Measurement of Audit Quality in Academic Studies

Abstract

“The auditors failed spectacularly” is usually claimed after the failure of companies, for example in the aftermath of the financial crises when many banks went bankrupt, or after scandals like in the Wirecard-case. As a political consequence, often changes in auditor´s related laws are proposed to increase the quality of the work of the auditor-profession. However, the quality of an audit is basically not directly tangible or observable and therefore represents a credence good for the addressees of financial statements. This implies that there are clear information asymmetries regarding the quality of the audit services provided, and the recipient cannot immediately determine the quality even after they have been performed. The audit process as such remains largely unobservable, a quality assessment is only possible to a very limited extent. A further problem is that audit quality is neither clearly defined by law, nor uniformly delineated by the profession or in the literature. These circumstances make it necessary to rely on quantitatively measurable substitutes of audit quality, so-called surrogates or proxies, which are based on publicly available information, instead of a direct measurement of quality.

Therefore, the focus of this academic paper is on the evaluation of various surrogates used in academic studies. The approach is database-driven, in that national and international empirical archival studies as currently the dominant method of analysis in accounting research are categorised according to the surrogates used, and subsequently critically assessed in terms of both the suitability of the quality surrogates and their form of data collection. Those surrogates, which are particularly widespread in empirical research, will be presented in more detail. Due to the extensive range of scientific studies within this research area, the present paper is limited in particular to the use of highly ranked peer-reviewed journals. The focus is on the conceptual examination of the individual surrogates. An overall assessment of the results from different perspectives of stakeholders with a strong relation to audit quality is carried out, to be able to classify their practical and theoretical relevance in particular and to derive concrete recommendations for action. The aim of this work is to show solution approaches, how the characteristic of audit quality as a credence good can be overcome, at least in part, by using suitable quality surrogates.

Keywords: Audit, Audit Quality, Mesurement of Audit Quality, Regulation of Auditors, Failures of Banks, Failures of Companies

JEL Classification: G15, G18, G28, M40, M41, M42, M48