Big N Auditors and Earnings Response Coefficients – A Comparison Study between the US and China

In the past 20 years, there have been considerable developments and changes in the audit industry in the US and China. Building on the seminal work of Teoh and Wong (1993), this essay revisits the tests of the prediction that earnings reports audited by larger audit firms have higher earnings response coefficients (ERCs). Specifically, we investigate whether the positive association between ERCs and perceived audit quality holds in either the US or China using long-term historical data. Empirical analysis based on US data from 1984 to 2012 shows that the ERCs of Big N clients are generally higher than those of non-Big N clients, but such differences have dissipated since 2002, the year the Sarbanes-Oxley Act (SOX) came into effect. However, we find weak evidence in China during 1995 to 2012 that Chinese investors value the credibility of large international auditors. The results also reveal that the relationship between Big N and ERCs is stronger in the US than in China. Overall, our results show that auditor reputation is valued by investors in more developed markets, indicating that both institutional and industry structure affect the relationship between Big N and ERCs.