Big 4 auditors are more likely than non–Big 4 auditors to issue going-concern modified opinions on ex–Arthur Andersen clients. Big 4 auditors are also more likely to allow a lower level of discretionary accruals on ex–Arthur Andersen clients.
What’s Inside?
In an attempt to understand auditing reporting conservatism, the author analyzes audits of ex–Arthur Andersen clients by Big 4 and non–Big 4 auditors and measures the likelihood of issuance of going-concern modified opinions and the level of discretionary accruals. His findings suggest that Big 4 auditors are more conservative than non–Big 4 auditors.
How Is This Research Useful to Practitioners?
Audit firms are divided into two major categories: Big 4 auditors and non–Big 4 auditors. Recently, some in the industry have suggested that reducing the concentration of Big 4 firms by increasing the market share of non–Big 4 firms would be wise. Given that Big 4 firms have deeper pockets and more leverage with clients than non–Big 4 firms, the general understanding among investment practitioners is that Big 4 firms are more conservative in audit reporting and more likely to manage client pressure, compared with non–Big 4 firms, in their attempts to reduce litigation risk.
The author evaluates auditing reporting conservatism using two measures: (1) the issuance of going-concern opinions to clients by auditors and (2) the level of audited discretionary accrual. His findings, which are consistent with his expectations, indicate that Big 4 auditors are more likely than non–Big 4 auditors to issue going-concern modified opinions on ex-Andersen clients. Big 4 auditors are also more likely than non–Big 4 auditors to allow a lower level of discretionary accruals on ex-Andersen clients. Ex-Andersen clients of Big 4 auditors would have had a lower likelihood of receiving going-concern opinions or a higher level of discretionary accruals if reporting practices for other clients had been applied to them. In the case of non–Big 4 auditors, the findings are reversed, indicating that Big 4 auditors report more conservatively and non–Big 4 auditors, less conservatively for ex–Andersen clients than for other clients.
How Did the Author Conduct This Research?
Using the issuance of going-concern modified audit opinions and the level of discretionary accruals of clients to proxy for auditor reporting conservatism, the author formulates the hypothesis that Big 4 auditors are more likely to issue going-concern modified statements to, and/or restrict the level of discretionary accruals of, clients that previously employed Arthur Andersen compared with the Big 4 firms’ other clients. He uses a logistic regression model to test the hypothesis on audit opinion and an ordinary least-squares (OLS) model to test the hypothesis on discretionary accruals.
The sample data cover the period of 2001–2002. The sample firms have incumbent auditors other than Andersen and have annual earnings announcements after 16 December 2001, when Enron restated its financials.
The sample for the logistic regression model to test audit opinion includes 782 observations. This sample comprises 432 Big 4 auditees and 350 non–Big 4 auditees, of which 188 are former Andersen clients and 594 are other clients. Similarly, for the OLS regression model to test discretionary accruals, the sample includes 7,586 firm-year observations. This sample comprises 5,798 Big 4 firms and 1,788 non–Big 4 firms, of which 663 are ex-Andersen clients and 6,923 are other clients. The author uses details of audit reports obtained from the EDGAR, Disclosure, and Compustat databases.
Abstractor’s Viewpoint
For investment practitioners, the research results indicate that Big 4 firms are more likely to be conservative in their audit practices. Thus, when analyzing financial statements, investment practitioners need to take these findings into account.