Do Big 4 Auditors Enhance Audit Quality? An Analysis of Client Selection and Audit Adjustments

Recent research challenges the notion that the Big 4 auditors provide a higher quality audit relative to non-Big 4 and suggests that the Big N effect could be due to self-selection. We contribute to this debate by controlling for pre-audit earnings quality, an important omitted variable in prior research. Using proprietary data from the Chinese Institute of CPAs, we first replicate prior studies by documenting lower earnings management and restatement likelihood for clients of Big 4 than those of non-Big 4. However, we find that pre-audit earnings quality is higher for the Big 4 clients. After controlling for pre-audit earnings quality, we do not find a significant difference between the Big 4 and non-Big 4 clients in earnings management and restatement frequencies. We also find that the Big 4 auditors are less likely to make income-decreasing audit adjustments than non-Big 4 auditors and audit adjustments proposed by non-Big 4 auditors enhance earnings quality, while results are mixed for the Big 4 auditors. Collectively, the findings cast doubt that the Big 4 provide better audit quality in China and indicate that besides client size, clients’ pre-audit earnings quality is a significant driver of the Big N effect.