Big Five Audits and Accounting Fraud

Abstract

Empirical studies of earnings management, audit pricing, and audit reporting provide extensive evidence that the Big Five public accounting firms are associated with higher quality financial statements (Francis 2004). Nevertheless, the recent high-profile financial reporting failures that roiled the U.S. capital markets cast doubt on whether this proposition remains valid. Indeed, many commentators interpret the steep upward trend during the late 1990s and early 2000s in accounting misstatements by companies with Big Five auditors as almost conclusive evidence that their assurance services have deteriorated over time (e.g., Coffee 2002; Imhoff 2003; Zeff 2003). Measuring trends in absolute audit quality is typically infeasible, so we more narrowly focus on discriminating between the relative performance of the Big Five and non-Big Five audit firms in preventing companies from orchestrating accounting fraud. Contrary to recent criticisms of the Big Five firms, we provide compelling evidence that they were consistently associated with a lower incidence of accounting fraud, even in the years shortly prior to the sweeping corporate governance reforms. Moreover, this finding is robust to controlling for the endogenous effects of screening by audit firms and selection by their clients.

Keywords: Big 5, fraud, audit quality

JEL Classification: M4