Audit quality and audit size: Evidence from auditor mergers in China

• Author: Jun Zhan,Keji Chen,Young‐Won Her
• Published date: 01 July 2020
• DOI: http://doi.org/10.1002/jcaf.22447
• Date: 01 July 2020

BLIND PEER REVIEW

Audit quality and audit size: Evidence from auditor

mergers in China

Jun Zhan | Young-Won Her | Keji Chen

David Nazarian College of Business and

Economics, Department of Accounting

and Information Systems, California State

University, Northridge, California

Correspondence

Jun Zhan, David Nazarian College of

Business and Economics, Department of

Accounting and Information Systems,

California State University, 18111

Nordhoff Street, Northridge, CA 91330.

Email: jun.zhan@csun.edu

Abstract

Focusing on the surge of mergers among Chinese local accounting firms

around the year 2000, this study examines the impacts of auditor mergers on

audit quality, and documents increased earnings quality for non-Big 5 clients

during the postmerger period. The study also brings up the question for further

investigation, whether the Big 5 auditors provide significant higher quality

audits than the non-Big auditors do in China, a far less litigious audit market

environment, during the period of 1999–2002. We find limited differences in

terms of audit quality between the Big 5 and non-Big 5 auditors. We do not

find significant differences in reported discretionary accruals and probability

of reporting losses between Big 5 clients and non-Big 5 clients. Only with the

earnings conservatism proxy, clients with Big 5 recognize bad news more

quickly than non-Big 5 clients. Furthermore, findings of this study suggest the

Big 5 audits do not contribute to the accruals quality differences in China,

implying legal enforcement and litigation risks have greater propensity to drive

auditor incentives.

KEYWORDS

accruals quality, audit size, auditor incentive, auditor mergers, Big 5 versus non-Big 5 audits

1|INTRODUCTION

Previous research has extensively examined mergers

among the Big N auditors (largest international accounting

firms), mainly focusing on the macro-level analysis, such as

direct influence of mergers on industry concentration and

market efficiency (e.g., General Accounting Office, 2003;

Ivancevich & Zardkoohi, 2000; Sullivan, 2002; Wolk et al.,

2001; Wootton et al., 1994). On the other hand, Ding & Jia

(2012), from a microlevel perspective, examine the impacts

of auditor mergers on audit quality. They investigate the

merger between Price Waterhouse and Coopers & Lybrand

in 1998, and document a significant improvement in

auditees' earning quality during the postmerger period.

Thus far, the line of research has paid little attention

on the non-Big N auditors. To fill in this gap, this study

explores the effects of mergers among small and

medium-sized auditors. Specifically, we study a surge of

mergers among Chinese local accounting firms (i.e., the

non-Big 5 auditors) that has occurred around the year

2000, and investigate the possible impacts of the mergers

on audit quality. In 2000, to enlarge regional accounting

firms and improve audit quality, the Chinese government

enacted multiple regulations and guidance to encourage

mergers among local accounting firms. By early 2001,

411 local accounting firms completed the consolidations

and were merged into 152 firms. Specifically based on

this surge of auditor consolidations, this article examines

the impact of the mergers on audit quality by comparing

the earnings quality of clients audited by Chinese local

accounting firms during the 2-year period before and

after the year 2000.

Received: 14 September 2019 Revised: 8 March 2020 Accepted: 25 March 2020

DOI: 10.1002/jcaf.22447

170 © 2020 Wiley Periodicals, Inc. J Corp Acct Fin. 2020;31:170–184.wileyonlinelibrary.com/journal/jcaf