The governance role of R&D specialist auditors: Evidence from discretionary R&D expenditure

Abstract

PurposeThis study aims to examine whether auditors who specialize in research and development (R&D) activities help reduce managers’ opportunistic adjustment of R&D expenditure for real earnings management (REM).Design/methodology/approachUsing a sample of US firms during the 2001–2017 period, the authors identify auditors’ R&D specialization as their prior experience of auditing R&D expenses spent by each client’s peers. The authors measure R&D-based REM as the negative deviation from the predicted level of R&D expenditure.FindingsThe authors find that clients of R&D specialist auditors are less likely to engage in REM through a discretionary reduction of R&D expenditure. This effect is more pronounced when clients face higher competition, have larger investment opportunities and entail higher audit risks.Practical implicationsThis study shows that auditors’ specialized knowledge can facilitate stronger monitoring of clients’ real decisions, providing implications for auditors’ knowledge acquisition and transfer in specific types of transactions.Originality/valueThis study contributes to the literature by documenting the governance role played by R&D specialist auditors in clients’ real economic decisions. Moreover, the study identifies R&D as a distinct area of auditor specialization.