Higher Audit Quality and Higher Restatement Rates: An Examination of Big Four Auditee Restatements

Abstract

Lower restatement rates are widely used as a proxy for higher audit quality. However, a restatement occurs when a misstated financial statement is corrected. While higher audit quality decreases the probability of a misstatement, it increases the probability that a misstatement is corrected. Higher audit quality can lead to higher restatement rates if the increase in correction probability dominates the decrease in misstatement probability. Using the PCAOB’s increased scrutiny of the Big Four auditors in the late 2000s as a natural experiment, we find that Big Four auditee restatement rates are higher than non-Big Four auditees in the higher scrutiny period, but not in the preceding or succeeding periods. Less material restatements drive the higher Big Four auditee restatement rate. However, we observe no deterioration in audit quality using non-misstatement measures. We offer suggestions on how researchers can more carefully evaluate the restatement results in specific research contexts.

Keywords: Restatements, Audit Quality, Big Four Auditors, Regulatory Scrutiny, PCAOB