The International Journal of Accounting

39 (2004) 175 196

Big Six auditors and audit quality:

The Korean evidence
Seok Woo Jeong a,*, Joonhwa Rho b
b

a
College of Business Administration, Korea University, Seoul, South Korea
College of Business Administration, Choongnam National University, Taejon, South Korea

Abstract
This study investigates the association between discretionary accruals and Big Six and non-Big
Six auditors, and the direction of auditor change. We hypothesize that there is no significant
difference in discretionary accruals between Big Six and non-Big Six clients when there is low
incentive for auditors to provide high-quality audits, as in Korea.
Upon examination of the discretionary accruals of firms listed on the Korean Stock Exchange
from 1994 to 1998, we find there is no significant difference between the discretionary accruals of
firms with Big Six and non-Big Six auditors. This holds true for firms that switch from non-Big Six
to Big Six auditors and vice versa. These resources imply that there may be no difference in audit
quality between Big Six and non-Big Six auditors in Korea. This is consistent with other studies in
Korea, while inconsistent with the findings of previous studies on audit quality in other countries.
D 2004 Published by University of Illinois. All rights reserved.
Keywords: Audit quality; Big Six auditor; Discretionary accruals

1. Introduction
In this study, we examine whether Big Six auditors (before shrinking to four) provide
higher quality audits than non-Big Six auditors in Korea where the institutional setting
does not motivate auditors to provide high-quality audits. Specifically, we compare the
discretionary accruals of firms audited by Big Six auditors with those of firms audited by
non-Big Six auditors, as well as the discretionary accruals of firms that change from Big
Six to non-Big Six auditors and vice versa, using Korean data. We also investigate whether
discretionary accruals increase (decrease) under the same conditions.
* Corresponding author.
E-mail addresses: jeong@korea.ac.kr (S.W. Jeong), jhrho@cnu.ac.kr (J. Rho).
0020-7063/$ 30.00 D 2004 Published by University of Illinois. All rights reserved.
doi:10.1016/j.intacc.2004.02.001

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Previous literature suggests that Big Six auditors are more likely to object to
managements accounting choices that increase earnings if auditors are likely to be sued
when financial statements overstate earnings (Becker, De Fond, Jiambalvo, & Subramanyam, 1998; Francis, Maydew, & Sparks, 1999). These findings, however, are based on
data from countries where auditors face high litigation risk when they provide low-quality
audits. However, when there is little risk of litigation and no other effective disciplinary
mechanism to control opportunistic behavior, auditors may choose not to provide highquality audits. Until recently, suing auditors has been very rare in Korea and there is no
other effective monitoring mechanism to prevent auditors opportunistic behavior. In
addition, since the auditors selected by a firm typically have personal ties to management,
they may not bring a high level of independence to their auditing. Independent audits by
external auditors are not necessary to obtain capital in Korea, and managers frequently
regard audit fees and the filing of audited financial statements with regulatory bodies in
Korea as unnecessary costs of doing business (Park, 1990). In such an institutional setting,
where the auditors incentive to provide high-quality audits is low, it is unlikely that Big
Six auditors would have much incentive to restrict their clients adoption of aggressive
accounting methods.
In this study we conduct empirical analysis on a sample of 2117 firm-year observations
over the period from 1994 to 1998. Discretionary accruals are obtained by using a crosssectional variation of the modified Jones model. The evidence suggests that there is no
statistically significant difference between the discretionary accruals of firms audited by
Big Six and non-Big Six auditors, or of firms that change from one to the other. We
interpret these results to mean that there may be no difference in audit quality between Big
Six and non-Big Six auditors in Korea. While these findings are consistent with the results
of other studies in Korea (e.g., Jeong, 1999; Jeong & Rho, 1999; Park, Jongil, & Won,
1999), they are inconsistent with the findings of many previous studies on audit quality in
other countries (e.g., DeAngelo, 1981; Palmrose, 1988; Becker et al., 1998). Therefore, we
need to examine whether auditor type can be used as a proxy for audit quality in research
on earnings management in different countries and, if so, under what circumstances.
The remainder of the paper is organized as follows. In the next section we describe the
institutional setting in the Korean audit market and the motivation for our hypothesis. The
sample-selection procedure is discussed in Section 3. In Section 4 we explain variable
measurement and our research methodology. Results are presented in Section 5, and the
summary and conclusion are presented in Section 6.

2. Motivation, the Korean audit market, and hypothesis

Previous studies document that Big Six auditors charge higher audit fees, spend more
time on audits, and have fewer lawsuits than non-Big Six auditors, which is taken to imply
that Big Six auditors provide higher quality audits than non-Big Six auditors (DeAngelo,
1981; Francis & Simon, 1987; Palmrose, 1988, 1989). Furthermore, Becker et al. (1998)
and Francis et al. (1999) find that clients of Big Six auditors report low discretionary
accruals compared to clients of non-Big Six auditors, even though clients of Big Six
auditors have high levels of total accruals. They argue that Big Six auditors have a greater

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177

ability to constrain their clients use of aggressive and questionable accounting methods
and practices, thus increasing the quality of reported earnings for high-accrual firms. Big
Six auditors have better methods for detecting problem areas, interpret GAAP conservatively (thereby reducing the scope for aggressive accruals-based earnings management),
and can take a strong negotiating stance with clients who require more adjustments to the
financial statements. Therefore, the fact that firms financial statements are audited by Big
Six auditors may indicate that earnings are subjected to less opportunistic earnings
management.
However, if the economic environment and institutional setting does not demand
high-quality audit services, auditors may not restrict the opportunistic behavior of
management but rather may behave opportunistically themselves to attract more clients.
Under the Acts on External Audits of Corporations in Korea, firms with total assets over
a certain amount should report financial statements audited by external independent
auditors. Annually, about 7000 firms, including 700 listed firms, issue audited financial
statement under this law. However, since many firms in Korea raise more capital
through debt financing than equity financing, managers do not appreciate the role and
importance of external audits. Rather, they consider audit fees and audited financial
statements filings as an unnecessary but unavoidable cost of doing business (Park,
1990). In addition, Korean business has traditionally operated on personal relationships
such as family ties, school ties, or regional ties (Kim, Chung-Ki, & Cheong, 2002). In a
relationship-based economy, auditors who are frequently selected on the basis of
personal ties to the manager are less likely to constrain managers opportunistic
behavior. The fact that audit contracts are renewed every year places auditors in a
weak bargaining position. For all these reasons, auditors in Korea are less likely to
restrict managers from adopting aggressive accounting policies compared to auditors in
other developed countries such as the United States.
In Korea there are two potential risks for auditors who provide low-quality audits: a
penalty imposed by the government agency that reviews audit works and the possibility of
litigation by a third party. Under the Acts on External Audits of Corporations, the
government agency monitors the quality of audits on a sample basis. It reviews about 150
firms annually, less than 2% of all audits done in a year. In this environment, auditors may
not believe they have a high likelihood of getting caught if they provide low-quality audits.
Moreover, even when they are caught by the government agency the penalties are not
severe enough to cause auditors to provide high-quality audits. Infractions for which
auditors are penalized include not keeping generally accepted Korean auditing standards
or irregularities in a firms financial statements. The penalties that can be imposed on
CPAs and their firms range from fines, reprimands, suspension of audit works for a certain
period of time, revoking licenses, or a combination of these. In reality, most penalties on
auditors are lightsmall fine, reprimands, or the suspension of audits for participating
CPAs for a limited period. In most cases, these penalties have not been harsh enough to
encourage auditors to change their behavior. In fact, the economic incentives would
encourage them to attract more clients and make more revenues than what they pay in
penalties by providing low- rather than high-quality audits. There has also been a very low
risk of litigation during the period. The first litigation against auditors occurred in 1991,
and during the 1990s there have been only 22 such lawsuits. During the same period, more

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than 60,000 firm-year external audits, including 6000 listed firm-year audits, have been
performed. In addition, the penalties against auditors by the court have been very small.1
Auditor-selection mechanisms that foster independent external audits did not exist in
Korea during most of the sample period. Auditor-selection committees, consisting of
interested parties, such as internal auditors, outside directors, who are typically the second
largest shareholders, and the largest debtors except the largest shareholders and related
parties, were introduced in 1997 and have been effective since 1998; audit committees
were introduced for listed firms in 2001. (Only one year, therefore, overlaps with our
sample period.) Therefore, we consider socioeconomic and institutional environment in
Korea to provide a generally weak incentive for performing high-quality audits during the
sample period.
Big Six auditors in Korea do adopt standardized audit technology, whereas non-Big Six
auditors use their own audit technology, even when they are associated with other
international auditing firms such as Grant Thornton, BDO Seidman, and so forth. Even
when the institutional environment provides a low incentive for performing high-quality
audits, Big Six auditors may provide high-quality audits because they apply their
standardized global audit technology for all audits and thus deliver the same audit quality
in Korea as in other countries. This is highly probable if Big Six auditors can monitor the
audits of their branches in Korea. However, Big Six auditors do not have mechanisms for
monitoring different local audit reports written in Korean than non-Big Six auditors. They
go through an internal review process to check for global audit quality standards only
when the audit reports are written in English by technical advisors from the Big Six
headquarters. All the audit reports required by the Security Exchange Acts and the Acts on
External Audits on Corporations in Korea are, however, provided in Korean and these are
the accounting numbers most investors in the Korean stock market use for decision
making. Audit reports written in English are not usually available to investors in Korea
unless firms are cross-listed on international exchanges. During the sample period, there
are very few cross-listed firms. Audit quality between Big Six auditors and non-Big Six
auditors in Korea may, therefore, not be different.
Previous studies in audit quality in Korea provide results consistent with this
conjecture. Audit quality has been proxied by many variables: audit fees, audit hours,
litigation rate, or discretionary accruals, for example. As suggested in previous studies in
the United States, Big Six auditors who provide high-quality audits will charge a premium
fee for their services. Empirical research using Korean data, however, show different
results. Choi and Paek (1998) examine whether Big Six auditors actually charge higher
fees and spend more time on audits than non-Big Six auditors. They document that there is
no difference in audit fees between Big Six and non-Big Six, but that Big Six auditors
spend more time on their audits. This suggests that Big Six auditors are not recognized as
providing a higher quality service than non-Big auditors.
Because litigations against auditors are very rare in Korea, researchers use the detection
ratio in audit reviews by the government agency as a proxy for audit quality. As noted

1
The largest penalty against auditors totals less than $100,000 during this period. Therefore, auditors rarely
settle the case outside the court.

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above, a Korean government agency reviews only a small samplethe audits of about 150
firmsannually and penalizes auditors when wrongdoings are uncovered. It follows that if
Big Six auditors provide higher quality audits, they should be detected and penalized less
often than non-Big Six auditors. However, Jeong (1999) examines the agency audit-review
results and finds no significant difference between Big Six and non-Big Six auditors.
Jeong and Rho (1999) and Kim and Hwang (1998) examine prior-year adjustments to
measure the differences between Big Six and non-Big Six auditors. If auditors find
accounting irregularities in previous financial statements, it is assumed that high-quality
auditors are more likely to make corrections and report the changes in current financial
statements. Kim and Hwang compare the number of prior year adjustments between
clients of Big Six and non-Big Six auditors and find no significant difference between the
two groups. Jeong and Rho examine the number of prior-year adjustments for firms that
change auditors and find the same results as Kim and Hwang, while documenting an
overall increase in the number of prior-year adjustments regardless of auditor type. Park et
al. (1999) look into the audit-quality issue using discretionary accruals. They compare the
discretionary accruals of Big Six and non-Big Six clients and find no difference between
them (using only univariate tests). Their results are limited, however, because discretionary accruals could be affected by variables such as firm size, leverage, operating
characteristics of firms, auditor change, and stock offering. We propose, therefore, to
add to the evidence of audit quality in Korea by examining discretionary accruals after
controlling for these variables.
In sum, previous studies suggest that audit quality in Korea may not differ between Big
Six and non-Big Six auditors, whereas audit quality in other developed countries such as
the United States does differ between Big Six and non-Big Six auditors. Because many
previous studies in earnings manipulation in Korea show that managers manipulate
accounting numbers in many cases,2 it would be interesting to look into whether auditors
play an appropriate monitoring role over the production of accounting information in
Korea. Using discretionary accruals as an indicator of quality, the first hypothesis we
examine is as follows.
H1. Given the institutional environment in Korea, firms with Big Six auditors are likely to
report the same level of discretionary accruals as firms with non-Big Six auditors.
When firms change auditors, the new auditors may have stronger incentives to
provide high-quality audits compared to the old auditors even if there is no effective
market monitoring over audit quality. This is not usually due to the new auditors
attempt to show that the prior auditors were not competent, which is unusual in a
relation-based economy. Rather, it is because the new auditors want to reduce the
likelihood of being reviewed by the government agency and are penalized for
accounting irregularities made in the prior year, even when there is not a high
litigation risk. Jeong and Rho (1999) provide evidence consistent with this argument
2
There are many indications that managers in Korean firms manipulate accounting numbers when a firm is
in financial distress, offer seasoned equities, and want to smooth income, and so forth, similar to managers in
other foreign firms. Yoon and Miller (2002a, 2002b) provide a good summary of recently published papers in this
area.

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by showing that prior year adjustments increase after an auditor change. Therefore, if
Big Six auditors provide higher quality audits than non-Big Six auditors, they will be
especially diligent when replacing a non-Big Six auditors. This leads us to assert that
there should be a difference in discretionary accruals between firms that change to a
Big Six auditor and those that change to non-Big Six, if Big Six and non-Big Six
provide differential quality audits. That is, if firms change auditors from non-Big Six
(Big Six) to Big Six (non-Big Six) auditors, the discretionary accruals of the firms are
likely to decrease (increase). However, when there is no effective mechanism that
enforces performing high-quality audits, auditors are likely to provide similar quality
audit service and there will be no difference in discretionary accruals between Big Six
and non-Big Six auditors and no change in the discretionary accruals after auditor
change, regardless of auditor change direction. To address this issue we examine the
following two hypotheses:
When there is low incentive for auditors to provide high-quality audits,
H2. Firms that switch from non-Big Six to Big Six auditors are likely to report the same
discretionary accruals as the firms that switch from Big Six to non-Big Six auditors.
H3. Firms that switch from non-Big Six to Big Six auditors are not more likely to increase
discretionary accruals than the firms that switch from Big Six to non-Big Six auditors.

3. Sample selection
To test the hypotheses we use two sets of samples. The first sample, which is used to
examine the first hypothesis, consists of 2117 firm-year observations listed in the Korean
Stock Market during the period 1994 to 1998. We exclude financial institutions from the
sample because of the differences in estimation of discretionary accruals from firms in
other industries. In addition, we use only December year-end firms. When there are fewer
than 10 firms in an industry (two-digit SIC codes), for the estimation of nondiscretionary
accruals, we eliminate them from the sample. We require that firms financial data be
available in the KIS-FAS database that contains financial statements of Korean listed
companies since 1980. In addition, we require that firms receive an unqualified audit
opinion because firms with a qualified opinion are likely to report more discretionary
accruals. We include firms that receive an unqualified opinion with an explanatory
paragraph in the sample. This sample-selection procedure yields 2117 firm-year observations of which 1311 firm-year observations are audited by Big Six auditors and 806 are
audited by non-Big Six auditors.
The second sample, which is used to examine the second and third hypotheses,
consists of firm-year observations that change auditors during the period 1995 to
1998, and meet all other sample-selection criteria used in the first sample-selection
procedure. Two hundred eighty-nine firm-year observations are included in the second
sample. We use the auditor-change sample for Hypotheses 2 and 3 because auditors
have a strong incentive to provide high-quality services when they are changed. If the
results in the change sample is not different from the first sample, there is a high
likelihood that the quality of audit services provided by Big Six auditors is not

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181

different from that provided by non-Big Six auditors. On average, 18% of listed firms
change auditors each year, implying that one out of five or six firms change their
auditor. Among these, 58% of the firms that change auditors are selected for our final
sample. They represent 10.3% of all listed firms in Korea and are spread out across
the sample period.

4. Research methodology and variable measurement

4.1. Estimation of discretionary accruals
Previous studies have used various methodologies to estimate the effects of accounting
choices on reported earnings. Healy (1985) uses total accruals and McNichols and Wilson
(1988) use the discretionary portion of an individual account, bad-debt provisions.
However, Healys model does not separate nondiscretionary accruals from discretionary
accruals and McNichols and Wilsons method does not examine the behavior of total
discretionary accruals. Therefore, to capture the net effect of all accounting choices on
reported income, Jones (1991) uses an OLS model, regressing total accruals against the
change in revenue and property, plant and equipment. Since then, many studies have
adopted the Jones Model. Dechow, Sloan, and Sweeney (1995) modify the Jones (1991)
estimation model by adding the change in accounts receivable as an additional explanatory
variable in the estimation regression and report better performance of their model in
estimating discretionary accruals. Furthermore, Subramanyam (1996) finds that the crosssectional Jones models are generally better specified than their time-series counterparts.
Therefore, we measure discretionary accruals by using the cross-sectional variation of the
modified Jones model.3
Total accruals can be defined in various ways. Jones (1991) defines total accruals by
subtracting operating cash flows from reported accounting earnings. Specifically, Jones
defines accruals as follows:
TAit DCAit  DCLit  DCashit STDit  DEPit

where
TAit = total accruals for firm i for year t;
DCAit = change in current assets for firm i for year t;
DCLit = change in current liability for firm i for year t;
DCashit = change in cash for firm i for year t;
STDit = current portion of long-term liability for firm i for year t;
DEPit = depreciation expenses (including amortization of intangible and deferred assets)
for firm i for year t.
3
We also estimate the original Jones model using the same definition of discretionary accruals, i.e., net
income minus operating cash flows, as in Becker et al. (1998), and find the results are qualitatively similar to the
results we report here.

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When we define accruals as the difference between accounting earnings and operating
cash flows, the accruals include gains or losses from investing and financing activities.
However, most previous studies use a definition of accruals that does not include the gains
or losses from investing and financing activities. This may be because COMPUSTAT does
not contain the details of the gains or losses from investing and financing activities. If the
data are available, we can explicitly differentiate accruals from gains and losses by
dividing accounting earnings into operating cash flows, accruals, and gains and losses
from investing and financing activities. Bae (1999) argues that separating accruals from
gains and losses from investing and financing activities is a more accurate measurement
and that the data required to measure accurate accruals are available in the Korean
database, KIS-FAS. Therefore, we follow Baes definition of accruals in this study to
maintain comparability with other studies in Korea. He estimates accruals in a way very
similar to Jones (1991) and other studies, while taking advantage of detailed data in the
KIS-FAS database to calculate accruals. The definition of accruals used in this study is the
following:
OAt = trade receivablest (short term and long term) + inventoryt + advance paymentst
(short term and long term) + prepaid expensest (short term and long term) + accrued
incomet;
OLt = trade payablest (short term and long term) + advance from customerst (short term
and long term) + accrued expensest (short term and long term) + accrued income
taxest + unearned incomet;
NCAt u noncurrent accrualst = depreciation (including special depreciation4) + amortization of intangible assetst + amortization of deferred assetst (excluding stock issuance
cost and debenture issuance cost) + severance benefits expensest;
DOAt = OAt  OAt  1;
DOLt = OLt  OLt  1;
CAt u current accruals = DOAt  DOLt;
TAt = total accruals = current accruals + noncurrent accruals = CAt  NCAt.
Using the estimated coefficients of the modified Jones model, we calculated discretionary accruals as follows:
eit TAijt =Aijt1  ajt 1=Aijt1  b1jt DREVijt  DRECijt =Aijt1 
b2jt PPEijt =Aijt1 

where
ajt, b1jt, and b2jt are the estimated coefficients of the modified Jones model;
TAijt = total accruals for firm i in industry j for year t;
Aijt  1 = total assets for firm i in industry j for year t  1;
4
In Korea, firms can depreciate tangible assets more than the amount normally calculated by the straight-line
method, accelerated method, and production method when they meet certain conditions in tax law and this
accounting treatment is permitted for financial reporting also.

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183

DREVijt = change in net revenues for firm i in industry j for year t;

DRECijt = change in accounts receivable for firm i in industry j for year t;
PPEijt = gross property plant and equipment for sample firm i in industry j for year t.
Discretionary accruals are usually estimated by using time-series data of the same
firm or cross-sectional data of the industry that the sample firm belongs to. We adopt
the cross-sectional version of the discretionary-estimation model using two-digit SIC
codes. If we use a time-series model in estimating the modified Jones model, we
would require that sample firms not change their auditors during the estimation period,
usually 8 to 10 years. If firms change their auditors during the estimation period, there
might be a change in the parameter of the estimation model due to the auditor change.
Most Korean firms change their auditors over a period of 8 years. On average, 17% to
20% of firms change auditors in a given year. Therefore, we use cross-sectional
industry data to estimate discretionary accruals. For the estimation of discretionary
accruals for our sample, we require that there be at least 10 firms within the industry.
The average explanatory power of the modified Jones model, i.e., the average of
adjusted R2 over years, is about 16.1%. Bae (1999) shows that the adjusted R2s of
several discretionary-accruals models using Korean data range between 12% and 17%.
This shows that our sample is similar to the samples in other studies that use Korean
data.
4.2. Multivariate test model and control variables
Because the comparison of discretionary accruals between firms with Big Six auditors
and non-Big Six auditors is the main focus of our analysis, we conduct univariate tests as
well as multivariate tests. In the multivariate test we control for potential differences across
the firms that may affect the results of simple univariate tests. We regress discretionary
accruals estimated in Eq. (2) on a dummy variable indicating auditor type and several
control variables. Specifically, we run the following multivariate regressions to test the
first hypothesis.
DAit b0 b1 Bigit b2 OCFit b3 Sizeit b4 HiLevit b5 Abs accit
b6 ShareIncit b7 Changeit b8 Ownshipit eit

where
DAit = estimated discretionary accruals;
Bigit = auditor type dummy variable equal to one if the auditor is Big Six;
OCFit = operating cash flows;
Sizeit = natural logarithm of total assets;
HiLevit = dummy variable indicating whether firms are among the highest decile
unclear of leverage, by year and industry;
Abs_accit = the absolute value of total accruals;
ShareIncit = dummy variable equal to one when there is an increase of more than 10%
of the total outstanding shares during the year;

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Changeit = dummy variable equal to one when there is an auditor change;

Ownshipit = percentage of ownership by the largest shareholders including related
parties.
In this study, we expect no significant coefficient on auditor-type dummy variable
(Big). To control for other relevant variables that affect discretionary accruals, we include
operating cash flows, total assets, leverage, the absolute value of total accruals, increase in
the number of shares outstanding, equity ownership by largest shareholders in the
regression. A variable to control for the effect of management compensation is not
included in the regression, even though previous literature suggests that the management
compensation contract is related to discretionary accruals. Management compensation
based on accounting earnings is not common in Korea.
Dechow et al. (1995) show that operating cash flows are negatively correlated with the
level of accruals. We expect a negative coefficient on operating cash flows. We use the
natural logarithm of total assets as a size variable to control for the political effect on
discretionary accruals and also as a surrogate for numerous omitted variables. Firms that
have a high chance of receiving political attention are more likely to manipulate
accounting numbers to avoid political scrutiny. During the sample period, most firms in
Korea pursue growth in size rather than profitability. Large firms, therefore, tend to show
lower profitability than small firms. However, if a large firm reports very low profitability,
it is more likely to get attention because of its size. During the sample period, large firms
reported lower profitability, and Jeong (1999) provides the evidence that large firms are
more likely to be involved in accounting manipulation than small firms. We, therefore,
expect a positive coefficient for the size variable.
To control for the possible effect of leverage, we include a dummy variable (HiLev),
which takes one when firms have the highest decile leverage in the same industry during
the year of interest in the multiple regression as in Becker et al. (1998). Press and Weintrop
(1990) find that firms with high leverage are more likely to be close to the violation of debt
covenants. DeFond and Jiambalvo (1994) show that debt-covenant violation is associated
with discretionary-accruals choice. Managers of firms with high leverage are more likely
to adopt income-increasing accounting methods. However, firms with high leverage are
more likely to be in financial distress (Beneish & Press, 1995). DeAngelo, DeAngelo, and
Skinner (1994) show that troubled companies have large negative accruals related to
contractual renegotiations that provide incentives to reduce earnings. Therefore, we do not
have prior expectation on this variable.
Francis et al. (1999) argue that firms with greater endogenous accruals-generating
potential have greater uncertainty about reported earnings because of the difficulty that
outsiders have in distinguishing discretionary and nondiscretionary accruals. If we do not
have an accurate mechanism for differenting discretionary accruals from nondiscretionary
accruals, it is likely that firms with the larger absolute value of total accruals will show
higher discretionary accruals. To control this effect we include the absolute value of total
accruals as a control variable in the regression as in Becker et al. (1998). We expect a
positive coefficient on this variable.
Teoh, Welch, and Wong (1998) find that managers report higher earnings when they
issue seasoned equities by adjusting current discretionary accruals. Beneish (1997) also

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185

argues that managers will manipulate earnings upward due to incentives associated with
selling their personal holdings as part of and subsequent to equity offerings. Therefore, we
include a dummy variable that indicates whether the number of outstanding shares has
increased by 10% or more.5 We expect a positive coefficient on this variable.
An auditor-change dummy variable is also included in the regression because new
auditors tend to attribute previous accounting irregularities on previous auditors. Jeong and
Rho (1999) and Kim and Hwang (1998) find that the number of prior year adjustments
increases after firms change their auditors regardless of auditor change direction. We
expect a positive coefficient on the auditor-change variable.
Klassen (1997) argues that closely held firms can inform shareholders of firm value
more efficiently than widely held firms through communication channels other than
audited financial statements and press releases. As a result, these firms face less pressure
from capital markets. Firms with less capital-market pressure have less incentive to
provide useful accounting information to decision makers. This implies that firms with
higher inside ownership may have more flexibility in financial reporting than firms with
lower inside ownership. Thus, we include an ownership variable in the regression to
control for the effect of inside ownership on reported earnings and discretionary accruals.
Inside ownership is defined as the percentage of shares held by management. A positive
coefficient is expected on this variable.
To compare discretionary accruals between Big Six and non-Big Six auditors using
auditor-change firms, we divide second sample firms into groups depending on the
direction of auditor change. When firms change from Big Six to non-Big Six auditors, we
put them into the BN change group; when firms change from non-Big Six to Big Six
auditors, we put them into the NB change group. While previous studies imply the firms in
the BN change group are likely to report more discretionary accruals than firms in the NB
change group, we expect no difference as explained in the previous section. For these
groups of firms, we first examine whether there is a difference in discretionary accruals
and change in discretionary accruals without controlling for other variables. Then we
control for other variables that may explain the difference in discretionary accruals across
sample groups to check whether our experimental variable explains discretionary accruals
after controlling for these variables. Specifically, we run the following multivariate
regressions to test the second and third hypotheses.
DAit orDDAit b0 b1 NB-changeit b2 BN-changeit b3 OCFit b4 Sizeit
b5 HiLevit b6 Abs accit b7 ShareIncit b8 Ownshipit eit
4
where
DAit = estimated discretionary accruals;
DDAit = change in discretionary accruals;
5
We did not include a dummy variable for a decrease in the outstanding shares because stock repurchase was
not allowed during the sample period.

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S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

NB-changeit = auditor-change dummy variable, when

non-Big Six auditors to Big Six auditors assign one,
BN-changeit = auditor-change dummy variable, when
Big Six auditors to non-Big Six auditors assign one,
Other variables are the same as in Eq. (3).

firms change their auditors from

zero otherwise;
firms change their auditors from
zero otherwise;

In this study, we expect no significant coefficients on either variable, while previous

studies imply that the coefficients on NB-change and BN-change are significantly negative
and positive, respectively.

5. Empirical results
5.1. Descriptive statistics and univariate results
Table 1 shows the descriptive statistics of variables used in the analysis. Operating cash
flows are about 2% of total assets. The median of assets are 156 billion Korean won.
Leverage is about 68% of total assets, which is 15% higher than that of U.S. firms used in
Becker et al. (1998). This implies that Korean firms have 100% higher debt ratio than U.S.
firms.6 Total accruals are higher than that of U.S. firms while the absolute value of total
accruals are smaller than that of US firms.
Size and ownership are significantly different between firms with Big Six and non-Big
Six auditors both on the parametric and nonparametric tests. Leverage and total accruals
are significantly different across the groups on the nonparametric tests. The mean and
median absolute values of total accruals scaled by assets are not statistically different
between firms with Big Six and non-Big Six auditors. Therefore, in addition to univariate
tests, we need multivariate tests that control other variables affecting discretionary accruals
before drawing any conclusions.
The univariate-analysis results of discretionary accruals of pooled observations over
years are presented in Table 2. Table 2 shows mean and median discretionary accruals
and the absolute value of discretionary accruals for firms with Big Six and non-Big Six
auditors. The differences obtained from subtracting the means and medians of non-Big
Six samples from those of Big Six samples are reported in the last two columns along
with the results of t tests and Wilcoxon two-sample tests of the differences between the
two samples. As Table 2 shows, there is no statistical difference in discretionary
accruals, while the mean and median of firms with non-Big Six auditors are slightly
larger than those of firms with Big Six auditors. We also compare the absolute value of
discretionary accruals because the larger they are the more likely managers may exercise
discretion in reporting earnings. The mean and median values of the absolute value of
discretionary accruals are almost the same for the two groups and not statistically
different. Along with the results of discretionary accruals, these findings also show that

6
Average debt equity ratio for Korean firms is 213% [ = 68 H (1 68)], and average debt equity ratio for U.S.
firms is 113% [ = 53 H (1 53)].

S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

187

Table 1
Descriptive statistics of variables for sample firms (N = 2117)
Panel A

OCF
Size
Lev
Tot_acc
Abs_acc
Ownship

Mean

S.D.

Maximum

Median

Minimum

0.0238
19.08
0.6774
 0.0226
0.0637
26.80

0.0935
1.343
0.2295
0.0855
0.0614
13.92

0.4370
24.01
4.4659
0.3970
0.8752
97.60

0.0237
18.87
0.6775
 0.0223
0.0487
25.50

 1.0061
16.07
0.1096
 0.8752
0.0001
0.80

Panel B

OCF
Size
Lev
Tot_acc
Abs_acc
Ownship

Non-Big Six (N = 806)

Big Six (N = 1311)

Differences

Mean

Median

Mean

Median

t statistic

Z statistic

0.0204
18.87
0.6709
0.0197
0.0636
27.47

0.0204
18.71
0.6639
 0.0167
0.518
26.20

0.0258
19.21
0.6814
 0.0244
0.0637
26.39

0.0263
19.00
0.6901
0.0240
0.0469
25.00

 1.27
 6.09***
 1.03
1.22
 0.03
1.77*

 1.50
 4.10***
 3.29***
1.90*
1.54
1.68*

OCF = operating cash flows divided by total assets; Size = log transformed total assets, which are measured in
thousand won; Lev = total liabilities divided by total assets; Tot_acc = total accruals divided by total assets;
Abs_acc = absolute value of total accruals; Ownship = the equity ownership percentage of the largest shareholder.
* Significant at 10% level.
*** Significant at 1% level.

the type of auditor make no difference to a managers accounting flexibility of

discretionary accruals.
To test whether there is a difference in the level of discretionary accruals
depending on the direction of auditor change we run the ANOVA. Table 3 presents
the results of the ANOVA test. It shows that discretionary accruals and the change in
discretionary accruals among auditor change groups are not significantly different
when we use all sample firms. In Korea, the Security and Future Committee (SFC)
Table 2
Comparison of discretionary accruals and absolute value of discretionary accruals between firms with Big Six and
non-Big Six auditors during 1994 1998

Discretionary accruals
( P value)
Absolute value of
discretionary accruals
( P value)

Non-Big Six (N = 806)

Big Six (N = 1311)

Differences

Mean

Median

Mean

Median

Mean

Median

0.0078
(.000)
0.0535

0.0107
(.000)
0.0409

0.0062
(.003)
0.0535

0.0040
(.031)
0.0395

0.0016
(.621)
0.0000

0.0045
(.124)
0.0014

(.000)

(.000)

(.000)

(.000)

(.967)

(.708)

Discretionary accruals are measured by the cross-sectional version of the modified Jones model by industry and
year.

188

Designated-change firms

Big 6 ! Big 6
Non-Big 6 !
Big 6
Big 6 !
Non-Big 6
Non-Big 6 !
Non-Big 6
All
F value

Free-change firms
DDA

DA

All
DDA

DA

DDA

DA

Mean (S.D.)

Mean (S.D.)

Mean (S.D.)

Mean (S.D.)

Mean (S.D.)

Mean (S.D.)

0.0045
(0.108)
 0.0231
(0.145)
0.0350
(0.150)
 0.0315
(0.130)
0.0053
(0.131)
1.486

59
(42.4)
23
(16.6)
42
(30.2)
15
(10.8)
139
(100.0)

 0.0017
(0.175)
 0.0209
(0.147)
0.0370
(0.163)
 0.0551
(0.142)
0.0014
(0.165)
1.340

58
(43.0)
22
(16.3)
41
(30.3)
14
(10.4)
135
(100.0)

 0.0026
(0.113)
0.0211
(0.117)
 0.0193
(0.170)
0.0274
(0.154)
0.0048
(0.143)
0.899

36
(24.0)
33
(22.0)
45
(30.0)
36
(24.0)
150
(100.0)

0.0378
(0.209)
0.0017
(0.161)
0.0119
(0.186)
0.0213
(0.222)
0.0181
(0.194)
0.213

35
(24.7)
33
(23.2)
41
(28.9)
33
(23.2)
142
(100.0)

0.0005
(0.123)
0.0073
(0.114)
 0.0023
(0.185)
 0.0035
(0.160)
0.0058
(0.149)
1.372

95
(32.9)
56
(19.4)
87
(30.1)
51
(17.6)
289
(100.0)

0.0132
(0.188)
 0.0074
(0.155)
0.0245
(0.174)
 0.0014
(0.203)
0.0099
(0.180)
1.340

93
(33.6)
55
(19.8)
82
(29.6)
47
(17.0)
277
(100.0)

DA = the discretionary accruals estimated by the modified Jones model and scaled by previous-year total assets.
DDA = the change in discretionary accruals estimated by the modified Jones model and scaled by previous-year total assets.

S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

Table 3
ANOVA analysis of auditor change direction and discretionary accruals

S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

189

has the power to order an auditor change if a firm does not meet the conditions that
the SFC requires.7 In this case, firms might have different discretion in choosing
accounting methods from firms that change auditors by their own intention. Therefore,
we separate the sample firms into two groups to determine whether the cause of
auditor change affects the results of our analysis. There are 129 firm-year observations
that change auditors by their own decision (free-change firms) and 125 firm-year observations that change auditors by the designation of the SFC (designated-change firms).
Whether we use designated-change firms or free-change firms, discretionary accruals
and the change in discretionary accruals among auditor groups are not significantly
different.
5.2. Multivariate analysis
Because we ignore a number of variables that affect discretionary accruals, we run the
multivariate regression with the control variables discussed in Section 4. Table 4 shows the
results of the estimation of regression equation (3) for the test of Hypothesis 1. The first
two columns show the results of pooled regressions and the last column shows the results
of yearly regressions. The coefficients on the first variable (Big), indicating whether firms
are audited by Big Six auditors, is not significant at all in any of the three regressions. This
is consistent with our expectation and the results of univariate tests. It suggests the
possibility that Big Six auditors in Korea do not provide higher quality audits than non-Big
Six auditors.
Most of the control variables in the multivariate regression are significantly related
to discretionary accruals with expected signs. Operating cash flows are strongly
negatively associated with discretionary accruals, which is consistent with the results
of Becker et al. (1998) and Dechow et al. (1995). The magnitude of the coefficient
on operating cash flows in this study is much larger than that of Becker et al. This
may be due to using Korean data. Most of Korean accounting standards required by
the SFC in financial reporting are based on the abstracts of the U.S. GAAP minus
the specific details, thereby allowing managers more flexibility in reporting. Thus, it
is easier to manipulate earnings in Korea than in other countries such as the United
States. Because discretionary accruals are not related to cash flows, when there are
more discretionary accruals in earnings, the coefficient on operating cash flows is
more likely to be negative. In addition, some of the negative coefficient value may
be caused by the number of nondiscretionary accruals treated as discretionary
accruals due to a classification error in the modified Jones model. Nondiscretionary
accruals may have a negative relation with cash flows from operation due to the
definition of total accruals. The positive coefficient on the size variable implies that
large firms are more inclined to income-increasing accounting policy. This is
consistent with results (Jeong, 1999) that firm size is significantly related to the
possibility of being detected for accounting irregularities in the audit-review process
by the government agency.

The role of the SFC in Korea is similar to that of SEC in the United States in regulating firms disclosure.

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S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

Table 4
Regression results of discretionary accruals on auditor type and control variables, 1994 1998 period
Pooled

Intercept
Big
OCF
Size
HiLev
Abs_acc
ShareInc
Change
Ownship
N
R2

1994 1998 (t statistic)

1994 1997 (t statistic)

 0.0558
 0.0010
 0.3613
0.0040
 0.0387
 0.2131
0.0150
0.0068
0.0003
2117
26.86%

 0.0495 (  2.33)**
 0.0022 (  0.76)
 0.3958 (  22.74)***
0.0035 (3.25)***
 0.0336 (  6.66)***
 0.0915 (  3.38)***
0.0110 (3.45)***
0.0057 (1.41)
0.0000 (0.33)
1723
25.82%

(  2.70)***
(  0.34)
(  23.36)***
(3.81)***
(  7.65)***
(  9.36)***
(1.67)*
(1.79)*
(2.61)***

Average estimate of 5 yearly

regressions (t statistic)a
 0.0315
 0.0017
 0.3748
0.0031
 0.0345
 0.1498
0.0149
0.0032
0.0001

(  0.92)
(  0.71)
(  12.59)***
(1.81)*
(  5.60)***
(  0.92)
(2.20)**
(0.52)
(0.71)

Big = an auditor type dummy variable equal to 1 if auditor is Big Six; OCF = operating cash flows divided by total
assets; Size = natural logarithm of total assets; HiLev = dummy variable indicating whether firms are among the
highest decile leverage, by year and industry; Abs_acc = absolute value of total accruals; ShareInc = dummy
variable equal to 1 when there is an increase of more than 10% of the total outstanding shares during the year;
Change = dummy variable equal to 1 when there is an auditor change; Ownshipit = percentage of ownership by the
largest shareholders including related parties.
a
The t-statistics are calculated using the variability in the yearly coefficient estimate as in Becker et al. (1998).
* Significant at 10% level.
** Significant at 5% level.
*** Significant at 1% level.

The negative coefficient on the leverage dummy variable is consistent with the result of
DeAngelo et al. (1994), that troubled companies are more likely to manage discretionary
accruals to reduce earnings due to contractual negotiations. The coefficient on the absolute
value of total accruals is negative, which is consistent with Becker et al. (1998). This
implies that managers of firms with large accruals tend to reduce earnings. The increase in
the number of outstanding shares is also significantly positively related to discretionary
accruals, suggesting that managers may manipulate earnings upward when there is
seasoned-equity offerings because they may sell their personal holdings higher as part
of and subsequent to equity offerings. This result is consistent with Teoh et al. (1998) and
Yoon and Miller (2002a, 2002b). The ownership variable is also significantly positive,
which is consistent with our expectation.
To check whether the Asian Currency Crisis and related corporate governance changes
in Korea affect the results, we also reestimate the regression after deleting (excluding)
firm-year observations after 1998 because the Foreign Currency Crisis started at the end of
1997 and began to affect the Korean audit environment in 1998. The second column of
Table 4 presents the regression-estimation results without the 1998 firm-year observations.
As you will note, the results are almost the same as those estimated with 1998 firm-year
observations. Big Six dummy is still not significant at all, while most control variables
show significant coefficients with expected signs.
If discretionary accruals reverse, using pooled data may not be appropriate. Because
previous studies show that discretionary accruals reverse, we estimate the regression
equation (3) yearly for 5 years of the sample period, and calculate t statistics using the

S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

191

variability in the annual-coefficient estimates as in Becker et al. (1998) and Bernard (1987)
to check whether the results that use pooled data change. The last column of Table 4 shows
the average coefficients for the five yearly estimates along with related t statistics. The
results are consistent with the pooled regression estimation except that size and ownership
variables lose significance. In particular, the coefficient on the Big Six dummy variable is
 .0003 and not significant at all at any conventional level. That is, firms with Big Six
auditors show indifferent levels of discretionary accruals compared to firms with non-Big
Six auditors. While this result is not consistent with the results of previous studies in other
countries, it is consistent with the results in Park et al. (1999) and our expectation.
To analyze the effect of auditor-change direction on discretionary accruals after
controlling for other influences on discretionary accruals, we estimate Eq. (4) using the
second set of data. Table 5 reports the results of the multivariate-regression analysis,
including the control variables.

Table 5
The effect of Auditor-change direction on discretionary accruals [DAit (or DDAit) = b0 + b1NB-changeit +
b2BN-changeit + b3OCFit + b4Sizeit + b5HiLevit + b6Abs_accit + b7ShareIncit + b8Ownshipit + eit]
All firms

Intercept
NB-change
BN-change
OCF
Size
HiLev
Abs_acc
ShareInc
Ownship
Adjusted R2
F statistic
N

Designated-change firms

Free-change firms

DA
(t statistic)

DDA
(t statistic)

DA
(t statistic)

DDA
(t statistic)

DA
(t statistic)

DDA
(t statistic)

 0.1370
(  1.28)
 0.0136
(  0.72)
 0.0205
(  1.21)
 0.643
(  8.28)***
0.0089
(1.62)
 0.0193
(  0.86)
 0.0877
(  0.83)
 0.0007
(  0.04)
0.0003
(0.67)
26.2%
12.20***
254

 0.2001
(  1.27)
 0.0367
(  1.32)
0.0046
(0.19)
 0.6677
(  5.82)***
0.0123
(1.51)
 0.0378
(  1.14)
0.1564
(0.46)
 0.0099
(  0.39)
0.0004
(0.51)
12.4%
5.49***
254

0.0359
(0.26)
 0.0367
(  1.41)
 0.0005
(  0.02)
 0.4579
(  4.89)***
0.0016
(0.22)
0.0013
(0.05)
 0.3316
(  2.46)**
 0.0039
(  0.17)
 0.0006
(  0.94)
28.6%

0.0124
(0.06)
 0.0231
(  0.60)
0.0336
(1.03)
 0.3202
(  2.31)**
0.0036
(0.35)
 0.1470
(  0.41)
 0.2536
(  1.27)
0.0001
(0.00)
 0.0017
(  1.86)*
10.4%
2.82***
125

 0.2594
(  1.59)
0.0097
(0.36)
 0.0225
(  0.87)
 0.8982
(  6.88)***
0.0131
(1.51)
 0.0518
(  1.12)
0.2179
(1.31)
0.0045
(0.18)
0.0015
(1.83)*
28.9%
7.43***
129

 0.3066
(  1.30)
 0.0332
(  0.85)
 0.0048
(  0.13)
 1.1288
(  6.00)***
0.0140
(1.11)
 0.0607
(  0.91)
0.5243
(2.18)**
 0.0080
(  0.22)
0.0030
(2.61)***
21.7%
5.44***
129

125

DDA = change in discretionary accruals; NB-change = auditor change dummy variable, when firms change their
auditor from non-Big 6 auditor to Big 6 auditor assign 1, otherwise 0; BN-change = auditor change dummy
variable, when firms change their auditor from Big 6 auditor to non-Big 6 auditor assign 1, otherwise 0; Other
variables are the same as in Table 4.
* Significant at 10%.
** Significant at 5%.
*** Significant at 1%.

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S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

The adjusted R2s of the regressions for all sample firms, designated-change firms, and
free-change firms are 26.2%, 28.6%, and 28.9%, respectively, when discretionary accruals
are the dependent variable. When the change in discretionary accruals is used as the
dependent variable, the adjusted R2s of the regression are 12.4%, 10.5%, and 21.7% for all
sample firms, designated firms, and free-change firms, respectively. The F statistics show
that all the multivariate-regression models are valid.
As Table 5 reveals, auditor change direction variables (NB-change and BN-change) are
not statistically significant in any regressions when all firms are used. To check whether
this result is driven by the method of auditor change, we divide the sample into two
groups, free change and designated change, and run the regression. Park (1996) shows that
firms with designated auditors report fewer discretionary accruals than other firms. If firms
that switch from Big Six to non-Big Six auditors change auditors by order of the SFC,
while firms that switch from non-Big Six to Big Six auditors change auditors by their own
decision, there is no difference in discretionary accruals even though firms with Big Six
auditors report fewer discretionary accruals. However, either in the free-change sample or
the designated-change sample the auditor change direction variables are not significant in
any regression, implying that the sample results are not driven by the method or direction
of auditor change. This issue will be examined further in sensitivity analysis. Among the
control variables, only operating cash flows (OCFs) have a significant expected coefficient, that is, a significant negative coefficient. The ownership variable (Ownship) is
statistically significantly positive regardless of the dependent variable for the free-change
sample, but is not significant for all samples.
5.3. Sensitivity test
To check the robustness of our analysis for the first hypothesis, we replicate the tests of
Becker et al. (1998). That is, we define total accruals as the difference between earnings
and operating cash flows, estimate discretionary accruals using the cross-sectional version
of the Jones model, and reestimate Eqs. (3) and (4). However, the coefficients on auditor
type and auditor change direction variables are not significant. The results are not reported
in the paper. We also calculate the Spearman correlation among the independent variables
to check whether multicollinearity exists among the variables. We find that there is no
statistically significant correlation among variables.
To check the robustness of results for the second and third hypotheses, we reestimate
the regression by using only firms that change their auditor from non-Big Six to Big Six
(NB change sample), and firms that change their auditor from Big Six to non-Big Six (BN
change sample), respectively. Auditor-change variables are not statistically significant in
all these regressions. The results are not reported in the paper.
The statistical insignificance of auditor change may be attributed to the fact that our
sample includes the period when there are significant changes in the accounting and
auditing systems in Korea. There have been many changes in accounting and audit-related
laws and regulations and auditing practices in Korea since the 1997 Foreign Currency
Crisis. Therefore, we separate the sample into two periods: before the crisis (1994 1997)
and after the crisis (1998), and reestimate the regressions. Again both auditor-change
variables are not significant in all regressions.

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193

The reasons for auditor change might affect the relation between auditor change and
discretionary accruals. Therefore, we add a dummy variable for auditor-change reasons to
regression Eq. (3). This dummy variable is one when firms change their auditor because
the SFC in Korea designates the auditor, zero otherwise. The following equation is used in
the regression estimation.
DAit or DDAit b0 b1 DEG1 c1 NB-change c3 BN-change
b3 OCFit b4 Sizeit b5 HiLevit b6 Abs accit b7 ShareIncit
b8 Ownshipit eit
b0 b1 DEG b1 c1 DEG NB-change b1 c3 DEG
BN-change b3 OCFit b4 Sizeit b5 HiLevit b6 Abs accit
b7 ShareIncit b8 Ownshipit eit

where DEG is a dummy for auditor-change reason. Other variables are the same as in
Eq. (4).
When auditors are designated by order of the SFC, they are usually assigned to a
firm for 3 years. These auditors, then, do not need to worry about next years contract,
making them more independent. Previous studies find that auditors are more likely to
constrain aggressive accounting by management when they are independent (Park,
1996). Table 6 presents the regression results of Eq. (5). All the signs of the auditorchange variable for the designated-change sample are the same as the results in the
previous analysis. That is, none of the coefficients of DEG NB-change variable and
DEG BN-change variable is statistically significant in any regressions. Among the

Table 6
The effect of auditor designation on discretionary accruals [DAit (or DDAit)=b0 + b1DEG b1c1DEG NBchange + b1c3DEG BN-change + b3OCFit + b4Sizeit + b5HiLevit + b6Abs_accit + b7ShareIncit + b8Ownshipit + eit]
Independent variables (expected sign)

DA (t statistic)

DA (t statistic)

Intercept
DEG (dummy)
DEG NB-change
DEG BN-change
OCF
Size
HiLev
Abs_acc
ShareInc
Ownship
Adjusted R2
F statistic
N of observations

0.1426 (1.34)
0.0036 (0.21)
0.0366 (1.28)
0.0110 (0.46)
0.6463 (8.21)***
0.0089 (1.61)
0.0157 (0.69)
0.0779 (0.71)
0.0026 (0.15)
0.0004 (0.88)
26.08%
10.92***
254

0.2164 (1.38)
0.0298 (1.16)
0.0254 (0.60)
0.0133 (0.38)
0.6739 (5.80)***
0.0129 (1.59)
0.0288 (0.86)
0.1034 (0.66)
0.0108 (0.42)
0.0006 (0.79)
12.38%
4.97***
254

DEG=auditor-change-reason dummy. When auditor is changed by the designation, DEG is 1, otherwise 0. Other
variables are the same as in Table 5.
*** Significant at 1% level.

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S.W. Jeong, J. Rho / International Journal of Accounting 39 (2004) 175196

control variables, only the operating cash flows variable reveals significant negative
coefficients.
Overall, several sensitivity analyses do not change the results in Table 5, that auditorchange variables (BN-change, NB-change) are related to discretionary accruals. This
implies that a finding of no difference in discretionary accruals is not a period-specific or
sample-specific phenomenon.

6. Summary and conclusion

In this study, we investigate the relation between discretionary accruals, auditor type,
and auditor-change direction. We investigate whether there is any audit-quality difference
between Big Six and non-Big Six auditors and whether auditor change affects the number
of discretionary accruals. Empirical results show that there is no statistically significant
difference between discretionary accruals of firms with Big Six and non-Big Six auditors.
In addition, the discretionary accruals of firms that change from non-Big Six to Big Six
auditors are not significantly different from those of firms that change from Big Six to nonBig Six auditors. Furthermore, there is no statistically significant difference in the change
in discretionary accruals between these two groups. This result is consistent after
controlling for other relevant variables that may affect discretionary accruals and does
not change in several sensitivity tests.
We interpret this result as meaning that there may be no difference in audit quality
between Big Six and non-Big Six auditors in Korea during the sample period. The result is
consistent with results in other studies in Korea, while inconsistent with many previous
studies on audit quality in other countries (e.g., Becker et al. 1998; DeAngelo 1981;
Palmrose 1988). In Korea, there may be different incentives for auditors to provide highor low-quality audits because the economic and institutional environments in Korea are
different from other countries.
This study adds new evidence to the audit-quality literature by showing that
financial statements audited by Big Six auditors may not provide higher quality
information in certain economic environments. This implies that when we use auditor
type as a proxy for audit quality we may need to consider economic environments. As
Becker et al. (1998) point out there is still questions about the wisdom of using
discretionary accruals as a proxy for auditor quality. In addition, further research is
necessary to find out what other factors motivate auditors to provide audits of different
quality.

Acknowledgements
We appreciate the helpful comments of Susan Hamlen, Hyoik Lee, and participants of
the 2000 Winter Korean Accounting Association Meeting, Conference on Emerging
Issues in International Accounting 2001, 2003 South East Regional meeting of AAA.
We also thank two anonymous reviewers for their valuable input. All remaining errors
are our own.

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