Review of Quantitative Finance and Accounting, 21: 35–48, 2003
2003 Kluwer Academic Publishers. Manufactured in The Netherlands.
Institutional Ownership and the Selection of Industry
Department of Accounting & MIS, Alfred Lerner College of Business & Economics, University of Delaware,
Newark, DE 19716, USA Tel.: (302) 831-1764
JOHN T. REISCH
Department of Accounting, School of Business, East Carolina University, Greenville, NC 27858-4353
Tel.: (252) 328-6619
DENNIS M. O’REILLY
Department of Accountancy, Williams College of Business, Xavier University, Cincinnati, OH 45207-5161
Tel.: (513) 745-2011
Abstract. This study provides evidence linking corporate governance mechanisms to the choice of auditor,
namely industry specialists. Given that institutional investors are likely to prefer higher quality ﬁnancial reports to
lower quality reports, we theorize that institutional investors will inﬂuence managers of companies in which they
invest to improve reporting quality by using higher quality, industry specialist auditors. Our ﬁndings indicate that
ﬁrms having relatively greater levels of institutional ownership tend to employ industry specialist audit ﬁrms. The
results of this study contribute to an understanding of an important facet of corporate governance, the selection of
a high quality audit ﬁrm.
Key words: industry specialization, audit quality, institutional ownership, corporate governance
JEL Classiﬁcation: M41
In this paper we examine the selection of industry specialist auditors by companies and
the investment in those companies by institutional investors.
Because these two decisions
are interrelated through management’s desire to make the ﬁrms attractive to institutional
investors by having high quality audits and the ability of institutional investors to demand
high quality auditors via increased voting power, we develop a simultaneous equation model
to examine this behavior.
Institutional investors are likely to demand higher levels of accounting quality in order
to facilitate their monitoring activities. Accounting quality can be viewed as the degree to
which the underlying economics of a business are reﬂected in the ﬁnancial reports. To the