The Influence of Audit Firm Specialization on Analysts’ Forecast Errors

Abstract

This study investigates audit firm specialization in settings where managers have incentives to modify earnings to achieve analysts' earnings forecasts. The results indicate that audit firms that have a large market share of clients within a particular industry, and audit firms that receive a significant portion of their firm revenues from a specific industry, are associated with audited financial statement earnings that increase absolute levels of analysts' forecast error and are less likely to just meet or beat analysts' forecasts.

http://www.growingscience.com/msl/Vol5/msl_2015_43.pdf

“…Using some regression techniques, the study has determined that while there was a positive and meaningful relationship between earnings accuracy and investment discipline in terms of short/long term investment sentiment, there was no meaningful relationship between earnings accuracy and volume of trades. The results of our survey are consistent with findings earlier reported in the literature (Coën et al, 2009;Fang, 2009;Payne, 2008;Rees & Sivaramakrishnan, 2007). The results of this survey suggest TSE officials to build a better rules and regulations, which could help many investors.…”

“…They reported that forecasting quality was positively related to the quality of both acquisition and capital expenditure decisions. Payne (2008) investigated audit firm specialization in settings where managers had incentives to modify earnings to reach analysts' earnings forecasts. Their results indicated that audit firms that had a large market share of clients within a specific industry, and audit companies that received a significant portion of their firm revenues from a particular industry, were related to audited financial statement earnings that increased absolute levels of analysts' forecast error and were less likely to just meet or beat analysts' forecasts.…”

Audit firm industry specialization and the audit report lag

“…1 summarizes the domain of industry specialist audit research. Firms audited by industry specialist auditors report lower levels of absolute discretionary accruals (Krishnan, 2003;Balsam et al, 2003;andVelury, 2003 in the US, andKwon et al, 2007 internationally); increased earnings conservatism (Krishnan, 2005); reduced propensity for the earnings to just meet or beat analysts' forecasts (Payne, 2008); improved disclosure quality (Dunn & Mayhew, 2004); enhanced predictability of earnings as measured by analyst earnings forecast accuracy and dispersion (Behn, Choi, & Kang, 2008); fewer earnings restatements (Romanus, Maher, & Fleming, 2008); and a higher ERC (Kwon et al, 2007) compared to the clients of non-specialist auditors. 2 Experimental evidence also reports beneficial effects of industry-specialist auditors, attributed to a comprehensive understanding of companies' error characteristics (Hammersley, 2006;Maletta & Wright, 1996;Solomon, Shields, & Whittington, 1999); industry-specific tasks (Owhoso, Messier, & Lynch, 2002;Taylor, 2000); and increased performance gains (Dowling & Moroney, 2008).…”

Changes in the measurement of fair value: Implications for accounting earnings

“…High-growth firms more likely to manage earnings to meet target as their share price is more sensitive to missing analyst forecasts (McVay et al 2006). Change in earnings (CHGINC) and earnings persistence (PERSIST) are included because greater changes and less persistence of earnings are more difficult to forecast (Payne 2008). We also include tier 1 and total capital ratios.…”

“…We include bank size (SIZE), analyst coverage (NUMEST) and analyst forecast dispersion (DISPERS) to control for cross-sectional differences in the information environment that may explain variations in forecast accuracy (Payne 2008;Davis et al 2009). We include the book to market ratio (BM), which controls for the future growth.…”