Group Audit Risk and Component Auditor Use: A Difference-in-Differences Analysis

Abstract

SUMMARY This study examines the association between group audit risk and component auditor use. The audit risk model defines audit risk as a function of the risk of material misstatement and detection risk. We use the revelation of an internal control material weakness (ICMW) as an event that increases the risk of material misstatement. Since higher risk of material misstatement requires the lead auditor to reduce detection risk, component auditor use could change after an ICMW. We find that the likelihood of starting component auditor use significantly increases after an ICMW. We also find an increase in the number of large component auditors used after an ICMW and such increase is concentrated in more pervasive entity-level ICMWs and higher-quality component auditors. Our evidence indicates that lead auditors perceive component auditor use as decreasing group audit risk. Our findings should inform the debate on the costs and benefits of component auditor use.