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SYNOPSIS:
Prior research suggests that the Big 4 audit firms are of higher quality than are non-Big 4 firms. However, existing tests for an association between audit firm size and reporting accuracy are indirect and provide mixed results. Our study extends this line of research by examining whether the Big 4 audit firms exhibit higher quality reporting by having fewer "audit-reporting errors" in the context of issuing going-concern modified reports. Our analyses examine both types of going-concern reporting errors (i.e., type I errors-modified opinions rendered to subsequently viable clients; and type II errors-unmodified opinions rendered to subsequently bankrupt clients) over an 11-year period. We also examine reporting error rate differences between the national second-tier firms and regional/local third-tier firms.
Our findings indicate that both type I and type II error rates for Big 4 audit firms are significantly lower compared to non-Big 4 firms. In contrast, we find no significant differences between the national second-tier and regional/local third-tier audit firms with respect to either type of reporting error. Our results provide evidence about a Big 4 audit quality difference in reporting on client's going-concern problems.
Keywords: audit quality; audit reporting; going concern; bankruptcy.
Data Availability: All data are publicly available from the sources indicated.
INTRODUCTION
This study investigates the relation between audit firm size and the quality of auditreporting decisions. Prior research generally concludes that the Big 4(1) auditing firms differ from non-Big 4 firms in a variety of accounting and auditing decision contexts (Simunic 1980; Palmrose 1988; DeFond 1992; Becker et al. 1998; Francis et al. 1999; Raghunandan and Rama 1999). Based on these earlier findings, we hypothesize that the larger audit firms are better able to discern when to modify or not modify their opinion for going-concern difficulties of their clients. This greater accuracy would in turn lead to lower going-concern "reporting error" rates. In our study, we examine differences between the Big 4, national (second-tier), and regional/local (third-tier) audit firms with respect to the relative proportions of the two types of reporting errors: going-concern modified reports issued to clients who do not subsequently fail (a type I error), and prior audit reports without a going-concern modification for bankrupt clients (a type II error).2 Our study adds to the audit firm quality...