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

Abstract

A restatement occurs when a previously issued financial statement contains a misstatement and this misstatement is detected and corrected. Higher audit quality lowers restatement probability by reducing misstatements, but it increases restatement probability by increasing the probability that misstatements will be detected and corrected. Most studies focus on misstatement reduction and equate higher audit quality with lower restatement rates. By contrast, we focus on how audit quality increases the probability that previously issued financial statements are restated. We find that Big Four auditees that have historically been associated with higher financial reporting quality, experienced an increase in restatement rates during the late 2000’s resulting in Big Four auditees having higher restatement rates than Non-Big Four auditees. The timing of this increase in restatement rates corresponds with a period of higher public scrutiny of Big Four auditors. We also find that the higher Big Four auditee restatement rate is driven by an increase in less material restatements and does not reflect a decrease in underlying financial reporting quality. Our findings underscore the importance of evaluating whether factors that increase audit quality could also increase restatement rates and highlight the bias that less material restatements introduce when evaluating financial reporting quality.

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