Why bigger is not stronger? A perspective on auditor groups and audit quality

This paper examines how the existence of auditor groups in accounting firms affects audit quality, using the unique regulatory and institutional settings of China. We define the auditor group as a cohort of exclusively and mutually cooperative and risk-sharing auditors who co-sign audit reports. Using hand-collected data on individual auditors and audit firms from 2010 to 2013, we identify 1,873 auditor groups and find that large auditor groups provide higher audit quality, measured as the propensity to issue qualified audit opinions. We show that audit quality varies among different auditor groups within audit firms. These findings indicate that the auditor group, rather than the audit firm or office, is the core decision-making and responsibility unit in the market for audit services in China. Our paper speaks to the literature on China’s bigger and stronger policy from a novel perspective of auditor groups inside the audit firm, and points out the importance of considering the internal structure of audit firms to better understand the relationship between audit firm size and audit quality, as suggested in DeAngelo (1981).