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Audit-Firm Portfolio Characteristics and Client Financial Reporting Quality

Author

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  • Ann Gaeremynck
  • Sofie Van Der Meulen
  • Marleen Willekens

Abstract

This paper contributes to the audit quality literature by defining continuous measures of expected future audit-firm losses and testing their association with proxies of financial reporting quality. In prior studies audit-firm size has been used as a proxy for expected future audit-firm losses and hence - following theoretical arguments in DeAngelo (Journal of Accounting and Economics, 3(3), pp. 183-199, 1981) and Dye (Journal of Political Economy, 101(5), pp. 887-914, 1993) - for audit quality. In particular, the Big 8/6/5/4 indicator variable has been tested empirically against various measures of client financial reporting quality. In this paper, we focus on testing various characteristics of an audit firm's client portfolio as drivers of audit quality (and therefore subsequently also client financial reporting quality), including measures to proxy size, visibility and financial health characteristics of an audit-firm portfolio. We test both a disclosure and earnings quality model for that purpose, and find for a sample of Belgian companies in financial distress, that audit-firm portfolio characteristics better explain variations in client financial reporting quality than the traditionally used Big N indicator variable. In particular, we find that - ceteris paribus - the size of an audit-firm portfolio is irrelevant in explaining the variation in financial reporting quality amongst companies. Next, we find that client visibility characteristics of an audit-firm portfolio have a constraining impact on earnings management, but no impact on the disclosure quality in the notes. Third, we find that solvency characteristics of an audit-firm portfolio (but not liquidity and profitability characteristics), are positively associated with the financial reporting quality. Taken together, the evidence suggests that not so much the size of an audit-firm portfolio (and the audit firm) but other portfolio and client characteristics drive audit and financial reporting quality.

Suggested Citation

  • Ann Gaeremynck & Sofie Van Der Meulen & Marleen Willekens, 2008. "Audit-Firm Portfolio Characteristics and Client Financial Reporting Quality," European Accounting Review, Taylor & Francis Journals, vol. 17(2), pages 243-270.
    • Handle: RePEc:taf:euract:v:17:y:2008:i:2:p:243-270
    DOI: 10.1080/09638180701705932
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    Citations

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    Cited by:

    1. Dusica STEVCEVSKA SRBINOSKA, 2022. "Audit modifications in emerging markets: The Macedonian Stock Exchange," Romanian Journal of Economics, Institute of National Economy, vol. 55(2(64)), pages 43-69, December.
    2. Jeroen van Raak & Erik Peek & Roger Meuwissen & Caren Schelleman, 2020. "The effect of audit market structure on audit quality and audit pricing in the private‐client market," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(3-4), pages 456-488, March.
    3. Maria Tsipouridou & Charalambos Spathis, 2014. "Audit opinion and earnings management: Evidence from Greece," Accounting Forum, Taylor & Francis Journals, vol. 38(1), pages 38-54, March.
    4. Tom Caneghem & Geert Campenhout, 2012. "Quantity and quality of information and SME financial structure," Small Business Economics, Springer, vol. 39(2), pages 341-358, September.
    5. 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.
    6. 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.
    7. Nora Muñoz-Izquierdo & María-del-Mar Camacho-Miñano & María-Jesús Segovia-Vargas & David Pascual-Ezama, 2019. "Is the External Audit Report Useful for Bankruptcy Prediction? Evidence Using Artificial Intelligence," IJFS, MDPI, vol. 7(2), pages 1-23, April.
    8. 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.
    9. 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.
    10. 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.

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