A New Measure of Accounting Quality*

Abstract

This study examines an alternative approach to measuring accounting quality. Adopting a neoclassical view of the audit market, we argue that unexplained audit fees are a measure of accounting quality. We develop a comprehensive model of audit fee determinants to estimate unexplained audit fees. We use the framework developed by Cronbach and Meehl (1955) to examine the construct validity of our new measure. We find that our audit fee-based measure of quality correlates positively with other empirical measures of quality. We further show our measure is predictive of fraud, restatements, and SEC comment letters, even after controlling for other measures of accounting quality. Finally, we show that it is less associated with innate firm characteristics than measures based on realized earnings, making it a good candidate for studies examining the economic consequences of accounting quality.

Keywords: Accounting Quality, Restatements, Fraud, Audit Fees

JEL Classification: M41, M43, M49, G12