Audit Quality and Risk Differences Among Auditors

Abstract

This study tests for differences in audit quality among Big Auditors and between Big Auditors and Small Auditors. The analysis is conducted using four separate "auditor eras" during the period from January 1980 through December 2003, with each era reflecting the number of Big Auditors in the industry. We begin by explicitly testing the validity of pooling across Big Auditors and time periods using an industry adjusted measure of the variance of earnings quality. These tests, as a proxy for audit quality, show important differences in quality among Big Auditors and across eras. Based on the recognition of these important differences, intercept tests of auditor based asset portfolios, using a three factor asset pricing model, are used to assess systematic risk differences. Results show that there was only one era in which significant asset pricing effects are seen between Big and Small Auditors, and virtually no differences among Big Auditors, despite significant differences in quality. These results indicate the need for reassessment of arbitrary quality distinctions between Big and Small Auditors made in early research

Keywords: Audit Quality, Arthur Andersen, Big Five, Earnings Quality

JEL Classification: G12, G34, L84, M49