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    Do Big 4 Auditors Provide Higher Audit Quality after...
    research summary posted September 17, 2015 by Jennifer M Mueller-Phillips, tagged 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality, 11.08 Proxies for Audit Quality, 11.11 Impact of Firm and External Inspection Programs 
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    Title:
    Do Big 4 Auditors Provide Higher Audit Quality after Controlling for the Endogenous Choice of Auditor?
    Practical Implications:

    The evidence presented in this paper is of interest to managers, audit committees, investors, creditors, and regulators. Managers and audit committees would like to know whether the Big 4 actually do provide higher quality audits. This information will help them choose an auditor. Given that Big 4 auditors earn a fee premium, managers and audit committees must decide whether the services they receive from the auditor are worth the premium. Investors and creditors will also be interested in the results, as this will help them assess the credibility of firms’ financial reports. Regulators are also interested in whether the Big 4 accounting firms actually provide higher quality audits.

    Citation:

    Eshleman, J. D., and G. Peng. 2014. Do Big 4 Auditors Provide Higher Audit Quality after Controlling for the Endogenous Choice of Auditor? Auditing: A Journal of Practice & Theory 33 (4): 197-219.

    Keywords:
    audit quality, audit quality proxies, Big 4 auditor, propensity-score matching
    Purpose of the Study:

    The purpose of this paper is to re-examine whether Big 4 auditors deliver higher audit quality after controlling for the endogenous choice of auditor.

    One of the earliest theories in the audit literature is that Big 4 auditors, due to their larger size and better training programs, provide higher audit quality than other auditors. The argument is that larger audit firms have more reputation to lose by sacrificing their independence on any given audit engagement. In addition, larger audit firms have more resources to invest in training programs, resulting in better trained auditors. To the extent that discretionary accruals capture opportunistic earnings management, this implies that Big 4 auditors tolerate less earnings management than other auditors. However, firms select their auditors and auditors decide if they will accept the firm as their client. Audit firms will tend to prefer less risky clients with higher earnings quality. In this study, the authors choose an audit quality proxy, which they believe better captures whether the client engaged in non-GAAP reporting. The proxy is the likelihood of a firm issuing an accounting restatement.

    Design/Method/ Approach:

    The authors use a regression model to test their hypotheses. The authors obtain financial statement data from the Compustat Fundamentals Annual file, and auditor and restatement data from Audit Analytics for the period 20002009. The first hypothesis is tested with a sample of 5,950 observations. The second hypothesis is tested with a sample of 3,248 observations.

    Findings:
    • Clients of non-Big 4 auditors are significantly more likely to subsequently issue an accounting restatement than are clients of the Big 4. This result holds after controlling for a set of innate firm characteristics known to affect the likelihood of issuing a restatement. This is consistent with non-Big 4 auditors allowing a higher frequency of material misstatements than Big 4 auditors.
    • In additional analyses, results show that clients of Big 4 auditors are significantly less likely to be sanctioned by the SEC for an Accounting and Auditing Enforcement Release (AAER) than are clients of other auditors.
    • The authors construct a matched sample of Mid-tier and small auditors. They find no evidence that Mid-tier auditors provide higher audit quality than the small audit firms.
    • The authors also construct a matched sample of Big 4 and small auditors. Clients of small auditors are significantly more likely to subsequently issue an accounting restatement than are clients of the Big 4.
    • Taken together, the evidence suggests a hierarchy of audit firms, with Big 4 auditors providing the highest audit quality, small auditors providing the lowest level of audit quality, and Mid-tier auditors providing audit quality in between the Big 4 and the small auditors.
    Category:
    Audit Quality & Quality Control
    Sub-category:
    Attempts to Measure Audit Quality, Impact of Firm & External Inspection Programs, Proxies for Audit Quality