David versus Goliath: The Relation Between Auditor Size and Audit Quality for U.K. Private Firms
European Accounting Review, Forthcoming
58 Pages Posted: 29 Jan 2018 Last revised: 23 Sep 2021
Date Written: September 21, 2021
We examine the relation between auditor size and audit quality for a sample of U.K. private firms. Private firms prioritize tax considerations over reducing information asymmetry in their financial reporting. We find that Big 4’s private clients exhibit higher levels of discretionary accruals and lower precision of accrual estimates than non-Big 4’s private clients. Although Big 4 auditors are less tolerant of income-increasing earnings management, they leave more room for downward earnings management and their private clients are able to engage in greater tax avoidance. These results are stronger for standalone firms than for business groups as the latter’s greater demand for stakeholder communication motivates Big 4 auditors to increase audit quality. Collectively, our evidence suggests that Big 4 auditors adjust audit quality in a more competitive segment of the audit market where client firms generally perceive the benefit from tax minimization to outweigh the cost of reduced earnings informativeness.
Keywords: Big 4, private firms, audit quality, tax planning
JEL Classification: H26, M41, M42
Suggested Citation: Suggested Citation