Auditor Size and Audit Quality

Xiaolei Jin

Prof. Sivadasan

Auditing Sec-01

Auditor size and audit quality

The objective of this paper is to argue whether audit quality depends on auditor size and the problem is auditors are sometimes chosen on the basis of arbitrary factors such as size of their firm. Some people argue that size alone should not arbitrarily distinguish between the largest eight and all other CPA firms. In addition, the Derieux Committee indicates that auditor size should not have something to do with selection of an auditor, assuming that auditor size has no effect on the quality of audit services. However, the current paper argues that audit quality is not independent of auditor size, and larger audit firms could supply a higher level of audit quality. And also incumbent auditors earn client-specific quasi-rents that, served as collateral, actually could increase audit quality from larger auditors.

In order to further find out the relationship between audit quality and auditor size, this paper also addresses the topic about audit quality. As mentioned, audit services are demanded as monitoring devices, and here conflict of interest is agency costs. Consumers could incur significant evaluation costs because they are unable to observe the actual procedures employed and are unware of auditor-client contract incentives. The solution to avoid high evaluation costs is to develop surrogates for audit quality and specialize in a uniform level of audit quality. However, different auditors will specialize in different quality levels due to differential agency costs. The significant cost of quality evaluation affects auditors to behave opportunistically. This opportunity occurs because it is costly to discover auditors cheating.

In addition, there are cost advantages to incumbent auditors because high start-up and transaction costs would be incurred to switch auditors. Bilateral monopoly exists between clients and incumbent auditors as the switching costs of both sides are...