Measuring Audit Quality

Extant research typically uses a variation of Big N auditor, discretionary accruals, audit fees, accrual quality, going-concern opinions, or meet or beat the quarterly earnings target as a proxy for audit quality. We provide evidence on the construct validity of these measures by evaluating whether they are able to successfully predict alleged audit deficiencies in engagements that are the subject of non-dismissed lawsuits and SEC’s AAERs filed against auditors over the violation years 1978-2011. The presence of a Big N auditor signing off on the statements of the company during the violation periods is negatively associated with the total number of audit quality allegations and this result is driven by a lower incidence of allegations that a Big N auditor did not exercise due care in the audit. Abnormal audit fees during the violation period are positively associated with the number of alleged audit quality violations. The relation between abnormal audit fees and specific allegations is mixed in that such fees are negatively associated with allegations that the audit was inadequately planned, financial statements were not GAAP compliant and auditor did not assess audit risk adequately but positively associated with other allegations. The proportion of non-audit fees to total fees is associated with accusations of independence violations. However, the other proxies are not systematically associated with audit deficiencies. Our results raise questions about the descriptive accuracy of the commonly used measures of audit quality in the literature. We acknowledge financial assistance from our respective schools. All errors are ours.