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How Big-4 Firms Improve Audit Quality

Author

Listed:
  • Limei Che

    (University of South-Eastern Norway, 3679 Notodden, Norway;)

  • Ole-Kristian Hope

    (Rotman School of Management, University of Toronto, Toronto, Ontario M5S 3A6, Canada; BI Norwegian Business School, 0484 Oslo, Norway)

  • John Christian Langli

    (BI Norwegian Business School, 0484 Oslo, Norway)

Abstract

This paper studies whether and how Big-4 firms provide higher-quality audits than non-Big-4 firms. Specifically, we first examine a Big-4 effect and then explore three sources of the Big-4 effect. To test the Big-4 effect, we use a unique data set of individual audit partners for a large sample of private companies and a novel research design exploiting the fact that auditees may follow the auditor who switches affiliation from a non-Big-4 firm to a Big-4 firm. Thus, we compare audit quality and audit fees of the same partner–auditee pairs before and after the switch. The results show that the Big-4 effect exists in the private-firm segment. More important, we find evidence for three sources of the Big-4 effect. First, Big-4 firms are able to recruit non-Big-4 partners who deliver higher audit quality than other non-Big-4 partners in the preswitch period. Second, enhanced learning has taken place after the switch. Third, the increased audit quality can also be attributed to stronger incentives/monitoring . These are new findings to the literature.

Suggested Citation

  • Limei Che & Ole-Kristian Hope & John Christian Langli, 2020. "How Big-4 Firms Improve Audit Quality," Management Science, INFORMS, vol. 66(10), pages 4552-4572, October.
    • Handle: RePEc:inm:ormnsc:v:66:y:2020:i:10:p:4552-4572
    DOI: 10.1287/mnsc.2019.3370
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    Cited by:

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    3. Ozili, Peterson Kitakogelu, 2021. "Big 4 auditors, bank earnings management and financial crisis in Africa," MPRA Paper 108608, University Library of Munich, Germany.
    4. Mohammad Abedalrahman Alhmood & Hasnah Shaari & Redhwan Al-dhamari, 2022. "Audit Partner Characteristics and Real Earnings Management Practices in Jordan," Economic Studies journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 185-200.
    5. Aase, Øivind André, 2022. "Size Management in Response to Mandatory Audit Rules," Discussion Papers 2022/2, Norwegian School of Economics, Department of Business and Management Science.
    6. Lee, Eugenia Y. & Ha, Wonsuk & Park, Sunyoung, 2023. "Auditor specialization in R&D and clients’ R&D investment-q sensitivity," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(2).
    7. Sundgren, Stefan & Alexeyeva, Irina, 2022. "Entrepreneurs’ legal infractions and hidden information: Evidence from small business bankruptcies," International Review of Law and Economics, Elsevier, vol. 69(C).

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