Measuring Audit Quality

Abstract

In this paper, we document 45 specific allegations related to audit deficiencies based on GAAS, as detailed in 141 AAERs and 153 securities class action lawsuits over the violation years 1978–2016. Next, we use these allegations to validate existing popular proxies of audit quality. Of all the audit quality proxies, we find that restatements consistently predict all of the top six most cited audit deficiencies. The ratio of audit fees to total fees and the presence of a city specialist auditor predict five of the most cited deficiencies. Overall, our results suggest that the predictive power of audit quality proxies depends on (i) the settings that researchers are interested in and (ii) the specific audit deficiencies hypothesized to matter in the investigated setting. For instance, future studies related to auditor independence might consider using restatements and the ratio of audit fees to total fees as proxies of audit quality.