Are Audit Firm Revenues Indicators of Their Audit Quality?

ObjectiveThe objective of financial statements is to provide useful information to users for making economic decisions. High-quality information improves resource allocation and enhances market efficiency. The reliability and quality of financial statements are verified by auditors. In other words, auditors enhance financial reporting quality through high-quality audit services. Previous research shows that there is no reliable proxy for evaluating the quality of audit services. In the literature, auditor size (due to the independence and competence that a larger size offers) is commonly used as a proxy for audit quality. However, some studies have questioned this theory, known as the "auditor size theory." Audit firm size is primarily characterized by Big N membership. Since Big N firms have not operated in Iran since the Islamic Revolution in 1979, Iranian researchers lack a mechanism to distinguish high-quality auditors. This study uses audit firm revenue as a proxy for auditor size and aims to test whether the revenues of audit firms in Iran are reliable indicators of the quality of their work.MethodsThe data from companies listed on the Tehran Stock Exchange between 2015 and 2020 have been used. To measure audit quality, seven different criteria have been employed: type of audit opinion, number of clauses and non-recurring clauses in the audit report, audit failure, accrual management, accrual quality, and accounting conservatism. This study focuses only on private TAFs because the Iranian Audit Organization (IAO) and Mofid Raahbar Audit Firm (MRAF), as state audit firms, have a monopolistic market share in auditing state-owned enterprises. Therefore, client firms audited by the IAO and MRAF have been excluded. In total, the final sample of this study includes 1,188 firm-year observations.ResultsAlthough high-revenue audit firms are more likely to issue qualified audit opinions and include more clauses (as well as more non-recurring clauses) in the audit report, auditors' revenue is not significantly associated with accrual quality, earnings management, audit failure, or conservatism.ConclusionAlthough high-revenue auditors tend to issue qualified audit opinions and include more clauses in their reports, firms' revenues are not significantly associated with other proxies, such as the number of non-recurring clauses in the audit report, audit failure, accrual management, accrual quality, and accounting conservatism. As a result, audit firms' revenues are not reliable indicators of their audit quality. Therefore, the auditor size theory is not supported in Iran. In other words, this study shows that audit fees do not affect the quality of services provided by auditors, possibly due to the unique characteristics of the Iranian audit market. The findings of this study offer valuable insights for clients, policymakers, and academics.