The effect of auditors' geographic distance and industry specialization on the reporting of goodwill impairment

Using a sample of 1,385 firm year observations collected for UK nonfinancial listed firms on the LSE FTSE ALL SHARES index, this paper investigates the effect of geographic proximity between auditors and their clients, and auditor industry specialization on the reporting of goodwill impairment over the period from 2006 – 2014. Results show a strongly significant positive relationship between geographic distance, measure by log of miles, and both the likelihood and magnitude of unexpected goodwill impairment. This indicates that the greater the distance between audit firm and the client headquarter, the greater information asymmetry and the less likely that auditors might control management from manipulating the impairment test and reporting more/less goodwill impairment than it should be. Interestingly, when the auditor is specialized, his expertise and knowledge helps to reduce the information asymmetry problems and become better able to challenge the management on the estimates and assumptions they have used, and thus constrain them from using goodwill impairment as a tool for managing their earnings. However, auditors’ specialization is moderating this relationship only when auditors are classified as being specialized on the regional level, demonstrating that knowledge and expertise are shared only between audit partners and offices located in the same region, and not expanded to others located outside that region.