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Rev Account Stud (2014) 19:506538 DOI 10.1007/s11142-013-9253-8
Paul Hribar Todd Kravet Ryan Wilson
Published online: 8 October 2013 Springer Science+Business Media New York 2013
Abstract This study develops a measure of accounting quality based on audit fees. Adopting a neoclassical view of the audit market, we argue that unexplained audit fees should contain information about accounting quality. We nd that our measure of unexplained audit fees correlates positively with other empirical measures of quality. We further show that our measure of accounting quality is incrementally predictive of fraud, restatements, and SEC comment letters, controlling for other measures of quality. Overall, we believe that the information in audit fees can be used to provide an alternative measure of a rms accounting quality.
Keywords Accounting quality Earnings management Restatements
Fraud
JEL Classication M41
1 Introduction
This study investigates whether audit fees can be used to construct a summary measure of accounting quality. Economic theory suggests that, in a competitive equilibrium, audit fees incorporate the expected cost of poor quality earnings.
P. Hribar (&)
Tippie College of Business, The University of Iowa, Iowa City, IA 52242, USA e-mail: [email protected]
T. Kravet
Naveen Jindal School of Management, University of Texas at Dallas, Richardson, TX 75080, USA e-mail: [email protected]
R. Wilson
Lundquist College of Business, University of Oregon, Eugene, OR 97403, USA e-mail: [email protected]
A new measure of accounting quality
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A new measure of accounting quality 507
Auditors face signicant reputation and litigation costs if their clients nancial reports are misstated (e.g., Palmrose 1987; Thompson and McCoy 2008; Hennes et al. 2010). In response, they can increase the audit hours they work, increase the risk premium they charge, or both when they perceive accounting quality to be low. Both actions lead to higher fees. Isolating this part of the audit fee from the total audit fee can therefore provide insight into the auditors assessment of the quality of the accounting system. We use a regression-based approach to remove the expected amount of audit fees based on the determinants of the audit that are unlikely to capture accounting quality (e.g., scope of the audit). In doing so, we intentionally use an incomplete set of determinants in the audit fee model, as we want the residual to capture the variation...