Big Five Audits and Accounting Fraud

Empirical studies of earnings management, audit pricing, and audit reporting provide extensive evidence that the Big Five public accounting firms are associated with higher quality financial statements (Francis 2004). Nevertheless, the recent high-profile financial reporting failures that roiled the U.S. capital markets cast doubt on whether this proposition remains valid. Indeed, many commentators interpret the steep upward trend during the late 1990s and early 2000s in accounting misstatements by companies with Big Five auditors as almost conclusive evidence that their assurance services have deteriorated over time (e.g., Coffee 2002; Imhoff 2003; Zeff 2003). Among other explanations, some observers blame these watershed events on the more lenient litigation landscape having a disproportionate impact on Big Five quality as well as market conditions that led them to increasingly pursue lucrative consulting contracts to the detriment of their independence on audit engagements (e.g., Earley, Odabashian, and Willenborg 2003). Measuring trends in absolute audit quality is typically infeasible, so we more narrowly focus on discriminating between the relative performance of the Big Five and non-Big Five audit firms in preventing companies from orchestrating accounting fraud. Several commentators motivate arguments on the underlying reasons for the apparent erosion in Big Five audit quality by highlighting the well-known cases of fraudulent financial reporting by their clients (e.g., Coffee 2002; Cox 2003). However, rigorous evidence on whether companies are less likely to engage in accounting fraud if they are