Audit Quality Attributes, Client Size and Cost of Capital
41 Pages Posted: 2 Oct 2005 Last revised: 17 Aug 2008
Date Written: April 2008
We investigate the effects of audit quality attributes related to the auditor and the auditor-client relationship on the firm's cost of capital. We further examine whether these effects differ according to client size. We focus on two auditor characteristics; auditor size and auditor industry specialization and two auditor-client relationship characteristics; auditor tenure and the auditor's opinion. We use the client firm's cost of capital as a proxy for the degree to which the market values these quality attributes.
Auditor size, industry specialization, tenure and type of auditor opinion are important determinants of perceived audit quality. The first three characteristics are negatively related to the cost of capital. We also find that that the client firm's cost of capital increases if the auditor issues any opinion other than a clean opinion. These results are driven by small clients, suggesting audit quality attributes are highly appreciated for smaller clients.
Keywords: Cost of capital, audit firm size, auditor specialization, information and monitoring
JEL Classification: M49
Suggested Citation: Suggested Citation