Understanding earnings quality - MIT Sloan School of Management

(1996) suggest that having “Big” auditors does not prevent extreme accounting manipulations. One
explanation for the difference in results is that the dichotomous partition of audit firms based on
audit firm size is too crude to capture auditor effectiveness in a small sample.
Audit firm size also is correlated with EQ proxies other than accruals. In a cross-country
analysis, Francis and Wang (2008) document that the positive association between country-level
investor protection and EQ, measured by abnormal accruals, the likelihood of reporting a loss, and
asymmetric timeliness, is higher only for firms with Big-four auditors. Teoh and Wong (1993) find
that firms with Big-eight auditors have significantly higher ERCs. Hackenbrack and Hogan (2002)
find that firms that switch auditors for service-related reasons have increasing ERCs after the auditor
change. However, firms that switch auditors for non-service-related reasons, related primarily to
fees and fee disputes, have decreasing ERCs.
DeFond and Subramanyam (1998) attempt to explain why the ex post incidence of litigation
against auditors is lower for Big-six auditors (see also, Palmrose, 1988). One explanation is that big
auditors force more conservative accounting, which leads to a lower litigation rate. In a sample of
firms that switch auditors, they show that Big-six predecessor auditors are more conservative in their
accounting choices (i.e., income decreasing discretionary accruals), and they provide weak evidence
that non-Big 6 successor auditors are less conservative.
5.4.2 Studies of auditor fees
Srinidhi and Gul (2007) document a positive association between the magnitude of fees for
audit services and accruals quality measured based on Dechow and Dichev (2002). Larcker and
Richardson (2004) document a positive association between total fees (i.e., the sum of audit and
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