Audit quality, auditor compensation and initial public offering underpricing

We jointly study the impact of audit quality on auditor compensation and initial public offering (IPO) underpricing using a sample of Australian firms going public over the period 1996–2003. We find that quality (Big Four) audit firms earn significantly higher fees than non‐Big Four auditors, and audit quality is positively associated with IPO underpricing. The positive relation between audit quality and underpricing is more pronounced for small issues, IPOs underwritten by non‐prestigious underwriters, and those that are not backed by venture capitalists. Taken together, our results suggest that quality auditors serve as a signalling device that enhances post‐issue market value of equity.