jeong-big six auditors and audit quality-the korean evidence

8/18/2019 Jeong-Big Six Auditors and Audit Quality-The Korean Evidence

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Big Six auditors and audit quality:

The Korean evidence

Seok Woo Jeonga,*, Joonhwa Rho b

a

College of Business Administration, Korea University, Seoul, South Korea bCollege of Business Administration, Choongnam National University, Taejon, South Korea

Abstract

This study investigates the association between discretionary accruals and Big Six and non-Big

Six auditors, and the direction of auditor change. We hypothesize that there is no significant

difference in discretionary accruals between Big Six and non-Big Six clients when there is low

incentive for auditors to provide high-quality audits, as in Korea.

Upon examination of the discretionary accruals of firms listed on the Korean Stock Exchange

from 1994 to 1998, we find there is no significant difference between the discretionary accruals of firms with Big Six and non-Big Six auditors. This holds true for firms that switch from non-Big Six

to Big Six auditors and vice versa. These resources imply that there may be no difference in audit

quality between Big Six and non-Big Six auditors in Korea. This is consistent with other studies in

Korea, while inconsistent with the findings of previous studies on audit quality in other countries.

D 2004 Published by University of Illinois. All rights reserved.

Keywords: Audit quality; Big Six auditor; Discretionary accruals

1. Introduction

In this study, we examine whether Big Six auditors (before shrinking to four) provide

higher quality audits than non-Big Six auditors in Korea where the institutional setting

does not motivate auditors to provide high-quality audits. Specifically, we compare the

discretionary accruals of firms audited by Big Six auditors with those of firms audited by

non-Big Six auditors, as well as the discretionary accruals of firms that change from Big

Six to non-Big Six auditors and vice versa, using Korean data. We also investigate whether

discretionary accruals increase (decrease) under the same conditions.

0020-7063/$ 30.00 D 2004 Published by University of Illinois. All rights reserved.

doi:10.1016/j.intacc.2004.02.001

* Corresponding author.

E-mail addresses: [email protected] (S.W. Jeong), [email protected] (J. Rho).

The International Journal of Accounting

39 (2004) 175–196


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Previous literature suggests that Big Six auditors are more likely to object to

management’s accounting choices that increase earnings if auditors are likely to be sued

when financial statements overstate earnings (Becker, De Fond, Jiambalvo, & Subrama-

nyam, 1998; Francis, Maydew, & Sparks, 1999). These findings, however, are based ondata from countries where auditors face high litigation risk when they provide low-quality

audits. However, when there is little risk of litigation and no other effective disciplinary

mechanism to control opportunistic behavior, auditors may choose not to provide high-

quality audits. Until recently, suing auditors has been very rare in Korea and there is no

other effective monitoring mechanism to prevent auditors’ opportunistic behavior. In

addition, since the auditors selected by a firm typically have personal ties to management,

they may not bring a high level of independence to their auditing. Independent audits by

external auditors are not necessary to obtain capital in Korea, and managers frequently

regard audit fees and the filing of audited financial statements with regulatory bodies in

Korea as unnecessary costs of doing business (Park, 1990). In such an institutional setting,

where the auditor’s incentive to provide high-quality audits is low, it is unlikely that Big

Six auditors would have much incentive to restrict their clients’ adoption of aggressive

accounting methods.

In this study we conduct empirical analysis on a sample of 2117 firm-year observations

over the period from 1994 to 1998. Discretionary accruals are obtained by using a cross-

sectional variation of the modified Jones model. The evidence suggests that there is no

statistically significant difference between the discretionary accruals of firms audited by

Big Six and non-Big Six auditors, or of firms that change from one to the other. We

interpret these results to mean that there may be no difference in audit quality between BigSix and non-Big Six auditors in Korea. While these findings are consistent with the results

of other studies in Korea (e.g., Jeong, 1999; Jeong & Rho, 1999; Park, Jongil, & Won,

1999), they are inconsistent with the findings of many previous studies on audit quality in

other countries (e.g., DeAngelo, 1981; Palmrose, 1988; Becker et al., 1998). Therefore, we

need to examine whether auditor type can be used as a proxy for audit quality in research

on earnings management in different countries and, if so, under what circumstances.

The remainder of the paper is organized as follows. In the next section we describe the

institutional setting in the Korean audit market and the motivation for our hypothesis. The

sample-selection procedure is discussed in Section 3. In Section 4 we explain variable

measurement and our research methodology. Results are presented in Section 5, and thesummary and conclusion are presented in Section 6.

2. Motivation, the Korean audit market, and hypothesis

Previous studies document that Big Six auditors charge higher audit fees, spend more

time on audits, and have fewer lawsuits than non-Big Six auditors, which is taken to imply

that Big Six auditors provide higher quality audits than non-Big Six auditors (DeAngelo,

1981; Francis & Simon, 1987; Palmrose, 1988, 1989). Furthermore, Becker et al. (1998)

and Francis et al. (1999) find that clients of Big Six auditors report low discretionaryaccruals compared to clients of non-Big Six auditors, even though clients of Big Six

auditors have high levels of total accruals. They argue that Big Six auditors have a greater

S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175–196 176


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ability to constrain their clients’ use of aggressive and questionable accounting methods

and practices, thus increasing the quality of reported earnings for high-accrual firms. Big

Six auditors have better methods for detecting problem areas, interpret GAAP conserva-

tively (thereby reducing the scope for aggressive accruals-based earnings management),and can take a strong negotiating stance with clients who require more adjustments to the

financial statements. Therefore, the fact that firms’ financial statements are audited by Big

Six auditors may indicate that earnings are subjected to less opportunistic earnings

management.

However, if the economic environment and institutional setting does not demand

high-quality audit services, auditors may not restrict the opportunistic behavior of

management but rather may behave opportunistically themselves to attract more clients.

Under the Acts on External Audits of Corporations in Korea, firms with total assets over

a certain amount should report financial statements audited by external independent

auditors. Annually, about 7000 firms, including 700 listed firms, issue audited financial

statement under this law. However, since many firms in Korea raise more capital

through debt financing than equity financing, managers do not appreciate the role and

importance of external audits. Rather, they consider audit fees and audited financial

statements filings as an unnecessary but unavoidable cost of doing business (Park,

1990). In addition, Korean business has traditionally operated on personal relationships

such as family ties, school ties, or regional ties (Kim, Chung-Ki, & Cheong, 2002). In a

relationship-based economy, auditors who are frequently selected on the basis of

personal ties to the manager are less likely to constrain managers’ opportunistic

behavior. The fact that audit contracts are renewed every year places auditors in aweak bargaining position. For all these reasons, auditors in Korea are less likely to

restrict managers from adopting aggressive accounting policies compared to auditors in

other developed countries such as the United States.

In Korea there are two potential risks for auditors who provide low-quality audits: a

penalty imposed by the government agency that reviews audit works and the possibility of

litigation by a third party. Under the Acts on External Audits of Corporations, the

government agency monitors the quality of audits on a sample basis. It reviews about 150

firms annually, less than 2% of all audits done in a year. In this environment, auditors may

not believe they have a high likelihood of getting caught if they provide low-quality audits.

Moreover, even when they are caught by the government agency the penalties are not severe enough to cause auditors to provide high-quality audits. Infractions for which

auditors are penalized include not keeping generally accepted Korean auditing standards

or irregularities in a firm’s financial statements. The penalties that can be imposed on

CPAs and their firms range from fines, reprimands, suspension of audit works for a certain

period of time, revoking licenses, or a combination of these. In reality, most penalties on

auditors are light—small fine, reprimands, or the suspension of audits for participating

CPAs for a limited period. In most cases, these penalties have not been harsh enough to

encourage auditors to change their behavior. In fact, the economic incentives would

encourage them to attract more clients and make more revenues than what they pay in

penalties by providing low- rather than high-quality audits. There has also been a very lowrisk of litigation during the period. The first litigation against auditors occurred in 1991,

and during the 1990s there have been only 22 such lawsuits. During the same period, more



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than 60,000 firm-year external audits, including 6000 listed firm-year audits, have been

performed. In addition, the penalties against auditors by the court have been very small.1

Auditor-selection mechanisms that foster independent external audits did not exist in

Korea during most of the sample period. Auditor-selection committees, consisting of interested parties, such as internal auditors, outside directors, who are typically the second

largest shareholders, and the largest debtors except the largest shareholders and related

parties, were introduced in 1997 and have been effective since 1998; audit committees

were introduced for listed firms in 2001. (Only one year, therefore, overlaps with our

sample period.) Therefore, we consider socioeconomic and institutional environment in

Korea to provide a generally weak incentive for performing high-quality audits during the

sample period.

Big Six auditors in Korea do adopt standardized audit technology, whereas non-Big Six

auditors use their own audit technology, even when they are associated with other

international auditing firms such as Grant Thornton, BDO Seidman, and so forth. Even

when the institutional environment provides a low incentive for performing high-quality

audits, Big Six auditors may provide high-quality audits because they apply their

standardized global audit technology for all audits and thus deliver the same audit quality

in Korea as in other countries. This is highly probable if Big Six auditors can monitor the

audits of their branches in Korea. However, Big Six auditors do not have mechanisms for

monitoring different local audit reports written in Korean than non-Big Six auditors. They

go through an internal review process to check for global audit quality standards only

when the audit reports are written in English by technical advisors from the Big Six

headquarters. All the audit reports required by the Security Exchange Acts and the Acts onExternal Audits on Corporations in Korea are, however, provided in Korean and these are

the accounting numbers most investors in the Korean stock market use for decision

making. Audit reports written in English are not usually available to investors in Korea

unless firms are cross-listed on international exchanges. During the sample period, there

are very few cross-listed firms. Audit quality between Big Six auditors and non-Big Six

auditors in Korea may, therefore, not be different.

Previous studies in audit quality in Korea provide results consistent with this

conjecture. Audit quality has been proxied by many variables: audit fees, audit hours,

litigation rate, or discretionary accruals, for example. As suggested in previous studies in

the United States, Big Six auditors who provide high-quality audits will charge a premiumfee for their services. Empirical research using Korean data, however, show different

results. Choi and Paek (1998) examine whether Big Six auditors actually charge higher

fees and spend more time on audits than non-Big Six auditors. They document that there is

no difference in audit fees between Big Six and non-Big Six, but that Big Six auditors

spend more time on their audits. This suggests that Big Six auditors are not recognized as

providing a higher quality service than non-Big auditors.

Because litigations against auditors are very rare in Korea, researchers use the detection

ratio in audit reviews by the government agency as a proxy for audit quality. As noted

1 The largest penalty against auditors totals less than $100,000 during this period. Therefore, auditors rarely

settle the case outside the court.



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above, a Korean government agency reviews only a small sample—the audits of about 150

firms—annually and penalizes auditors when wrongdoings are uncovered. It follows that if

Big Six auditors provide higher quality audits, they should be detected and penalized less

often than non-Big Six auditors. However, Jeong (1999) examines the agency audit-reviewresults and finds no significant difference between Big Six and non-Big Six auditors.

Jeong and Rho (1999) and Kim and Hwang (1998) examine prior-year adjustments to

measure the differences between Big Six and non-Big Six auditors. If auditors find

accounting irregularities in previous financial statements, it is assumed that high-quality

auditors are more likely to make corrections and report the changes in current financial

statements. Kim and Hwang compare the number of prior year adjustments between

clients of Big Six and non-Big Six auditors and find no significant difference between the

two groups. Jeong and Rho examine the number of prior-year adjustments for firms that

change auditors and find the same results as Kim and Hwang, while document ing an

overall increase in the number of prior-year adjustments regardless of auditor type. Park et

al. (1999) look into the audit-quality issue using discretionary accruals. They compare the

discretionary accruals of Big Six and non-Big Six clients and find no difference between

them (using only univariate tests). Their results are limited, however, because discretion-

ary accruals could be affected by variables such as firm size, leverage, operating

characteristics of firms, auditor change, and stock offering. We propose, therefore, to

add to the evidence of audit quality in Korea by examining discretionary accruals after

controlling for these variables.

In sum, previous studies suggest that audit quality in Korea may not differ between Big

Six and non-Big Six auditors, whereas audit quality in other developed countries such asthe United States does differ between Big Six and non-Big Six auditors. Because many

previous studies in earnings manipulation in Korea show that managers manipulate

accounting numbers in many cases,2 it would be interesting to look into whether auditors

play an appropriate monitoring role over the production of accounting information in

Korea. Using discretionary accruals as an indicator of quality, the first hypothesis we

examine is as follows.

H1. Given the institutional environment in Korea, firms with Big Six auditors are likely to

report the same level of discretionary accruals as firms with non-Big Six auditors.

When firms change auditors, the new auditors may have stronger incentives to

provide high-quality audits compared to the old auditors even if there is no effective

market monitoring over audit quality. This is not usually due to the new auditors’

attempt to show that the prior auditors were not competent, which is unusual in a

relation-based economy. Rather, it is because the new auditors want to reduce the

likelihood of being reviewed by the government agency and are penalized for

accounting irregularities made in the prior year, even when there is not a high

litigation risk. Jeong and Rho (1999) provide evidence consistent with this argument

2 There are many indications that managers in Korean firms manipulate accounting numbers when a firm is

in financial distress, offer seasoned equities, and want to smooth income, and so forth, similar to managers in

other foreign firms. Yoon and Miller (2002a, 2002b) provide a good summary of recently published papers in this

area.



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by showing that prior year adjustments increase after an auditor change. Therefore, if

Big Six auditors provide higher quality audits than non-Big Six auditors, they will be

especially diligent when replacing a non-Big Six auditors. This leads us to assert that

there should be a difference in discretionary accruals between firms that change to aBig Six auditor and those that change to non-Big Six, if Big Six and non-Big Six

provide differential quality audits. That is, if firms change auditors from non-Big Six

(Big Six) to Big Six (non-Big Six) auditors, the discretionary accruals of the firms are

likely to decrease (increase). However, when there is no effective mechanism that

enforces performing high-quality audits, auditors are likely to provide similar quality

audit service and there will be no difference in discretionary accruals between Big Six

and non-Big Six auditors and no change in the discretionary accruals after auditor

change, regardless of auditor change direction. To address this issue we examine the

following two hypotheses:

When there is low incentive for auditors to provide high-quality audits,

H2. Firms that switch from non-Big Six to Big Six auditors are likely to report the same

discretionary accruals as the firms that switch from Big Six to non-Big Six auditors.

H3. Firms that switch from non-Big Six to Big Six auditors are not more likely to increase

discretionary accruals than the firms that switch from Big Six to non-Big Six auditors.

3. Sample selection

To test the hypotheses we use two sets of samples. The first sample, which is used to

examine the first hypothesis, consists of 2117 firm-year observations listed in the Korean

Stock Market during the period 1994 to 1998. We exclude financial institutions from the

sample because of the differences in estimation of discretionary accruals from firms in

other industries. In addition, we use only December year-end firms. When there are fewer

than 10 firms in an industry (two-digit SIC codes), for the estimation of nondiscretionary

accruals, we eliminate them from the sample. We require that firms’ financial data be

available in the KIS-FAS database that contains financial statements of Korean listed

companies since 1980. In addition, we require that firms receive an unqualified audit

opinion because firms with a qualified opinion are likely to report more discretionaryaccruals. We include firms that receive an unqualified opinion with an explanatory

paragraph in the sample. This sample-selection procedure yields 2117 firm-year observa-

tions of which 1311 firm-year observations are audited by Big Six auditors and 806 are

audited by non-Big Six auditors.

The second sample, which is used to examine the second and third hypotheses,

consists of firm-year observations that change auditors during the period 1995 to

1998, and meet all other sample-selection criteria used in the first sample-selection

procedure. Two hundred eighty-nine firm-year observations are included in the second

sample. We use the auditor-change sample for Hypotheses 2 and 3 because auditors

have a strong incentive to provide high-quality services when they are changed. If theresults in the change sample is not different from the first sample, there is a high

likelihood that the quality of audit services provided by Big Six auditors is not



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different from that provided by non-Big Six auditors. On average, 18% of listed firms

change auditors each year, implying that one out of five or six firms change their

auditor. Among these, 58% of the firms that change auditors are selected for our final

sample. They represent 10.3% of all listed firms in Korea and are spread out acrossthe sample period.

4. Research methodology and variable measurement

4.1. Estimation of discretionary accruals

Previous studies have used various methodologies to estimate the effects of accounting

choices on reported earnings. Healy (1985) uses total accruals and McNichols and Wilson

(1988) use the discretionary portion of an individual account, bad-debt provisions.

However, Healy’s model does not separate nondiscretionary accruals from discretionary

accruals and McNichols and Wilson’s method does not examine the behavior of total

discretionary accruals. Therefore, to capture the net effect of all accounting choices on

reported income, Jones (1991) uses an OLS model, regressing total accruals against the

change in revenue and property, plant and equipment. Since then, many studies have

adopted the Jones Model. Dechow, Sloan, and Sweeney (1995) modify the Jones (1991)

estimation model by adding the change in accounts receivable as an additional explanatory

variable in the estimation regression and report better performance of their model in

estimating discretionary accruals. Furthermore, Subramanyam (1996) finds that the cross-sectional Jones models are generally better specified than their time-series counterparts.

Therefore, we measure discretionary accruals by using the cross-sectional variation of the

modified Jones model.3

Total accruals can be defined in various ways. Jones (1991) defines total accruals by

subtracting operating cash flows from reported accounting earnings. Specifically, Jones

defines accruals as follows:

TAit ¼ DCAit DCLit DCashit þ STDit DEPit ð1Þ

where

TAit = total accruals for firm i for year t ;

DCAit = change in current assets for firm i for year t ;

DCLit = change in current liability for firm i for year t ;

DCashit = change in cash for firm i for year t ;

STDit = current portion of long-term liability for firm i for year t ;

DEPit = depreciation expenses (including amortization of intangible and deferred assets)

for firm i for year t .

3 We also estimate the original Jones model using the same definition of discretionary accruals, i.e., net

income minus operating cash flows, as in Becker et al. (1998), and find the results are qualitatively similar to the

results we report here.



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When we define accruals as the difference between accounting earnings and operating

cash flows, the accruals include gains or losses from investing and financing activities.

However, most previous studies use a definition of accruals that does not include the gains

or losses from investing and financing activities. This may be because COMPUSTAT doesnot contain the details of the gains or losses from investing and financing activities. If the

data are available, we can explicitly differentiate accruals from gains and losses by

dividing accounting earnings into operating cash flows, accruals, and gains and losses

from investing and financing activities. Bae (1999) argues that separating accruals from

gains and losses from investing and financing activities is a more accurate measurement

and that the data required to measure accurate accruals are available in the Korean

database, KIS-FAS. Therefore, we follow Bae’s definition of accruals in this study to

maintain comparability with other studies in Korea. He estimates accruals in a way very

similar to Jones (1991) and other studies, while taking advantage of detailed data in the

KIS-FAS database to calculate accruals. The definition of accruals used in this study is the

following:

OAt = trade receivablest (short term and long term) + inventoryt + advance paymentst (short term and long term) + prepaid expensest (short term and long term) + accrued

incomet ;

OLt = trade payablest (short term and long term) + advance from customerst (short term

and long term) + accrued expensest (short term and long term) + accrued income

taxest + unearned incomet ;

NCAt u

noncurrent accrualst = depreciation (including special depreciation

4

) + amorti-zation of intangible assetst + amortization of deferred assetst (excluding stock issuance

cost and debenture issuance cost) + severance benefits expensest ;

DOAt = OAt OAt 1;DOLt = OLt OLt 1;CAt u current accruals = DOAt DOLt ;TAt = total accruals = current accruals + noncurrent accruals = CAt NCAt .

Using the estimated coefficients of the modified Jones model, we calculated discre-

tionary accruals as follows:

eit ¼ TAijt =Aijt 1 ða jt ½1=Aijt 1 þ b1 jt ½ðDREVijt DRECijt Þ=Aijt 1

þ b2 jt ½PPEijt =Aijt 1Þ ð2Þ

where

a jt , b1 jt , and b2 jt are the estimated coefficients of the modified Jones model;

TAijt = total accruals for firm i in industry j for year t ;

Aijt 1 = total assets for firm i in industry j for year t 1;

4 In Korea, firms can depreciate tangible assets more than the amount normally calculated by the straight-line

method, accelerated method, and production method when they meet certain conditions in tax law and this

accounting treatment is permitted for financial reporting also.



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DREVijt = change in net revenues for firm i in industry j for year t ;

DRECijt = change in accounts receivable for firm i in industry j for year t ;

PPEijt = gross property plant and equipment for sample firm i in industry j for year t .

Discretionary accruals are usually estimated by using time-series data of the same

firm or cross-sectional data of the industry that the sample firm belongs to. We adopt

the cross-sectional version of the discretionary-estimation model using two-digit SIC

codes. If we use a time-series model in estimating the modified Jones model, we

would require that sample firms not change their auditors during the estimation period,

usually 8 to 10 years. If firms change their auditors during the estimation period, there

might be a change in the parameter of the estimation model due to the auditor change.

Most Korean firms change their auditors over a period of 8 years. On average, 17% to

20% of firms change auditors in a given year. Therefore, we use cross-sectional

industry data to estimate discretionary accruals. For the estimation of discretionary

accruals for our sample, we require that there be at least 10 firms within the industry.

The average explanatory power of the modified Jones model, i.e., the average of

adjusted R2 over years, is about 16.1%. Bae (1999) shows that the adjusted R2s of

several discretionary-accruals models using Korean data range between 12% and 17%.

This shows that our sample is similar to the samples in other studies that use Korean

data.

4.2. Multivariate test model and control variables

Because the comparison of discretionary accruals between firms with Big Six auditors

and non-Big Six auditors is the main focus of our analysis, we conduct univariate tests as

well as multivariate tests. In the multivariate test we control for potential differences across

the firms that may affect the results of simple univariate tests. We regress discretionary

accruals estimated in Eq. (2) on a dummy variable indicating auditor type and several

control variables. Specifically, we run the following multivariate regressions to test the

first hypothesis.

DAit ¼ b0 þ b1Bigit þ b2OCFit þ b3Sizeit þ b4HiLevit þ b5Abs accit

þ b6ShareIncit þ b7Changeit þ b8Ownshipit þ eit ð3Þ

where

DAit = estimated discretionary accruals;

Bigit = auditor type dummy variable equal to one if the auditor is Big Six;

OCFit = operating cash flows;

Sizeit = natural logarithm of total assets;

HiLevit = dummy variable indicating whether firms are among the highest decile

unclear of leverage, by year and industry;

Abs_accit = the absolute value of total accruals;ShareIncit = dummy variable equal to one when there is an increase of more than 10%

of the total outstanding shares during the year;



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Changeit = dummy variable equal to one when there is an auditor change;

Ownshipit = percentage of ownership by the largest shareholders including related

parties.

In this study, we expect no significant coefficient on auditor-type dummy variable

(Big). To control for other relevant variables that affect discretionary accruals, we include

operating cash flows, total assets, leverage, the absolute value of total accruals, increase in

the number of shares outstanding, equity ownership by largest shareholders in the

regression. A variable to control for the effect of management compensation is not

included in the regression, even though previous literature suggests that the management

compensation contract is related to discretionary accruals. Management compensation

based on accounting ear nings is not common in Korea.

Dechow et al. (1995) show that operating cash flows are negatively correlated with the

level of accruals. We expect a negative coefficient on operating cash flows. We use the

natural logarithm of total assets as a size variable to control for the political effect on

discretionary accruals and also as a surrogate for numerous omitted variables. Firms that

have a high chance of receiving political attention are more likely to manipulate

accounting numbers to avoid political scrutiny. During the sample period, most firms in

Korea pursue growth in size rather than profitability. Large firms, therefore, tend to show

lower profitability than small firms. However, if a large firm reports very low profitability,

it is more likely to get attention because of its size. During the sample period, large firms

reported lower profitability, and Jeong (1999) provides the evidence that large firms are

more likely to be involved in accounting manipulation than small firms. We, therefore,expect a positive coefficient for the size variable.

To control for the possible effect of leverage, we include a dummy variable (HiLev),

which takes one when firms have the highest decile leverage in the same industry during

the year of interest in the multiple regression as in Becker et al. (1998). Press and Weintrop

(1990) find that firms with high leverage are more likely to be close to the violation of debt

covenants. DeFond and Jiambalvo (1994) show that debt-covenant violation is associated

with discretionary-accruals choice. Managers of firms with high leverage are more likely

to adopt income-increasing accounting methods. However, firms with high leverage are

more likely to be in financial distress (Beneish & Press, 1995). DeAngelo, DeAngelo, and

Skinner (1994) show that troubled companies have large negative accruals related tocontractual renegotiations that provide incentives to reduce earnings. Therefore, we do not

have prior expectation on this variable.

Francis et al. (1999) argue that firms with greater endogenous accruals-generating

potential have greater uncertainty about reported earnings because of the difficulty that

outsiders have in distinguishing discretionary and nondiscretionary accruals. If we do not

have an accurate mechanism for differenting discretionary accruals from nondiscretionary

accruals, it is likely that firms with the larger absolute value of total accruals will show

higher discretionary accruals. To control this effect we include the absolute value of total

accruals as a control variable in the regression as in Becker et al. (1998). We expect a

positive coefficient on this variable.Teoh, Welch, and Wong (1998) find that managers report higher earnings when they

issue seasoned equities by adjusting current discretionary accruals. Beneish (1997) also



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argues that managers will manipulate earnings upward due to incentives associated with

selling their personal holdings as part of and subsequent to equity offerings. Therefore, we

include a dummy variable that indicates whether the number of outstanding shares has

increased by 10% or more.5 We expect a positive coefficient on this variable.An auditor-change dummy variable is also included in the regression because new

auditors tend to attribute previous accounting irregularities on previous auditors. Jeong and

Rho (1999) and Kim and Hwang (1998) find that the number of prior year adjustments

increases after firms change their auditors regardless of auditor change direction. We

expect a positive coefficient on the auditor-change variable.

Klassen (1997) argues that closely held firms can inform shareholders of firm value

more efficiently than widely held firms through communication channels other than

audited financial statements and press releases. As a result, these firms face less pressure

from capital markets. Firms with less capital-market pressure have less incentive to

provide useful accounting information to decision makers. This implies that firms with

higher inside ownership may have more flexibility in financial reporting than firms with

lower inside ownership. Thus, we include an ownership variable in the regression to

control for the effect of inside ownership on reported earnings and discretionary accruals.

Inside ownership is defined as the percentage of shares held by management. A positive

coefficient is expected on this variable.

To compare discretionary accruals between Big Six and non-Big Six auditors using

auditor-change firms, we divide second sample firms into groups depending on the

direction of auditor change. When firms change from Big Six to non-Big Six auditors, we

put them into the BN change group; when firms change from non-Big Six to Big Sixauditors, we put them into the NB change group. While previous studies imply the firms in

the BN change group are likely to report more discretionary accruals than firms in the NB

change group, we expect no difference as explained in the previous section. For these

groups of firms, we first examine whether there is a difference in discretionary accruals

and change in discretionary accruals without controlling for other variables. Then we

control for other variables that may explain the difference in discretionary accruals across

sample groups to check whether our experimental variable explains discretionary accruals

after controlling for these variables. Specifically, we run the following multivariate

regressions to test the second and third hypotheses.

DAit ðor DDAit Þ ¼ b0 þ b1 NB-changeit þ b2BN-changeit þ b3OCFit þ b4Sizeit

þ b5HiLevit þ b6Abs accit þ b7ShareIncit þ b8Ownshipit þ eit

ð4Þ

where

DAit = estimated discretionary accruals;

DDAit = change in discretionary accruals;

5 We did not include a dummy variable for a decrease in the outstanding shares because stock repurchase was

not allowed during the sample period.



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NB-changeit = auditor-change dummy variable, when firms change their auditors from

non-Big Six auditors to Big Six auditors assign one, zero otherwise;

BN-changeit = auditor-change dummy variable, when firms change their auditors from

Big Six auditors to non-Big Six auditors assign one, zero otherwise;Other variables are the same as in Eq. (3).

In this study, we expect no significant coefficients on either variable, while previous

studies imply that the coefficients on NB-change and BN-change are significantly negative

and positive, respectively.

5. Empirical results

5.1. Descriptive statistics and univariate results

Table 1 shows the descriptive statistics of variables used in the analysis. Operating cash

flows are about 2% of total assets. The median of assets are 156 billion Korean won.

Leverage is about 68% of total assets, which is 15% higher than that of U.S. firms used in

Becker et al. (1998). This implies that Korean firms have 100% higher debt ratio than U.S.

firms.6 Total accruals are higher than that of U.S. firms while the absolute value of total

accruals are smaller than that of US firms.

Size and ownership are significantly different between firms with Big Six and non-Big

Six auditors both on the parametric and nonparametric tests. Leverage and total accrualsare significantly different across the groups on the nonparametric tests. The mean and

median absolute values of total accruals scaled by assets are not statistically different

between firms with Big Six and non-Big Six auditors. Therefore, in addition to univariate

tests, we need multivariate tests that control other variables affecting discretionary accruals

before drawing any conclusions.

The univariate-analysis results of discretionary accruals of pooled observations over

years are presented in Table 2. Table 2 shows mean and median discretionary accruals

and the absolute value of discretionary accruals for firms with Big Six and non-Big Six

auditors. The differences obtained from subtracting the means and medians of non-Big

Six samples from those of Big Six samples are reported in the last two columns alongwith the results of t tests and Wilcoxon two-sample tests of the differences between the

two samples. As Table 2 shows, there is no statistical difference in discretionary

accruals, while the mean and median of firms with non-Big Six auditors are slightly

larger than those of firms with Big Six auditors. We also compare the absolute value of

discretionary accruals because the larger they are the more likely managers may exercise

discretion in reporting earnings. The mean and median values of the absolute value of

discretionary accruals are almost the same for the two groups and not statistically

different. Along with the results of discretionary accruals, these findings also show that

6 Average debt equity ratio for Korean firms is 213% [ = 68H (1–68)], and average debt equity ratio for U.S.

firms is 113% [ = 53H (1–53)].



13/22

the type of auditor make no difference to a manager’s accounting flexibility of

discretionary accruals.

To test whether there is a difference in the level of discretionary accruals

depending on the direction of auditor change we run the ANOVA. Table 3 presents

the results of the ANOVA test. It shows that discretionary accruals and the change in

discretionary accruals among auditor change groups are not significantly different

when we use all sample firms. In Korea, the Security and Future Committee (SFC)

Table 1

Descriptive statistics of variables for sample firms ( N = 2117)

Panel A

Mean S.D. Maximum Median Minimum

OCF 0.0238 0.0935 0.4370 0.0237 1.0061Size 19.08 1.343 24.01 18.87 16.07

Lev 0.6774 0.2295 4.4659 0.6775 0.1096

Tot _ acc 0.0226 0.0855 0.3970 0.0223 0.8752Abs _ acc 0.0637 0.0614 0.8752 0.0487 0.0001

Ownship 26.80 13.92 97.60 25.50 0.80

Panel B

Non-Big Six ( N = 806) Big Six ( N = 1311) Differences

Mean Median Mean Median t statistic Z statisticOCF 0.0204 0.0204 0.0258 0.0263 1.27 1.50Size 18.87 18.71 19.21 19.00 6.09*** 4.10***Lev 0.6709 0.6639 0.6814 0.6901 1.03 3.29***Tot _ acc 0.0197 0.0167 0.0244 0.0240 1.22 1.90*Abs _ acc 0.0636 0.518 0.0637 0.0469 0.03 1.54Ownship 27.47 26.20 26.39 25.00 1.77* 1.68*

OCF = operating cash flows divided by total assets; Size = log transformed total assets, which are measured in

thousand won; Lev = total liabilities divided by total assets; Tot _ acc = total accruals divided by total assets;

Abs _ acc = absolute value of total accruals; Ownship = the equity ownership percentage of the largest shareholder.

*Significant at 10% level.

***Significant at 1% level.

Table 2

Comparison of discretionary accruals and absolute value of discretionary accruals between firms with Big Six and

non-Big Six auditors during 1994–1998

Non-Big Six ( N = 806) Big Six ( N = 1311) Differences

Mean Median Mean Median Mean Median

Discretionary accruals 0.0078 0.0107 0.0062 0.0040 0.0016 0.0045

( P value) (.000) (.000) (.003) (.031) (.621) (.124)

Absolute value of

discretionary accruals

0.0535 0.0409 0.0535 0.0395 0.0000 0.0014

( P value) (.000) (.000) (.000) (.000) (.967) (.708)

Discretionary accruals are measured by the cross-sectional version of the modified Jones model by industry and

year.



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Table 3

ANOVA analysis of auditor change direction and discretionary accruals

Designated-change firms Free-change firms All

DA DDA DA DDA DA

Mean (S.D.) N Mean (S.D.) N Mean (S.D.) N Mean (S.D.) N Mean

Big 6 ! Big 6 0.0045(0.108)

59

(42.4)

0.0017(0.175)

58

(43.0)

0.0026(0.113)

36

(24.0)

0.0378

(0.209)

35

(24.7)

0.000

(0.12

Non-Big 6 !

Big 6

0.0231

(0.145)

23

(16.6)

0.0209

(0.147)

22

(16.3)

0.0211

(0.117)

33

(22.0)

0.0017

(0.161)

33

(23.2)

0.007

(0.11Big 6 !

Non-Big 6

0.0350

(0.150)

42

(30.2)

0.0370

(0.163)

41

(30.3)

0.0193(0.170)

45

(30.0)

0.0119

(0.186)

41

(28.9)

0.(0.18

Non-Big 6 ! Non-Big 6

0.0315(0.130)

15

(10.8)

0.0551(0.142)

14

(10.4)

0.0274

(0.154)

36

(24.0)

0.0213

(0.222)

33

(23.2)

0.(0.16

All 0.0053

(0.131)

139

(100.0)

0.0014

(0.165)

135

(100.0)

0.0048

(0.143)

150

(100.0)

0.0181

(0.194)

142

(100.0)

0.005

(0.14

F value 1.486 1.340 0.899 0.213 1.372

DA = the discretionary accruals estimated by the modified Jones model and scaled by previous-year total assets.

DDA = the change in discretionary accruals estimated by the modified Jones model and scaled by previous-year total assets.


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has the power to order an auditor change if a firm does not meet the conditions that

the SFC requires.7 In this case, firms might have different discretion in choosing

accounting methods from firms that change auditors by their own intention. Therefore,

we separate the sample firms into two groups to determine whether the cause of auditor change affects the results of our analysis. There are 129 firm-year observations

that change auditors by their own decision (free-change firms) and 125 firm-year ob-

servations that change auditors by the designation of the SFC (designated-change firms).

Whether we use designated-change firms or free-change firms, discretionary accruals

and the change in discretionary accruals among auditor groups are not significantly

different.

5.2. Multivariate analysis

Because we ignore a number of variables that affect discretionary accruals, we run the

multivariate regression with the control variables discussed in Section 4. Table 4 shows the

results of the estimation of regression equation (3) for the test of Hypothesis 1. The first

two columns show the results of pooled regressions and the last column shows the results

of yearly regressions. The coefficients on the first variable (Big), indicating whether firms

are audited by Big Six auditors, is not significant at all in any of the three regressions. This

is consistent with our expectation and the results of univariate tests. It suggests the

possibility that Big Six auditors in Korea do not provide higher quality audits than non-Big

Six auditors.

Most of the control variables in the multivariate regression are significantly relatedto discretionary accruals with expected signs. Operating cash flows are strongly

negatively associated with discretionary accruals, which is consistent with the results

of Becker et al. (1998) and Dechow et al. (1995). The magnitude of the coefficient

on operating cash flows in this study is much larger than that of Becker et al. This

may be due to using Korean data. Most of Korean accounting standards required by

the SFC in financial reporting are based on the abstracts of the U.S. GAAP minus

the specific details, thereby allowing managers more flexibility in reporting. Thus, it

is easier to manipulate earnings in Korea than in other countries such as the United

States. Because discretionary accruals are not related to cash flows, when there are

more discretionary accruals in earnings, the coefficient on operating cash flows ismore likely to be negative. In addition, some of the negative coefficient value may

be caused by the number of nondiscretionary accruals treated as discretionary

accruals due to a classification error in the modified Jones model. Nondiscretionary

accruals may have a negative relation with cash flows from operation due to the

definition of total accruals. The positive coefficient on the size variable implies that

large firms are more inclined to income-increasing accounting policy. This is

consistent with results (Jeong, 1999) that firm size is significantly related to the

possibility of being detected for accounting irregularities in the audit-review process

by the government agency.

7 The role of the SFC in Korea is similar to that of SEC in the United States in regulating firms’ disclosure.



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The negative coefficient on the leverage dummy variable is consistent with the result of

DeAngelo et al. (1994), that troubled companies are more likely to manage discretionary

accruals to reduce earnings due to contractual negotiations. The coefficient on the absolute

value of total accruals is negative, which is consistent with Becker et al. (1998). This

implies that managers of firms with large accruals tend to reduce earnings. The increase in

the number of outstanding shares is also significantly positively related to discretionary

accruals, suggesting that managers may manipulate earnings upward when there is

seasoned-equity offerings because they may sell their personal holdings higher as part

of and subsequent to equity offerings. This result is consistent with Teoh et al. (1998) and

Yoon and Miller (2002a, 2002b). The ownership variable is also significantly positive,which is consistent with our expectation.

To check whether the Asian Currency Crisis and related corporate governance changes

in Korea affect the results, we also reestimate the regression after deleting (excluding)

firm-year observations after 1998 because the Foreign Currency Crisis started at the end of

1997 and began to affect the Korean audit environment in 1998. The second column of

Table 4 presents the regression-estimation results without the 1998 firm-year observations.

As you will note, the results are almost the same as those estimated with 1998 firm-year

observations. Big Six dummy is still not significant at all, while most control variables

show significant coefficients with expected signs.

If discretionary accruals reverse, using pooled data may not be appropriate. Because previous studies show that discretionary accruals reverse, we estimate the regression

equation (3) yearly for 5 years of the sample period, and calculate t statistics using the

Table 4

Regression results of discretionary accruals on auditor type and control variables, 1994–1998 period

Pooled Average estimate of 5 yearly

1994–1998 (t statistic) 1994 – 1997 (t statistic) regressions (t statistic)a

Intercept 0.0558 ( 2.70)*** 0.0495 ( 2.33)** 0.0315 ( 0.92)Big 0.0010 ( 0.34) 0.0022 ( 0.76) 0.0017 ( 0.71)OCF 0.3613 ( 23.36)*** 0.3958 ( 22.74)*** 0.3748 ( 12.59)***Size 0.0040 (3.81)*** 0.0035 (3.25)*** 0.0031 (1.81)*

HiLev 0.0387 ( 7.65)*** 0.0336 ( 6.66)*** 0.0345 ( 5.60)***Abs _ acc 0.2131 ( 9.36)*** 0.0915 ( 3.38)*** 0.1498 ( 0.92)ShareInc 0.0150 (1.67)* 0.0110 (3.45)*** 0.0149 (2.20)**

Change 0.0068 (1.79)* 0.0057 (1.41) 0.0032 (0.52)

Ownship 0.0003 (2.61)*** 0.0000 (0.33) 0.0001 (0.71)

N 2117 1723

R2

26.86% 25.82%Big = an auditor type dummy variable equal to 1 if auditor is Big Six; OCF = operating cash flows divided by total

assets; Size = natural logarithm of total assets; HiLev = dummy variable indicating whether firms are among the

highest decile leverage, by year and industry; Abs _ acc = absolute value of total accruals; ShareInc= dummy

variable equal to 1 when there is an increase of more than 10% of the total outstanding shares during the year;

Change = dummy variable equal to 1 when there is an auditor change; Ownshipit = percentage of ownership by the

largest shareholders including related parties.a The t -statistics are calculated using the variability in the yearly coefficient estimate as in Becker et al. (1998).

*Significant at 10% level.

**Significant at 5% level.

***Significant at 1% level.



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variability in the annual-coefficient estimates as in Becker et al. (1998) and Bernard (1987)

to check whether the results that use pooled data change. The last column of Table 4 shows

the average coefficients for the five yearly estimates along with related t statistics. The

results are consistent with the pooled regression estimation except that size and ownershipvariables lose significance. In particular, the coefficient on the Big Six dummy variable is

.0003 and not significant at all at any conventional level. That is, firms with Big Sixauditors show indifferent levels of discretionary accruals compared to firms with non-Big

Six auditors. While this result is not consistent with the results of previous studies in other

countries, it is consistent with the results in Park et al. (1999) and our expectation.

To analyze the effect of auditor-change direction on discretionary accruals after

controlling for other influences on discretionary accruals, we estimate Eq. (4) using the

second set of data. Table 5 reports the results of the multivariate-regression analysis,

including the control variables.

Table 5

The effect of Auditor-change direction on discretionary accruals [DAit (or DDAit ) =b0 + b1 NB-changeit +

b2BN-changeit +b3OCFit +b4Sizeit +b5HiLevit +b6Abs _ accit +b7ShareIncit +b8Ownshipit + eit ]

All firms Designated-change firms Free-change firms

DA

(t statistic)

DDA

(t statistic)

DA

(t statistic)

DDA

(t statistic)

DA

(t statistic)

DDA

(t statistic)

Intercept 0.1370

( 1.28)

0.2001

( 1.27)

0.0359

(0.26)

0.0124

(0.06)

0.2594

( 1.59)

0.3066

( 1.30) NB-change 0.0136( 0.72)

0.0367( 1.32)

0.0367( 1.41)

0.0231( 0.60)

0.0097

(0.36)

0.0332( 0.85)

BN-change 0.0205( 1.21)

0.0046

(0.19)

0.0005( 0.02)

0.0336

(1.03)

0.0225( 0.87)

0.0048( 0.13)

OCF 0.643( 8.28)***

0.6677( 5.82)***

0.4579( 4.89)***

0.3202( 2.31)**

0.8982( 6.88)***

1.1288( 6.00)***

Size 0.0089

(1.62)

0.0123

(1.51)

0.0016

(0.22)

0.0036

(0.35)

0.0131

(1.51)

0.0140

(1.11)

HiLev 0.0193( 0.86)

0.0378( 1.14)

0.0013

(0.05)

0.1470( 0.41)

0.0518( 1.12)

0.0607( 0.91)

Abs _ acc 0.0877

( 0.83)

0.1564

(0.46)

0.3316

( 2.46)**

0.2536

( 1.27)

0.2179

(1.31)

0.5243

(2.18)**ShareInc 0.0007

( 0.04) 0.0099( 0.39)

0.0039( 0.17)

0.0001

(0.00)

0.0045

(0.18)

0.0080( 0.22)

Ownship 0.0003

(0.67)

0.0004

(0.51)

0.0006( 0.94)

0.0017( 1.86)*

0.0015

(1.83)*

0.0030

(2.61)***

Adjusted R2 26.2% 12.4% 28.6% 10.4% 28.9% 21.7%

F statistic 12.20*** 5.49*** 2.82*** 7.43*** 5.44***

N 254 254 125 125 129 129

DDA = change in discretionary accruals; NB-change = auditor change dummy variable, when firms change their

auditor from non-Big 6 auditor to Big 6 auditor assign 1, otherwise 0; BN-change = auditor change dummy

variable, when firms change their auditor from Big 6 auditor to non-Big 6 auditor assign 1, otherwise 0; Other

variables are the same as in Table 4.

*Significant at 10%.

**Significant at 5%.

***Significant at 1%.



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The adjusted R2s of the regressions for all sample firms, designated-change firms, and

free-change firms are 26.2%, 28.6%, and 28.9%, respectively, when discretionary accruals

are the dependent variable. When the change in discretionary accruals is used as the

dependent variable, the adjusted R2s of the regression are 12.4%, 10.5%, and 21.7% for allsample firms, designated firms, and free-change firms, respectively. The F statistics show

that all the multivariate-regression models are valid.

As Table 5 reveals, auditor change direction variables (NB-change and BN-change) are

not statistically significant in any regressions when all firms are used. To check whether

this result is driven by the method of auditor change, we divide the sample into two

groups, free change and designated change, and run the regression. Park (1996) shows that

firms with designated auditors report fewer discretionary accruals than other firms. If firms

that switch from Big Six to non-Big Six auditors change auditors by order of the SFC,

while firms that switch from non-Big Six to Big Six auditors change auditors by their own

decision, there is no difference in discretionary accruals even though firms with Big Six

auditors report fewer discretionary accruals. However, either in the free-change sample or

the designated-change sample the auditor change direction variables are not significant in

any regression, implying that the sample results are not driven by the method or direction

of auditor change. This issue will be examined further in sensitivity analysis. Among the

control variables, only operating cash flows (OCFs) have a significant expected coeffi-

cient, that is, a significant negative coefficient. The ownership variable (Ownship) is

statistically significantly positive regardless of the dependent variable for the free-change

sample, but is not significant for all samples.

5.3. Sensitivity test

To check the robustness of our analysis for the first hypothesis, we replicate the tests of

Becker et al. (1998). That is, we define total accruals as the difference between earnings

and operating cash flows, estimate discretionary accruals using the cross-sectional version

of the Jones model, and reestimate Eqs. (3) and (4). However, the coefficients on auditor

type and auditor change direction variables are not significant. The results are not reported

in the paper. We also calculate the Spearman correlation among the independent variables

to check whether multicollinearity exists among the variables. We find that there is no

statistically significant correlation among variables.To check the robustness of results for the second and third hypotheses, we reestimate

the regression by using only firms that change their auditor from non-Big Six to Big Six

(NB change sample), and firms that change their auditor from Big Six to non-Big Six (BN

change sample), respectively. Auditor-change variables are not statistically significant in

all these regressions. The results are not reported in the paper.

The statistical insignificance of auditor change may be attributed to the fact that our

sample includes the period when there are significant changes in the accounting and

auditing systems in Korea. There have been many changes in accounting and audit-related

laws and regulations and auditing practices in Korea since the 1997 Foreign Currency

Crisis. Therefore, we separate the sample into two periods: before the crisis (1994–1997)and after the crisis (1998), and reestimate the regressions. Again both auditor-change

variables are not significant in all regressions.



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The reasons for auditor change might affect the relation between auditor change and

discretionary accruals. Therefore, we add a dummy variable for auditor-change reasons to

regression Eq. (3). This dummy variable is one when firms change their auditor because

the SFC in Korea designates the auditor, zero otherwise. The following equation is used inthe regression estimation.

DAit ðor DDAit Þ ¼ b0 þ b1DEGð1 þ c1 NB-change þ c3BN-changeÞ

þ b3OCFit þ b4Sizeit þ b5HiLevit þ b6Abs accit þ b7ShareIncit

þ b8Ownshipit þ eit

¼ b0 þ b1DEG þ b1c1DEG NB-change þ b1c3DEG

BN-change þ b3OCFit þ b4Sizeit þ b5HiLevit þ b6Abs accit

þ b7ShareIncit þ b8Ownshipit þ eit ð5Þ

where DEG is a dummy for auditor-change reason. Other variables are the same as in

Eq. (4).

When auditors are designated by order of the SFC, they are usually assigned to a

firm for 3 years. These auditors, then, do not need to worry about next year’s contract,

making them more independent. Previous studies find that auditors are more likely to

constrain aggressive accounting by management when they are independent (Park,

1996). Table 6 presents the regression results of Eq. (5). All the signs of the auditor-

change variable for the designated-change sample are the same as the results in the

previous analysis. That is, none of the coefficients of DEG NB-change variable andDEG BN-change variable is statistically significant in any regressions. Among the

Table 6

The effect of auditor designation on discretionary accruals [DAit (or DDAit )=b0 + b1DEGb1c1DEG NB-change+ b1c3DEGBN-change +b3OCFit +b4Sizeit +b5HiLevit +b6Abs _ accit +b7ShareIncit +b8Ownshipit + eit ]

Independent variables (expected sign) DA (t statistic) DA (t statistic)

Intercept 0.1426 (1.34) 0.2164 (1.38)

DEG (dummy) 0.0036 (0.21) 0.0298 (1.16)DEG NB-change 0.0366 (1.28) 0.0254 (0.60)DEGBN-change 0.0110 (0.46) 0.0133 (0.38)OCF 0.6463 (8.21)*** 0.6739 (5.80)***Size 0.0089 (1.61) 0.0129 (1.59)

HiLev 0.0157 (0.69) 0.0288 (0.86)Abs _ acc 0.0779 (0.71) 0.1034 (0.66)ShareInc 0.0026 (0.15) 0.0108 (0.42)Ownship 0.0004 (0.88) 0.0006 (0.79)

Adjusted R2 26.08% 12.38%

F statistic 10.92*** 4.97***

N of observations 254 254

DEG=auditor-change-reason dummy. When auditor is changed by the designation, DEG is 1, otherwise 0. Other

variables are the same as in Table 5.

*** Significant at 1% level.



20/22

control variables, only the operating cash flows variable reveals significant negative

coefficients.

Overall, several sensitivity analyses do not change the results in Table 5, that auditor-

change variables (BN-change, NB-change) are related to discretionary accruals. Thisimplies that a finding of no difference in discretionary accruals is not a period-specific or

sample-specific phenomenon.

6. Summary and conclusion

In this study, we investigate the relation between discretionary accruals, auditor type,

and auditor-change direction. We investigate whether there is any audit-quality difference

between Big Six and non-Big Six auditors and whether auditor change affects the number

of discretionary accruals. Empirical results show that there is no statistically significant

difference between discretionary accruals of firms with Big Six and non-Big Six auditors.

In addition, the discretionary accruals of firms that change from non-Big Six to Big Six

auditors are not significantly different from those of firms that change from Big Six to non-

Big Six auditors. Furthermore, there is no statistically significant difference in the change

in discretionary accruals between these two groups. This result is consistent after

controlling for other relevant variables that may affect discretionary accruals and does

not change in several sensitivity tests.

We interpret this result as meaning that there may be no difference in audit quality

between Big Six and non-Big Six auditors in Korea during the sample period. The result isconsistent with results in other studies in Korea, while inconsistent with many previous

studies on audit quality in other countries (e.g., Becker et al. 1998; DeAngelo 1981;

Palmrose 1988). In Korea, there may be different incentives for auditors to provide high-

or low-quality audits because the economic and institutional environments in Korea are

different from other countries.

This study adds new evidence to the audit-quality literature by showing that

financial statements audited by Big Six auditors may not provide higher quality

information in certain economic environments. This implies that when we use auditor

type as a proxy for audit quality we may need to consider economic environments. As

Becker et al. (1998) point out there is still questions about the wisdom of usingdiscretionary accruals as a proxy for auditor quality. In addition, further research is

necessary to find out what other factors motivate auditors to provide audits of different

quality.

Acknowledgements

We appreciate the helpful comments of Susan Hamlen, Hyoik Lee, and participants of

the 2000 Winter Korean Accounting Association Meeting, Conference on Emerging

Issues in International Accounting 2001, 2003 South East Regional meeting of AAA.We also thank two anonymous reviewers for their valuable input. All remaining errors

are our own.



21/22

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