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An International Meeting of American Accounting
Association
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The Effects of Auditor’s Portfolio Industry Concentration and Diversification Typology on Auditor Clients’ Earnings Quality |
Ahmed M. Abdel - Meguid
Syracuse University
Abstract: This paper investigates the effect of the auditor’s overall portfolio structure, in terms of industry concentration and industry-mix, on clients’ earnings quality. I introduce two new measures extensively used in the strategy literature; a portfolio-level Herfindahl (H) concentration index and the Entropy measure of diversification. Results show that the overall industry concentration (total diversification) of the auditor’s portfolio is negatively (positively) related to clients’ abnormal accruals. In addition, I find that the engagement of the auditor by clients in different, but related industries (i.e. related diversification), leads to lower abnormal accruals. I refer to this phenomenon as “Inter-Industry Knowledge Spillovers”. I document an opposite effect for unrelated diversification. Overall, my results suggest that the auditor’s portfolio structure is an important determinant of auditing effectiveness, and thus earnings quality.