Association between audit quality and earnings quality- Do local big four auditors provide quality-differentiated audits in Bangladesh?

Md Humayun Kabir
Auckland University of Technology
New Zealand

Md Ainul Islam
Massey University
New Zealand

Divesh Sharma
Florida International University

Amirus Salat
University of Dhaka
Bangladesh

Abstract:
We investigated the impact of local Big Four auditors on earnings quality of listed companies in Bangladesh. We used the Dechow-Dichev (2002) model to estimate our primary measure of earnings quality and ran the model for both time-series and cross-sectional samples. Though we found that local Big Four clients had lower earnings quality than their non-Big Four counterparts, the significance of the relationship depends on the sample and tentative concluded that there was no significant difference between local Big Four and non-Big Four as far their impact on the earnings quality of their clients is concerned. We also found that negative income, earnings variability and leverage were associated with earnings quality, implying that investors in Bangladesh stock market can use these measures as surrogates of earnings quality.

Our conclusions regarding the impact of local Big Four firms on earnings quality of their clients are reinforced when we used four other measures of earnings quality: (a) Healy’s (1985) model, (b) earnings persistence, (c) earnings smoothness, and (c) closeness to cash. No significant difference was observed between Big Four and non-Big Four clients.

Our findings are different from the US findings (e.g., Becker et al., 1998; Francis et al., 1999) that Big Four clients have lower discretionary accruals than their non-Big Four counterparts. We argue that Bangladesh audit environment probably provides an explanation for these different findings. The audit environment is characterized by the small market, the low demand for quality auditing services and poor monitoring. This environment probably provides inadequate incentives for Big Four auditors to provide quality auditing services.

JEL classification: M41, M42

Keywords: Earnings quality; Big Four auditors, Bangladesh Audit environment