Understanding the Big 4 Effect : Clients’ Pre-audit Earnings Quality and Audit Adjustments

This paper investigates whether the differences in audit quality between Big 4 and non-Big 4 auditors can be attributed to the client’s pre-audit financial reporting quality or to the differences in audit treatment via audit adjustments. Hand-collected pre-audit and audited financial statement data of Croatian listed companies enables us to determine the pre-audit client financial characteristics as well as the frequency and the magnitude of audit adjustments on each specific line item of financial statements. Even though Big 4 and non-Big 4 auditors generally make similar adjustments to financial statements, we find that the Big 4 auditors make larger audit adjustments on fixed assets, revaluation reserves, impairment and net income. Also, they more frequently adjust provisions compared to the non-Big 4 auditors. We find that Big 4 clients have significantly higher pre-audit and audited accrual quality. However, after applying regression analysis, propensity-score matching and difference-in-differences technique to control for pre-audit earnings quality, our results indicate that the Big 4 effect on audited earnings quality is not significant