Litigation Risk and the Financial Reporting Credibility of Big 4 versus Non-Big 4 Audits: Evidence from Anglo-American Countries

• Published in: The Accounting review Vol. 79; no. 2; pp. 473 - 495
• Main Authors: Khurana, Inder K., Raman, K. K.
• Format: Journal Article
• Language: English
• Published: Sarasota American Accounting Association 01-04-2004
• Subjects: Accounting; Accounting methods; Analytical forecasting; Auditors; Audits; Big Four accounting firms; Brand names; Business accounting; Business audits; Capital costs; Corporate governance; Cost of equity; Credibility; Earnings forecasting; Economics; Equity capital; Financial audits; Financial reporting; Investors; Litigation; Regression analysis; Reputations; Risk; United States > US
• ISSN: 0001-4826; 1558-7967
• DOI: 10.2308/accr.2004.79.2.473

Prior research suggests that Big 4 auditors provide higher quality audits in the U.S. in order to protect the firm's brand name reputation and to avoid costly litigation. In this study, we examine whether the perceived higher quality of a Big 4 audit is related to auditor litigation exposure or to reputation concerns. Specifically, we utilize an estimable proxy for financial reporting credibility-the ex ante cost of equity capital-to examine whether Big 4 auditors are perceived as providing higher quality audits (relative to non-Big 4 auditors) in the U.S., and in the less litigious (but economically similar) environments in other Anglo-American countries during the 1990-99 period. We find that a Big 4 audit is associated with a lower ex ante cost of equity capital for auditees in the U.S. but not in Australia, Canada, or the U.K. Our findings suggest that it is litigation exposure rather than brand name reputation protection that drives perceived audit quality.