Did the First 10 Years of the PCAOB Inspection Regime Attenuate the Big 4 Audit Quality Differential?

• In Event: Continental Breakfast & Research and Education Forum
  In Paper Session: Table 8: Audit Quality

Abstract

We examine the impact of the first 10 years of the PCAOB inspection regime on what DeFond et al. (2016) refer to as the Big N effect, i.e., the audit quality differential between the Big 4 and other auditors. Two views motivate our inquiry. The first view predicts that the impact of the PCAOB inspection regime could narrow the quality differential between Big 4 and other auditors. The argument is that the Big 4 already provide audit quality in excess of minimum professional standards due to the enhanced litigation exposure and risk of reputation loss they face. As a result, the new element of regulatory risk introduced by PCAOB inspections is likely to have a greater effect on the audit quality of the non-Big 4 auditors than that of the Big 4. The second view predicts the Big 4 audit quality differential to remain unchanged because the new regulatory risk posed by PCAOB inspections could incentivize an improvement in audit quality for both Big 4 and non-Big 4 auditors. Our results show an attenuation in the audit quality differential between Big 4 and other auditors, and show that this attenuation is robust to controlling for self-selection bias and for matching based on client characteristics. Further, we find that the attenuation in audit quality occurs only between Big 4 and mid-tier (i.e., other annually inspected) auditors but not between the Big 4 and the small (i.e., triennially inspected) auditors.

Authors

• Nathan Lundstrom, University of Missouri-Columbia

• Inder K Khurana, University of Missouri-Columbia

• K. K. Raman, University of Texas-San Antonio