Audit quality attributes, client size and cost of equity capital

Guy D. Fernando, Ahmed M. Abdel‐Meguid and Randal J. Elder

Review of Accounting and Finance, 2010, vol. 9, issue 4, 363-381

Abstract: Purpose - The purpose of this paper is to investigate the impact of certain audit quality attributes, namely auditor size, auditor industry specialization and auditor tenure on a client firm's cost of equity capital. Design/methodology/approach - The paper uses empirical data to construct a measure ofex antecost of equity capital for each firm and year using analyst forecasts. Independent audit quality measures used are auditor size, auditor industry specialization and auditor tenure. Firm cost of equity capital is regressed against the three independent variables and appropriate control variables. Findings - The paper finds that auditor size (auditor is a member of the BigX), auditor industry specialization and auditor tenure are negatively associated with the client firm's cost of equity capital. However, the paper finds that this effect is limited only to small client firms, potentially reflecting the poor information environment associated with such firms. Practical implications - The study highlights the importance of audit quality attributes in determining the firm's cost of capital. It also highlights ways in which firms (especially small firms) can reduce the cost of equity capital by improving their information environment through the judicious selection of auditors. Originality/value - This is believed to be the first paper to examine whether the effects of three audit quality attributes (auditor size, auditor industry specialization and auditor tenure) on a firm's cost of capital are dependent on the client's size. The paper empirically shows that such effects are more pronounced for smaller clients.

Keywords: Cost of capital; Auditing; Auditors; Equity capital; United States of America (search for similar items in EconPapers)
Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:rafpps:v:9:y:2010:i:4:p:363-381

DOI: 10.1108/14757701011094571

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