[Previous research demonstrates that "brand name" (e.g., Big Eight versus non-Big Eight) is a factor affecting audit prices and auditor selection. As a quality surrogate, brand name reflects differences between auditor size categories in concern for reputation (DeAngelo 1981b) and the ability to withstand client pressure (Goldman and Barlev 1974). It has not, however, been demonstrated that these features characterize quality differences within an auditor size category. Although tests are difficult without a direct measure of quality, recent announcements by the General Accounting Office on CPA quality in governmental audits indicate a need to determine the factors that affect quality differences within auditor size categories, which is the subject of this study. Audit quality is defined as the probability that the auditor will both discover and report a breach in the client's accounting system (DeAngelo 1981a). Two explanations for variations in audit quality involve reputation and power conflict. Because an incumbent auditor captures client-specific quasi-rents, there is incentive to lower audit quality to retain the client. However, audit firm size is a moderating effect since a large client base allows a concern for reputation to remain more important than retention of any given client. The expectations are that (1) audit quality decreases as auditor tenure increases and (2) audit quality increases with the number of clients. In power conflicts, the client can exert pressure on the auditor to violate professional standards, and a large, financially healthy client can exert greater pressure with a threat of replacing the auditor. However, the established review of audit results or audit working papers by third parties can increase the auditor's ability to withstand client pressure. The expectations are that (3) audit quality is negatively related to the size and financial health of the firm and (4) audit quality improves when the auditor knows work will be subject to review by third parties and that sanctions for poor quality work will occur. This article presents the results of an investigation into the determinants of audit quality provided by small, independent CPA firms in Texas on audits of independent school districts. The study analyzes quality control review (QCR) findings to obtain a relatively more direct measure of audit quality. Between 1984 and 1989 the Audit Division of the Texas Education Agency (TEA) conducted 308 QCRs. Numerical scoring of 232 QCR letters of findings represents the measure of minimum audit quality and the dependent variable in the regression analysis. Explanatory variables associated with reputation effects, power conflict effects, report timeliness, audit hours, and reported breaches were obtained from TEA sources. The major finding of the study is that audit quality definitions (DeAngelo 1981b; Goldman and Barlev 1974) considered descriptive among audit size categories are sufficiently robust to explain quality variations within an audit size group. The results also confirm earlier studies relating audit quality to audit report timeliness (Dwyer and Wilson 1989) and actual audit hours (Palmrose 1986, 1989). We conclude that audit hours is a suitable surrogate for audit quality when direct measures are unavailable.]

Abstract This paper extends the application of the bootstrap method in accounting research to a simultaneous equations model of the demand and supply of audit services with mixed qualitative and continuous dependent variables. A moderately sized sample of 118 quality control reviews (Copley, Doucet, and Gaver 1994) is used to demonstrate the bootstrap method and compare results to estimates of standard errors obtained from Amemiya's 1978 asymptotic generalized least squares (GLS) procedure. We find that the GLS t ‐statistics are inflated by as much as 55 percent and the corresponding p ‐values are likewise overstated when compared to the bootstrap results. The problem is more acute with the qualitative dependent variable for audit quality, which is often the key variable of interest.

Abstract Previous research demonstrates that "brand name" (e.g., Big Eight versus non-Big Eight) is a factor affecting audit prices and auditor selection. As a quality surrogate, brand name reflects differences between auditor size categories in concern for reputation (DeAngelo 1981b) and the ability to withstand client pressure (Goldman and Barley 1974). it has not, however, been demonstrated that these features characterize quality differences within an auditor size category Although tests are difficult without a direct measure of quality, recent announcements by the General Accounting Office on CPA quality in governmental audits indicate a need to determine the factors that affect quality differences within auditor size categories, which is the subject of this study. Audit quality is defined as the probability that the auditor will both discover and report a breach in the client's accounting system (DeAngelo 1981a). Two explanations for variations in audit quality involve reputation and power conflict. Because an incumbent auditor captures client-specific quasi-rents, there is incentive to lower audit quality to retain the client. However, audit firm size is a moderating effect since a large client base allows a concern for reputation to remain more important than retention of any given client. The expectations are that (1) audit quality decreases as auditor tenure increases and (2) audit quality increases with the number of clients, in power conflicts, the client can exert pressure on the auditor to violate professional standards, and a large, financially healthy client can exert greater pressure with a threat of replacing the auditor. However, the established review of audit results or audit working papers by third parties can increase the auditor's ability to withstand client pressure. The expectations are that (3) audit quality is negatively related to the size and financial health of the firm and (4) audit quality improves when the auditor knows work will be subject to review, by third parties and that sanctions for poor quality work will occur. This article presents the results of an investigation into the determinants of audit quality provided by small, independent CPA firms in Texas on audits of independent school districts. The study analyzes quality control review (QCR) findings to obtain a relatively more direct measure of audit quality. Between 1984 and 1989 the Audit Division of the Texas Education Agency (TEA) conducted 308 QCRs. Numerical scoring of 232 QCR letters of findings represents the measure of minimum audit quality and the dependent variable in the regression analysis. Explanatory variables associated with reputation effects, power conflict effects, report timeliness, audit hours, and reported breaches were obtained from TEA sources. The major finding of the study is that audit quality definitions (DeAngelo 1981b; Goldman and Barley 1974) considered descriptive among audit size categories are sufficiently robust to explain quality variations within an audit size group. The results also confirm earlier studies relating audit quality to audit report timeliness (Dwyer and Wilson 1989) and actual audit hours (Palmrose 1986, 1989). We conclude that audit hours is a suitable surrogate for audit quality when direct measures are unavailable.

This paper examines the potential impacts of artificial smoothing (abnormal accruals) and real smoothing (derivatives) on firm value. We find that the value of the firm decreases with the magnitude of abnormal accruals and increases with the level of derivative use. Moreover, the accrual discount is more pronounced in firms with weak investor protection and the hedging premium is greater for poorly governed firms. These results suggest that although managers can engage in real smoothing to improve the informativeness of firms’ earnings and thus reduce agency costs, they might use artificial techniques to cosmetically improve the income stream in order to expropriate minority shareholders. In further support of agency theories, we report that poor corporate governance motivates the use of abnormal accruals and discourages derivative use.