Further evidence on the effect of regulation on the exit of small auditors from the audit market and resulting audit quality

This paper provides evidence on the effect of regulation on the ability of small auditors to continue to provide audit services, their exit from the audit market after the introduction of increased regulation including PCAOB inspections, and the resulting impact on audit quality. Using client discretionary accruals and the likelihood of the clients restating financial statements as proxies for audit quality we do not find that the exiting auditors were of lower quality. We find that the companies audited by the exiting auditors had on average higher absolute discretionary accruals as well as higher likelihood of restating their financial statements than other companies audited by non-exiting auditors. The results suggest that the higher absolute discretionary accruals and higher likelihood of restatements are explained by the overall firm specific characteristics of these clients rather than these companies being audited by the auditors that exited the market.