Do Big 4 Auditors Enhance Audit Quality in China? A “Behind the Scenes Look”

We contribute to the debate on whether the “Big N effect” on audit quality is due to client self-selection by controlling for pre-audit earnings quality, an important variable omitted in prior research. Using proprietary data from the Chinese Institute of CPAs, we find that pre-audit earnings quality is higher for Big 4 clients. Controlling for pre-audit earnings quality, restatement frequency is lower for Big 4 clients than for non-Big 4 clients, but there is no significant difference in discretionary accruals between Big 4 and non-Big 4 clients. Our findings indicate that Big 4 and non-Big 4 auditors in China pursue different strategies to enhance audit quality. The Big 4 enhance audit quality by recruiting and retaining clients with higher earnings quality and acting more conservatively towards clients with a higher risk for earnings restatement. In contrast, non-Big 4 auditors enhance audit quality by requiring more downward audit adjustments.