Big 4 Auditors and Climate Risk

Abstract

We examine the role of Big 4 auditors in mitigating firm-level climate risk. We argue that Big 4 auditors help in reducing climate risk because it can be a source of material misstatements in annual reports and because there is increasing pressure from the investors on the auditors to incorporate climate risk. By analysing a large US dataset from 2010 to 2024, we find that Big 4 auditors are negatively related to firm-level climate risk. This relationship withstands a number of robustness tests. We then explore three sources of the Big 4 effect through mediation analysis, revealing that the negative effect of the Big 4 on climate risk is due to the fact that Big 4 exert greater audit effort, render greater consultancy services, and are more industry specialised. Furthermore, we find that the Big 4 effect is more pronounced when the internal control environment is weak, there is greater asymmetric information in the firm. We also use Critical Audit matters (CAM) enactment and Paris Agreement to sharpen our identification.

Keywords: Firm-level Carbon emissions, Big 4 auditors, Audit effort, Non-audit services, Industry specialist auditor