The Impact of the Global Financial Crisis on Audit Quality : A Study of Publicly Listed Swedish Firms

Abstract: Audit quality is a widely researched topic but remains a complex concept that is difficult to quantify, which is why several different proxy measurements have been developed. The earnings quality measurement discretionary accruals has been chosen as the proxy measurement for this study as it captures small variations in audit quality which is important since it allows for analysis of a relatively small sample size. Previous literature has found that for example client size, audit firm size, firm performance and company growth have a significant impact on audit quality. There has also been limited research on what the impact of financial crises has been on audit quality. The evidence in prior studies has suggested that financial crises could have both a positive and a negative impact on earnings quality and audit quality. This study therefore tests two alternative hypotheses regarding the effects of the Global Financial Crisis (GFC) on publicly traded Swedish companies’ audit quality. The first hypothesis stipulates that audit quality improved from the pre-crisis period to the crisis period and continued to improve in the post-crisis period. The alternative hypothesis stipulates that audit quality, in terms of discretionary accruals, worsened during the GFC in an effort by companies to hide their real economic performance during a period of financial turmoil. The study concludes that audit quality, in terms of discretionary accruals, was significantly higher for the time periods during the financial crisis (2008-2009) and during the post-crisis period (2010-2012) compared to the pre-crisis period (2005-2007). This finding confirms the first part of hypothesis 1 that stipulated that audit quality would increase from the pre-crisis period to the crisis period while it rejects hypothesis 2. No conclusive evidence was found in the data that audit quality continued to improve after the end of the GFC. The reasons for the improved audit quality could be that companies are incentivized to improve their financial reporting quality when they have liquidity issues in order to attract financing and that auditors tend to be more conservative during periods of increased business risk such as during a financial crisis. The finding is of particular interest since poorly performing companies in the sample have a lower level of audit quality and companies in general performed worse during the GFC compared to the other two time periods analyzed.