Two essays on auditing

Abstract

Essay I: Audit Market Competition and Audit Quality: Evidence from the Entry of Big 4 into City-level Audit Markets in the U.S. Given that the Big 4 audit firms continue to expand into new geographical areas in the U.S., our study examines how the entry of a Big 4 audit firm affects the audit quality of existing audit firms. The results suggest that the entry of a Big 4 firm encourages incumbent audit offices in the relevant market (i.e., within 200 km of the new Big 4 entrant) to enhance their audit quality, as their clients report lower discretionary accruals and fewer incidences of accounting restatements and are more likely to receive going-concern opinions. These results are robust to an instrumental variable approach for dealing with endogeneity in entry decisions. We explore the channel through which intensified competition affects incumbents’ audit quality and find that incumbent audit firms invest more in developing industry-specific knowledge to differentiate their service quality from their competitors after the entry of a new Big 4 firm. Furthermore, we find that the enhanced audit quality is mainly attributable to existing audit offices owned by other Big 4 firms rather than those owned by non-Big 4 firms. Moreover, changes in audit quality are more pronounced for existing audit offices with fewer Big 4 incumbents in their relevant markets (i.e., within 200 km of existing audit offices) and when the incoming Big 4 firm has prior experience in a city’s most important industry. Finally, following the entry of a new Big 4 firm, audit fees paid to incumbent Big 4 audit offices and to non-Big 4 audit offices, do not change significantly. Overall, our findings suggest that the entry of a new rival compels incumbent large audit firms to improve their audit quality without an increase in audit fees. Essay II: Labor Market Settlement and Audit Quality This study investigates whether concerns about post-retirement job opportunities incentivize individual auditors approaching retirement to provide high quality audits. We find that being an industry specialist or having better capital market credibility, measured by client ERC before retirement, helps auditors become board members of listed firms after retirement. Conversely, being sanctioned by the government or experiencing client restatements significantly reduces the chances of auditors obtaining corporate board memberships after leaving the audit profession. In addition, good audit quality increases the number of board memberships and the total pay obtained by auditors after retirement. We also show that audit quality immediately before retirement has more effect on post-retirement opportunities than auditors’ earlier audit quality. These findings suggest that labor market benefits give end-of-career individual auditors incentives to provide high quality audits.

Date of Award	2019
Original language	English
Awarding Institution	The Hong Kong University of Science and Technology