Does audit quality affect firms’ investment efficiency?

Abstract This study investigates the effect of audit quality on firm investment efficiency for 125 French-listed companies over 2008–2015. It uses parametric and non-parametric measures of firm investment efficiency, based on residuals extracted from the investment efficiency model and the data envelopment analysis (DEA) approach, respectively, to assess whether audit quality improves investment inefficiency. It analyses this relationship after distinguishing between firms that under-invest and those that over-invest. The results show that investment inefficiency decreases with audit quality. Specifically, auditor knowledge leads to less investment in firms prone to over-investment and more investment in firms prone to under-investment. This relationship appears to be independent of a firm’s financial reporting quality, which indicates that auditors provide value-added services that impact the investment decisions of firm managers, separately from the quality of accounting information.

[1]  Katherine Schipper,et al.  The market pricing of accruals quality , 2005 .

[2]  C. Lennox.  Audit Quality and Auditor Size: An Evaluation of Reputation and Deep Pockets Hypotheses , 1999 .

[3]  Jere R. Francis,et al.  Big 4 Office Size and Audit Quality , 2009 .

[4]  Steven M. Fazzari,et al.  Financing Constraints and Corporate Investment , 1987 .

[5]  C. Lim,et al.  Legal Systems and Earnings Quality: The Role of Auditor Industry Specialization , 2007 .

[6]  Mark L. DeFond,et al.  The Effect of Audit Quality on Earnings Management , 1998 .

[7]  Doyoung Kim.  Capital budgeting for new projects: On the role of auditing in information acquisition , 2006 .

[8]  D. Simunic,et al.  Auditor Size and Audit Quality Revisited: The Importance of Audit Technology , 2011 .

[9]  Jere R. Francis,et al.  The Joint Effect of Investor Protection and Big 4 Audits on Earnings Quality Around the World , 2006 .

[10]  Marcos Pereira Estellita Lins,et al.  Review of Methods for Increasing Discrimination in Data Envelopment Analysis , 2002, Ann. Oper. Res..

[11]  Arnold M. Wright,et al.  Corporate Governance and the Audit Process , 2002 .

[12]  Gary C. Biddle,et al.  Accounting Quality and Firm-Level Capital Investment , 2006 .

[13]  R. Kellogg.  Accounting activities, security prices, and class action lawsuits , 1984 .

[14]  Fumio Hayashi,et al.  TOBIN'S MARGINAL q AND AVERAGE q: A NEOCLASSICAL INTERPRETATION , 1982 .

[15]  J. Krishnan,et al.  Auditor Industry Expertise and Cost of Equity , 2013 .

[16]  Brad Tuttle,et al.  An Experimental Test of the Interaction of the Insurance and Information-Signaling Hypotheses in Auditing* , 2006 .

[17]  Luk N. Van Wassenhove,et al.  Behind the Learning Curve: Linking Learning Activities to Waste Reduction , 2000 .

[18]  Joe Zhu,et al.  DEA Models for Identifying Critical Performance Measures , 2003, Ann. Oper. Res..

[19]  Henock Louis.  Acquirers' Abnormal Returns and the Non-Big 4 Auditor Clientele Effect , 2005 .

[20]  Ronald A. Dye,et al.  Auditing Standards, Legal Liability, and Auditor Wealth , 1993, Journal of Political Economy.

[21]  Jian Zhou,et al.  Auditor Brand Name, Industry Specialisation, and Earnings Management: Evidence from Taiwanese Companies , 2006 .

[22]  Brian W. Mayhew,et al.  Audit Firm Industry Specialization and Client Disclosure Quality , 2004 .

[23]  R. Glaser,et al.  Learning Theory and the Study of Instruction , 1989 .

[24]  David C. Wheelock,et al.  Why do Banks Disappear? The Determinants of U.S. Bank Failures and Acquisitions , 2000, Review of Economics and Statistics.

[25]  Allen N. Berger,et al.  Bank efficiency derived from the profit function , 1993 .

[26]  Kenneth J. Reichelt,et al.  National and Office-Specific Measures of Auditor Industry Expertise and Effects on Audit Quality , 2010 .

[27]  Asma Houcine.  The effect of financial reporting quality on corporate investment efficiency: Evidence from the Tunisian stock market , 2017 .

[28]  M. C. Jensen,et al.  Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers , 1999 .

[29]  L. DeAngelo,et al.  Auditor size and audit quality , 1981 .

[30]  J. Tobin.  A General Equilibrium Approach to Monetary Theory , 1969 .

[31]  Stephen L Taylor,et al.  Auditor brand name reputations and industry specializations , 1995 .

[32]  A. Vanstraelen,et al.  Earnings Management and Audit Quality in Europe: Evidence from the Private Client Segment Market , 2008 .

[33]  S. Balsam,et al.  Auditor Industry Specialization and Earnings Quality , 2003 .

[34]  Linda DeAngelo,et al.  Auditor independence, ‘low balling’, and disclosure regulation , 1981 .

[35]  Karla M. Zehms,et al.  Earnings Manipulation Risk, Corporate Governance Risk, and Auditors' Planning and Pricing Decisions , 2004 .

[36]  Tian-Yu Zhang,et al.  The effect of audit adjustments on earnings quality: Evidence from China , 2016 .

[37]  Anne Beatty,et al.  Financial Reporting Quality, Private Information, Monitoring and the Lease-Versus-Buy Decision , 2010 .

[38]  Accounting Conservatism and Firm Investment Efficiency , 2016 .

[39]  Jere R. Francis,et al.  The Role of Big 6 Auditors in the Credible Reporting of Accruals , 1999 .

[40]  Dana R. Hermanson,et al.  The Audit Committee Oversight Process , 2009 .

[41]  B. Jaggi,et al.  Earnings Quality: Some Evidence on the Role of Auditor Tenure and Auditors' Industry Expertise , 2009 .

[42]  Abbie J. Smith,et al.  Financial Accounting Information and Corporate Governance , 2001 .

[43]  Andrei Shleifer,et al.  Do Managerial Objectives Drive Bad Acquisitions? , 1989 .

[44]  D. Yu.  THE EFFECT OF BIG FOUR OFFICE SIZE ON AUDIT QUALITY , 2007 .

[45]  Chandra Kanodia,et al.  Investment and disclosure: The disciplinary role of periodic performance reports , 1998 .

[46]  Louis-Philippe Sirois,et al.  Proposition d’une nouvelle approche de la relation entre la taille de l’auditeur et la qualité de l’audit: l’importance de la technologie d’audit , 2016 .

[47]  Gary C. Biddle,et al.  How Does Financial Reporting Quality Relate to Investment Efficiency? , 2009 .

[48]  Scott A. Richardson,et al.  Over-investment of free cash flow , 2006 .

[49]  A. U.S.,et al.  Measuring the efficiency of decision making units , 2003 .

[50]  Costas Meghir,et al.  Dynamic Investment Models and the Firm's Financial Policy , 1994 .

[51]  Walter Ukovich,et al.  A classification of DEA models when the internal structure of the Decision Making Units is considered , 2010, Ann. Oper. Res..

[52]  Selim Zaim,et al.  Measuring the relative efficiency of quality management practices in Turkish public and private universities , 2013, J. Oper. Res. Soc..

[53]  William F. Messier,et al.  Error Detection by Industry‐Specialized Teams during Sequential Audit Review , 2002 .

[54]  Ole‐Kristian Hope,et al.  Financial Reporting Quality and Investment Efficiency of Private Firms in Emerging Markets , 2010 .

[55]  Larry H. P. Lang,et al.  The Ultimate Ownership of Western European Corporations , 2002 .

[56]  Ira Solomon,et al.  What Do Industry-Specialist Auditors Know? , 1999 .

[57]  Patricia M. Dechow,et al.  The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors , 2002 .

[58]  Paul Danos,et al.  Specialized knowledge and its communication in auditing , 1989 .

[59]  R. G. Dyson,et al.  Data envelopment analysis, operational research and uncertainty , 2010, J. Oper. Res. Soc..

[60]  F. Gul,et al.  The Differential Effects of Auditors' Nonaudit and Audit Fees on Accrual Quality* , 2007 .

[61]  George J. Benston,et al.  BRANCH BANKING AND ECONOMIES OF SCALE , 1965 .

[62]  K. Lai.  Does Audit Quality Matter More for Firms with High Investment Opportunities , 2009 .