The Relationship between Auditor Accuracy and Auditor Size: An Evaluation of Reputation and Deep Pockets Arguments

Abstract

Empirical results presented in this paper indicate that large auditors are more accurate than small auditors. DeAngelo (1981) has argued that large auditors have more incentive to maintain a reputation for accurate auditing because an audit failure may lead to a loss of rents due to auditor switching. In addition, Dye (1993) and Schwartz (1997) have shown that the depth of an auditor's pockets may be an important determinant of accuracy. The aim of this paper is to discriminate between these two explanations. In a deep pockets model, it is shown that large auditors may receive relatively more litigation despite having more incentive to issue accurate-reports. This is consistent with evidence presented in this paper. on the other hand, the evidence does not indicate that auditors suffer losses of clients or lower fees as a result of criticism. These findings suggest that deep pockets rather than reputation help to explain the superior accuracy of large auditors.