Guardians of governance: the role of auditor industry specialization in mitigating corporate misconduct through internal controls

Purpose This study examines the impact of statutory auditor industry specialization on corporate misconduct in China’s A-share market, with a specific focus on the mediating role of internal control quality in mitigating corporate misconduct. Design/methodology/approach Using a sample of 3,794 firms (2010-2022), we apply fixed-effects regression models and a two-stage least squares (2SLS) approach to address potential endogeneity. We quantify auditor industry specialization using market share, while the occurrence and frequency of regulatory violations are used to measure corporate misconduct. Findings The results show that auditors with industry specialization significantly reduce both the likelihood and frequency of corporate misconduct. Furthermore, internal control quality serves as a significant mediating mechanism in the relationship between auditor industry specialization and corporate misconduct. These findings highlight the role of industry specialized auditors as vital external governance agents, particularly in firms with concentrated ownership or those operating in highly competitive industries. Practical implications This study highlights policy implications for regulators and policymakers, recommending the development of auditor industry specialization through certification programs and stricter industry-specific auditing standards. Firms should engage industry-specialized auditors and invest in resources and training to improve the quality of internal controls. Originality/value This research significantly contributes to the corporate governance and auditing literature by highlighting that auditor industry specialization serves as a key external disciplinary mechanism that enhances the effectiveness of internal control. It also contributes to agency and resource-based theories by highlighting the critical role of auditor industry specialization and internal control in detecting and preventing corporate misconduct.