What do we know about audit quality?

This paper reviews empirical research over the past 25 years, mainly from the United States, in order to assess what we currently know about audit quality with respect to publicly listed companies. The evidence indicates that outright audit failure rates are infrequent, far less than 1% annually, and audit fees are quite small, less than 0.1% of aggregate client sales. This suggests there may be an acceptable level of audit quality at a relatively low cost. There is also evidence of voluntary differential audit quality (above the legal minimum) along a number of dimensions such as firm size, industry specialization, office characteristics, and cross-country differences in legal systems and auditor liability exposure. The evidence is very positive although there is some indication that audit quality may have declined in the 1990s, in which case there could be merit in recent reforms such as the Sarbanes-Oxley Act of 2002 in the US. However, we do not know from research the optimal level of audit quality and therefore whether we currently have ‘too little’ or ‘too much’ auditing? Despite this lacuna we are entering an era of more mandated auditing in response to high-profile corporate governance failures including the Enron–Andersen affair. Finally, while recent reforms have scaled back the scope of non-audit services due to independence concerns, a case can be made that audit quality will always be somewhat suspect if other services are provided that are perceived to potentially compromise the auditor's objectivity and skepticism. For this reason public confidence in audit quality may be increased by proscribing all non-audit services for audit clients. Recommendations are also proposed with respect to legal liability reform and changes in partner compensation arrangements.