Audit Firm Size and the Association Between Reported Earnings and Security Returns.

Members of the investment community widely assume that Big Eight accountants provide a higher quality audit than is provided by smaller audit firms. In this paper we investigate the possible existence of such a quality differential and employ a methodology that compares the correlations between earnings forecast errors and abnormal returns. Our results are consistent with a quality difference between Big Eight and non-Big Eight auditors. The signs of our test statistics are in the appropriate direction, but consistent with test results of other research in the area, the significance levels are low. Our results support previous theoretical research, such as DeAngelo [1981] and Simunic and Stein [1986], and previous empirical research, such as Nichols and Smith [1983] and the findings of the Report of the National Commission of Fraudulent Financial Reporting [1987].