The effect of the financial crisis on audit quality: European evidence

• DOI: https://doi.org/10.1108/IJAIM-07-2021-0135
• Published date: 05 January 2022
• Date: 05 January 2022
• Pages: 143-158
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Maria I. Kyriakou

The effect of the financial crisis on

audit quality: European evidence

Maria I. Kyriakou

Department of Economics, International Hellenic University, Serres, Greece

Abstract

Purpose –This paper aimsto examine the impact of the recent financial crisis on audit qualityby analysing

discretionaryaccruals.

Design/methodology/approach –This study considers a sample of German, French, Italian and

Spanish non-financial firms from 2005 to 2013 to investigate the auditor’s independence. It uses a cross-

sectional and time-series ordinary least squares regression model to control for other predictors of the

auditor’sindependence when the financial crisis producesa decrease in audit quality.

Findings –The proportion of the non-financial firms having lower audit quality was higher during the

financial crisis. In addition, during the crisisauditors were less likely to provide a higher audit quality for

these non-financial firms. The level of audit quality returned to normal levels during the post-crisis years

when the crisishad ceased.

Originality/value –These findings contribute to the literature on the impact of economic and financial

changes on audit quality. In addition,this research finds that the Big Four accounting firms provide a higher

audit qualityin different circumstances from non-Big Four accountingfirms, and that audit quality decreased

during the crisisand returned to normal in the post-crisis period.

Keywords Financial crisis, Discretionary accruals, Audit quality, Non-audit fees

Paper type Research paper

1. Introduction

The recent financial crisis put pressure on whether companies around the world could

continue in business. Some companiessurvived, while others did not. This was clear in the

post-recession period, which gave companies the opportunity to cease trading or to find a

way to continue in business. The great recession,which began within the USA and spread to

Europe, startedat the end of 2007 and lasted until 2009.

The financial crisis was not an audit crisis. However, during the Global Financial Crisis

(GFC) and in the post-GFC period, non-Big Four auditors became more conservative

compared to Big Four auditors regarding their clients’going concern problems with

different insights and perspectives (Persakis and Iatridis, 2015;Sanoran, 2018). In another

study, Persakis and Iatridis(2016) stated there was a decline in audit quality during the GFC

period. In addition, Chen et al. (2019) found thataudit fees decreased during the GFC due to

the pressure from auditorson their clients; however, this could have resulted in auditquality

being impaired. After 2009, many companies found it difficult to continue doing business

immediately and took some timeto return to normal business.

A data set for the period 2005–2013 is used, and the aim of this paper was to study

the impact of the recession on audit quality (measured by discretionaryaccruals [DAC]) for

JEL classification –M41, M42

The author would like to thank the editor and three anonymous referees for their valuable

suggestions.

Effect of the

financial crisis

on audit

quality

143

Received7 July 2021

Revised24 October 2021

Accepted5 December 2021

InternationalJournal of

Accounting& Information

Management

Vol.30 No. 1, 2022

pp. 143-158

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-07-2021-0135

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

non-financial firms in Germany, France, Italy and Spain. This is an important issue to

be examined through the mediating effect of corporate social responsibility (CSR),

as companies’investments in social capital are not constant over time. The financial crisis

provides such a setting in which identifying trustworthiness during different periods is

more valuable (Lins et al.,2019). I chose these four countries as they are among the largest

Eurozone countries.All four of them are part of the Eurozone and since 2005 have used IFRS

for their financial reporting. Thus, Big Four audit firms may facilitate the diffusion of CSR

practices after 2005 in their non-financialfirms’reports which enhance their role when they

consider the audit quality of a report, and this superiorityis achieved through the Big Four

audit fee premium (Xiao et al.,2004).

The results and the causes of the recession are not distinct during the period at the

beginning of this crisis. As a result, the data showcertain consequences of the recession for

companies and whether or not such companieswould survive in the near future. In the crisis

period, some companies, being stronger than others, followed strategies that led to their

expansion and survivalafter the crisis. During the crisis, there was an increase in the quality

of audits and earnings announcements were not dependent on auditors’size or auditors’

independence for US financial and non-financial firms (Shahzad et al.,2018). For those

companies that found it difficult to survive or to continue during and after the crisis, the

auditors may have beencautious about providing a higher audit quality.

The data show that, during the recessionaryperiod, companies paid lower non-audit fees.

However, the risk effect from the financialcrisis supports the argument that auditors tend to

charge higher audit fees during a financial crisis period (Chen et al., 2018). This is true

whether the auditors were Big Four firms or smaller auditproviders. The objectives of this

study were to look at the impact of financial crisis years on the association between audit

quality and non-audit fees and in thedifference in audit quality before and during the crisis.

This study contributes to the deterioration or improvement of non-audit fees paid to

auditors by their clients in the crisis period, examined through a cross-sectional and time-

series ordinary least squares (OLS) regression method with interaction effects. In addition,

Salehi et al. (2019) found that financialcrises had no impact on the association between audit

quality and audit fee stickiness.

Previewing my results, I find that during the financial crisis, the auditors might

characterize a company’s reports as qualified or unqualified. In general, the financial crisis

questioned the role and value of external audits. This episode stressed reflection on the

independence of auditors. Many financial institutions collapsed or bailed out in a short

period after havingreceived an unqualified audit opinion (Sikka, 2009).

However, the study’sfindings suggest that the auditors’independence returned to

normal after the recession. Even after controlling for a number of factors, this study finds

that after the recession auditors were more likely to provide a higher audit quality to

companies. This trendwas evident from 2008/2009 (the years of crisis) to 2010 and then until

2013, when the likelihoodreturned to normal.

The remainder of this paper is organized as follows. Section 2 provides a literature

review and develops the research questions. Section 3 describes the dataset used in this

study and the methodology that is followed. Section 4 analyses the results and, finally,

Section 5 provides the conclusion.

2. Prior literature and development of research questions

The Big Four accounting firms provide three keyservices: audit, tax and advisory services.

Wyatt (2004) and Hermanson(2009) found that the services offered by an accounting firm to

an individual or company may differ over time. This means that the accountants may

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