Diversification by the audit offices in the US and its impact on audit quality

Sharad Asthana ()
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Sharad Asthana: University of Texas at San Antonio

Review of Quantitative Finance and Accounting, 2017, vol. 48, issue 4, No 6, 1003-1030

Abstract: Abstract Audit offices in the US exhibit a wide variation in the number of industries they service. Strategic management theory suggests that diversification can affect the quality of output, depending on the nature and circumstances of diversification. This paper examines the effect of diversification at the audit office level on audit quality. Five proxies of audit quality are examined, mainly, absolute discretionary accruals, propensity to meet-or-beat earnings expectations by a cent, propensity to restate financial statements, propensity to receive a comment letter after an SEC review and propensity to issue a going concern opinion. Results suggest that diversification has detrimental effects on audit quality. On the other hand, when the diversification is part of the audit firm level strategy, the detrimental effects on audit quality are dampened. Moreover, when the diversification at the office level is part of a revenue expansion strategy, the audit quality is adversely affected. However, there is no detrimental effect on the audit quality when revenue expansion is not the objective. Also, diversification across dissimilar industries leads to more adverse effect on audit quality than diversification to similar industries. Results also suggest that when the audit office is located in a market with more (less) diversified client base, the adverse effects of diversification on audit quality are weaker (stronger). Finally, the offices of big-4 audit firms handle diversification better with less adverse effect on audit quality. The findings are important since they identify additional factors that explain audit quality at the audit office level.

Keywords: Audit office; Audit firm; Diversification; Audit quality (search for similar items in EconPapers)
JEL-codes: D46 G12 G14 M41 M42 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s11156-016-0576-y

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