Abstract
Abstract industry in the US and China. Building on the seminal work of Teoh and Wong (1993), this essay revisits the tests of the prediction that earnings reports audited by larger audit firms have higher earnings response coefficients (ERCs). Specifically, we investigate whether the positive association between ERCs and perceived audit quality holds in either the US or China using long-term historical data. Empirical analysis based on US data from 1984 to 2012 shows that the ERCs of Big N clients are generally higher than those of non-Big N clients, but such differences have dissipated since 2002, the year the Sarbanes-Oxley Act (SOX) came into effect. However, we find weak evidence in China during 1995 to 2012 that Chinese investors value the credibility of large international auditors. The results also reveal that the relationship between Big N and ERCs is stronger in the US than in China. Overall, our results show that auditor reputation is valued by investors in more developed markets, indicating that both institutional and industry structure affect the relationship between Big N and ERCs.
Highlights
Auditors provide at least two major valuable functions to increase the credibility of financial reporting
We find that the indicator of Big N auditors is significantly positively associated with earnings response coefficients (ERCs) in the pre-Sarbanes-Oxley Act (SOX) era, suggesting that Big N auditors provided a better audit service to their clients during the period 1983 to 2012
Column 1 in Table 4 shows that the coefficients of BIGN*UE are 0.573 with less than 5% significance level, suggesting that Big N clients are associated with higher ERC
Summary
Auditors provide at least two major valuable functions to increase the credibility of financial reporting. The inspection results show that the Big N auditors and some second-tier auditors met the criteria during the period from 2004 to 2011 (Cassell et al, 2013), suggesting that second-tier auditors are likely to provide comparable audit quality to Big N auditors These two factors are likely to contribute toward reducing the financial reporting credibility gap between Big N and non-Big N auditors. Our results are generally consistent with recent studies (Boone et al, 2010; Chang et al, 2010; Cassell et al, 2013) and support the notion that audit market competition and regulation environment are two important forces that affect perceived audit quality. The rest of the paper is organised as follows: Section II describes the data and the samples; Section III presents the research methodology; Section IV discusses the empirical results; and Section V concludes the article
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