The impact of litigation risk on the association between audit quality and auditor size : Evidence from China

Raymond M.K. WONG*, Michael A. FIRTH, Agnes W. Y. LO

*Corresponding author for this work

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

1 Scopus Citations

Abstract

We examine whether audit quality varies across different sizes of CPA firms under high or low auditor-specific litigation risk exposure. We measure audit quality by the issuance of modified audit opinions and the audit fees charged to clients, and we use the organizational form of CPA firms as the proxy for auditors’ litigation risk exposure, where a partnership (limited liability) CPA firm represents a high (low) litigation risk exposure. Built on Choi, Kim, Liu, and Simunic's (2008) theoretical framework, we hypothesize that the litigation risk exposure of CPA firm moderates the association between auditor size and audit quality. Our results show that when the auditor's liability is capped (i.e., registered as a limited liability form of CPA firm), larger size CPA firms are associated with higher audit quality when compared to smaller size CPA firms. However, this positive association between auditor size and audit quality disappears for audit firms that are subject to high litigation risk exposures (i.e., registered as a partnership form of CPA firm). Our research provides new insights on the impact of auditor-specific litigation risks on the relation between audit quality and auditor size. In particular, we show that only when auditor-specific litigation risk is limited, do large CPA firms appear to perform higher quality audits than small CPA firms.

Original languageEnglish
Pages (from-to)280-311
Number of pages32
JournalJournal of International Financial Management and Accounting
Volume29
Issue number3
Early online date16 Apr 2018
DOIs
Publication statusPublished - Oct 2018

Fingerprint

Audit quality
Auditors
Litigation risk
China
Risk exposure
Limited liability
Firm size
Large firms
Audit firms
Quality audit
Small firms
Audit fees
Organizational form
Auditor liability
Theoretical framework
Audit opinion

Keywords

  • audit fees
  • audit quality
  • auditor size
  • litigation risk
  • modified audit opinions

Cite this

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title = "The impact of litigation risk on the association between audit quality and auditor size : Evidence from China",
abstract = "We examine whether audit quality varies across different sizes of CPA firms under high or low auditor-specific litigation risk exposure. We measure audit quality by the issuance of modified audit opinions and the audit fees charged to clients, and we use the organizational form of CPA firms as the proxy for auditors’ litigation risk exposure, where a partnership (limited liability) CPA firm represents a high (low) litigation risk exposure. Built on Choi, Kim, Liu, and Simunic's (2008) theoretical framework, we hypothesize that the litigation risk exposure of CPA firm moderates the association between auditor size and audit quality. Our results show that when the auditor's liability is capped (i.e., registered as a limited liability form of CPA firm), larger size CPA firms are associated with higher audit quality when compared to smaller size CPA firms. However, this positive association between auditor size and audit quality disappears for audit firms that are subject to high litigation risk exposures (i.e., registered as a partnership form of CPA firm). Our research provides new insights on the impact of auditor-specific litigation risks on the relation between audit quality and auditor size. In particular, we show that only when auditor-specific litigation risk is limited, do large CPA firms appear to perform higher quality audits than small CPA firms.",
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The impact of litigation risk on the association between audit quality and auditor size : Evidence from China. / WONG, Raymond M.K.; FIRTH, Michael A.; LO, Agnes W. Y.

In: Journal of International Financial Management and Accounting, Vol. 29, No. 3, 10.2018, p. 280-311.

Research output: Journal PublicationsJournal Article (refereed)Researchpeer-review

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