IDEAS home Printed from https://ideas.repec.org/a/inm/ormnsc/v66y2020i10p4552-4572.html
   My bibliography  Save this article

How Big-4 Firms Improve Audit Quality

Author

Listed:
  • Limei Che

    (University of South-Eastern Norway, 3679 Notodden, Norway;)

  • Ole-Kristian Hope

    (Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3A6, Canada; BI Norwegian Business School, 0484 Oslo, Norway)

  • John Christian Langli

    (BI Norwegian Business School, 0484 Oslo, Norway)

Abstract

This paper studies whether and how Big-4 firms provide higher-quality audits than non-Big-4 firms. Specifically, we first examine a Big-4 effect and then explore three sources of the Big-4 effect. To test the Big-4 effect, we use a unique data set of individual audit partners for a large sample of private companies and a novel research design exploiting the fact that auditees may follow the auditor who switches affiliation from a non-Big-4 firm to a Big-4 firm. Thus, we compare audit quality and audit fees of the same partner–auditee pairs before and after the switch. The results show that the Big-4 effect exists in the private-firm segment. More important, we find evidence for three sources of the Big-4 effect. First, Big-4 firms are able to recruit non-Big-4 partners who deliver higher audit quality than other non-Big-4 partners in the preswitch period. Second, enhanced learning has taken place after the switch. Third, the increased audit quality can also be attributed to stronger incentives/monitoring . These are new findings to the literature.

Suggested Citation

  • Limei Che & Ole-Kristian Hope & John Christian Langli, 2020. "How Big-4 Firms Improve Audit Quality," Management Science, INFORMS, vol. 66(10), pages 4552-4572, October.
    • Handle: RePEc:inm:ormnsc:v:66:y:2020:i:10:p:4552-4572
    DOI: 10.1287/mnsc.2019.3370
    as

    Download full text from publisher

    File URL: https://doi.org/10.1287/mnsc.2019.3370
    Download Restriction: no
    File URL: https://libkey.io/10.1287/mnsc.2019.3370?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Kim, E. Han & Morse, Adair & Zingales, Luigi, 2009. "Are elite universities losing their competitive edge?," Journal of Financial Economics, Elsevier, vol. 93(3), pages 353-381, September.
    2. Linda Myers & Jaime Schmidt & Michael Wilkins, 2014. "An investigation of recent changes in going concern reporting decisions among Big N and non-Big N auditors," Review of Quantitative Finance and Accounting, Springer, vol. 43(1), pages 155-172, July.
    3. Boris Groysberg & Linda-Eling Lee & Ashish Nanda, 2008. "Can They Take It With Them? The Portability of Star Knowledge Workers' Performance," Management Science, INFORMS, vol. 54(7), pages 1213-1230, July.
    4. Ole-Kristian Hope & Dushyantkumar Vyas, 2017. "Private company finance and financial reporting," Accounting and Business Research, Taylor & Francis Journals, vol. 47(5), pages 506-537, July.
    5. Alexander Oettl, 2012. "Reconceptualizing Stars: Scientist Helpfulness and Peer Performance," Management Science, INFORMS, vol. 58(6), pages 1122-1140, June.
    6. W. Robert Knechel & Lasse Niemi & Mikko Zerni, 2013. "Empirical Evidence on the Implicit Determinants of Compensation in Big 4 Audit Partnerships," Journal of Accounting Research, Wiley Blackwell, vol. 51(2), pages 349-387, May.
    7. Healy, Paul & Lys, Thomas, 1986. "Auditor changes following big eight mergers with non-big eight audit firms," Journal of Accounting and Public Policy, Elsevier, vol. 5(4), pages 251-265.
    8. DeAngelo, Linda Elizabeth, 1981. "Auditor size and audit quality," Journal of Accounting and Economics, Elsevier, vol. 3(3), pages 183-199, December.
    9. Karla M. Johnstone & Jean C. Bedard, 2004. "Audit Firm Portfolio Management Decisions," Journal of Accounting Research, Wiley Blackwell, vol. 42(4), pages 659-690, September.
    10. Beaver, Wh, 1966. "Financial Ratios As Predictors Of Failure," Journal of Accounting Research, Wiley Blackwell, vol. 4, pages 71-111.
    11. Ball, Ray & Shivakumar, Lakshmanan, 2005. "Earnings quality in UK private firms: comparative loss recognition timeliness," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 83-128, February.
    12. Ann Vanstraelen & Caren Schelleman, 2017. "Auditing private companies: what do we know?," Accounting and Business Research, Taylor & Francis Journals, vol. 47(5), pages 565-584, July.
    13. W. Robert Knechel & Ann Vanstraelen & Mikko Zerni, 2015. "Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions," Contemporary Accounting Research, John Wiley & Sons, vol. 32(4), pages 1443-1478, December.
    14. Iacus, Stefano M. & King, Gary & Porro, Giuseppe, 2011. "Multivariate Matching Methods That Are Monotonic Imbalance Bounding," Journal of the American Statistical Association, American Statistical Association, vol. 106(493), pages 345-361.
    15. K. Hung Chan & Donghui Wu, 2011. "Aggregate Quasi Rents and Auditor Independence: Evidence from Audit Firm Mergers in China," Contemporary Accounting Research, John Wiley & Sons, vol. 28(1), pages 175-213, March.
    16. Boone, Jeff P. & Khurana, Inder K. & Raman, K.K., 2010. "Do the Big 4 and the Second-tier firms provide audits of similar quality?," Journal of Accounting and Public Policy, Elsevier, vol. 29(4), pages 330-352, July.
    17. Dye, Ronald A, 1993. "Auditing Standards, Legal Liability, and Auditor Wealth," Journal of Political Economy, University of Chicago Press, vol. 101(5), pages 887-914, October.
    18. Ohlson, Ja, 1980. "Financial Ratios And The Probabilistic Prediction Of Bankruptcy," Journal of Accounting Research, Wiley Blackwell, vol. 18(1), pages 109-131.
    19. Patricia M. Dechow & Amy P. Hutton & Jung Hoon Kim & Richard G. Sloan, 2012. "Detecting Earnings Management: A New Approach," Journal of Accounting Research, Wiley Blackwell, vol. 50(2), pages 275-334, May.
    20. Beaver, Wh, 1966. "Financial Ratios As Predictors Of Failure - Reply," Journal of Accounting Research, Wiley Blackwell, vol. 4, pages 123-127.
    21. Kothari, S.P. & Leone, Andrew J. & Wasley, Charles E., 2005. "Performance matched discretionary accrual measures," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 163-197, February.
    22. DeFond, Mark & Zhang, Jieying, 2014. "A review of archival auditing research," Journal of Accounting and Economics, Elsevier, vol. 58(2), pages 275-326.
    23. Stefan Sundgren & Tobias Svanström, 2013. "Audit office size, audit quality and audit pricing: evidence from small- and medium-sized enterprises," Accounting and Business Research, Taylor & Francis Journals, vol. 43(1), pages 31-55, February.
    24. Mark DeFond & David H. Erkens & Jieying Zhang, 2017. "Do Client Characteristics Really Drive the Big N Audit Quality Effect? New Evidence from Propensity Score Matching," Management Science, INFORMS, vol. 63(11), pages 3628-3649, November.
    25. Ann Gaeremynck & Marleen Willekens, 2003. "The endogenous relationship between audit-report type and business termination: evidence on private firms in a non-litigious environment," Accounting and Business Research, Taylor & Francis Journals, vol. 33(1), pages 65-79.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Catalin Mos, 2024. "Uncertainty, Financial Reporting Quality and Accounting Enforcement: Evidence from The European Union," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 23(3), pages 616-642, September.
    2. Eugster, Nicolas & Kowalewski, Oskar & Śpiewanowski, Piotr, 2024. "Internal governance mechanisms and corporate misconduct," International Review of Financial Analysis, Elsevier, vol. 92(C).
    3. Xiaoqian Zhu & Jianping Li & Yinghui Wang, 2024. "Are risk disclosures in financial reports informative? A text mining-based perspective," Palgrave Communications, Palgrave Macmillan, vol. 11(1), pages 1-18, December.
    4. Lee, Eugenia Y. & Ha, Wonsuk & Park, Sunyoung, 2023. "Auditor specialization in R&D and clients’ R&D investment-q sensitivity," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(2).
    5. Yu, Lin & Bai, Tao & Yin, Jingwei & Tan, Xue, 2024. "Overcoming the liability of origin by hiring foreign independent directors: Evidence from Chinese firms' cross-border M&As," Journal of World Business, Elsevier, vol. 59(2).
    6. Aase, Øivind André Strand, 2022. "Effects of Voluntary Audit on Accounting Quality in Small Private Firms," Discussion Papers 2022/1, Norwegian School of Economics, Department of Business and Management Science.
    7. Zhang, Yifu, 2024. "Capital market liberalization and accounting quality: Evidence from China," Finance Research Letters, Elsevier, vol. 64(C).
    8. Mahfuz Chy & Ole-Kristian Hope, 2021. "Real effects of auditor conservatism," Review of Accounting Studies, Springer, vol. 26(2), pages 730-771, June.
    9. Mohammad Abedalrahman Alhmood & Hasnah Shaari & Redhwan Al-dhamari, 2022. "Audit Partner Characteristics and Real Earnings Management Practices in Jordan," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 185-200.
    10. Aase, Øivind André, 2022. "Size Management in Response to Mandatory Audit Rules," Discussion Papers 2022/2, Norwegian School of Economics, Department of Business and Management Science.
    11. Sundgren, Stefan & Alexeyeva, Irina, 2022. "Entrepreneurs’ legal infractions and hidden information: Evidence from small business bankruptcies," International Review of Law and Economics, Elsevier, vol. 69(C).
    12. Rachael Modupe Gbadamosi & Ezekiel Alade, 2024. "Auditors' Characteristics and Timeliness of Listed Family-Owned Firms in Nigeria," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 23(1), pages 215-236, January.
    13. Ozili, Peterson Kitakogelu, 2021. "Big 4 auditors, bank earnings management and financial crisis in Africa," MPRA Paper 108608, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Mark DeFond & David H. Erkens & Jieying Zhang, 2017. "Do Client Characteristics Really Drive the Big N Audit Quality Effect? New Evidence from Propensity Score Matching," Management Science, INFORMS, vol. 63(11), pages 3628-3649, November.
    2. Pan, Yue & Shroff, Nemit & Zhang, Pengdong, 2023. "The dark side of audit market competition," Journal of Accounting and Economics, Elsevier, vol. 75(1).
    3. Daniel Aobdia & Luminita Enache & Anup Srivastava, 2021. "Changes in Big N auditors’ client selection and retention strategies over time," Review of Quantitative Finance and Accounting, Springer, vol. 56(2), pages 715-754, February.
    4. Guangming Gong & Liang Xiao & Si Xu & Xun Gong, 2019. "Do Bond Investors Care About Engagement Auditors’ Negative Experiences? Evidence from China," Journal of Business Ethics, Springer, vol. 158(3), pages 779-806, September.
    5. Breuer, Matthias & Le, Anthony & Vetter, Felix, 2023. "Audit mandates, audit firms, and auditors," Working Papers 333, The University of Chicago Booth School of Business, George J. Stigler Center for the Study of the Economy and the State.
    6. Wen Hua Sharpe & Peter Carey & Hong Feng Zhang, 2023. "Being private, Big 4 auditors, and debt raising," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(2), pages 2295-2345, June.
    7. Shaw, Kenneth W. & Whitworth, James D., 2022. "Client importance and unconditional conservatism in complex accounting estimates," Advances in accounting, Elsevier, vol. 58(C).
    8. Rajat Deb & Mukesh Nepal & Sourav Chakraborty, 2023. "IFRS and Audit Quality: A Systematic Literature Review," Management and Labour Studies, XLRI Jamshedpur, School of Business Management & Human Resources, vol. 48(1), pages 118-138, February.
    9. Reiner Quick & Niklas Schenk & Florian Schmidt & Thilo Towara, 2018. "The impact of corporate governance on auditor choice: evidence from Germany," Journal of Management & Governance, Springer;Accademia Italiana di Economia Aziendale (AIDEA), vol. 22(2), pages 251-283, June.
    10. Cahan, Steven & Hay, David & Li, Lina Z., 2021. "Audit firm merger and the strategic response by large audit firms," The British Accounting Review, Elsevier, vol. 53(3).
    11. DeFond, Mark & Zhang, Jieying, 2014. "A review of archival auditing research," Journal of Accounting and Economics, Elsevier, vol. 58(2), pages 275-326.
    12. Tsipouridou, Maria & Spathis, Charalambos, 2012. "Earnings management and the role of auditors in an unusual IFRS context: The case of Greece," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 21(1), pages 62-78.
    13. Juan García Lara & Beatriz Osma & Evi Neophytou, 2009. "Earnings quality in ex‐post failed firms," Accounting and Business Research, Taylor & Francis Journals, vol. 39(2), pages 119-138.
    14. Zhu, Tingting & Lu, Meiting & Shan, Yaowen & Zhang, Yuanlong, 2015. "Accrual-based and real activity earnings management at the back door: Evidence from Chinese reverse mergers," Pacific-Basin Finance Journal, Elsevier, vol. 35(PA), pages 317-339.
    15. Timothy B. Bell & Monika Causholli & W. Robert Knechel, 2015. "Audit Firm Tenure, Non‐Audit Services, and Internal Assessments of Audit Quality," Journal of Accounting Research, Wiley Blackwell, vol. 53(3), pages 461-509, June.
    16. Knechel, W. Robert & Thomas, Edward & Driskill, Matthew, 2020. "Understanding financial auditing from a service perspective," Accounting, Organizations and Society, Elsevier, vol. 81(C).
    17. Chy, Mahfuz & De Franco, Gus & Su, Barbara, 2021. "The effect of auditor litigation risk on clients' access to bank debt: Evidence from a quasi-experiment," Journal of Accounting and Economics, Elsevier, vol. 71(1).
    18. Giuseppe Iuliano & Gaetano Matonti, 2015. "Do big 4 audit companies detect earnings management and report it in the audit opinion? Empirical evidence from italian non-listed firms," ESPERIENZE D'IMPRESA, FrancoAngeli Editore, vol. 2015(2), pages 5-43.
    19. Kevin Koh & Li Li & Xuejiao Liu & Chunfei Wang, 2023. "The Effect of Audit Partner Diversity on Audit Quality: Evidence from China," Abacus, Accounting Foundation, University of Sydney, vol. 59(1), pages 340-380, March.
    20. Nathan R. Berglund, 2020. "Do Client Bankruptcies Preceded by Clean Audit Opinions Damage Auditor Reputation?," Contemporary Accounting Research, John Wiley & Sons, vol. 37(3), pages 1914-1951, September.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:66:y:2020:i:10:p:4552-4572. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.