum of the audit fees of all clients that an auditor services in that year, is greater than 3/(number of industries in the sample), 0 otherwise
Coefficients for my first hypothesis test do not show any significant association between auditor industry specializations and forecast error both using market share and portfolio approach
Summary
A high-quality auditor is believed to reduce information asymmetry and increase the quality of financial reporting. According to the FASB Conceptual Framework, the general purpose of external financial reporting is to increase the usefulness of published financial reports to its users by decreasing the information asymmetry between the preparer and user of financial reports. For example, potential investors, creditors, lenders, or advisors, need this information for the prediction of future performance of the firm. Analysts need published financial reports to predict the future performance of the firm. It is logical to argue that high-quality financial reports should improve the quality of earnings forecast. This paper examines the relationship between auditor industry specialization, a common proxy for audit quality, and analysts’ earnings forecast. The analysis is performed on Australian listed firms between 2003 and 2012 and uses auditor industry market share, and auditor portfolio share both to determine the auditor industry specialization
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