Industry-Specific Knowledge Transfer in Audit Firms : Evidence from Audit Firm Mergers in China

We utilize the setting of the audit market consolidation in China to examine the effect of industry-specific knowledge transfer on audit performance. For each audit firm merger, we sort all client companies into the treatment and control groups based on the relative industry expertise of their auditors before the merger. We employ a difference-in-difference approach and find an economically significant improvement in audit quality (as reflected in a reduction in misstatements) for the treatment group relative to the control group in the same merged audit firm. Further, we show that the treatment effect is not driven by changes in auditor incentives or personnel movement and is more pronounced when we expect stronger communication between the less and more specialized auditors after the merger. Together, our findings suggest that industry-specific knowledge transfer in audit firms leads to an economically significant audit performance improvement