Impact of audit quality on firm performance

Increased importance of the audited financial statements is continuously given by investors and shareholders. Audited statements are considered essential for reducing information asymmetries between parties and assuring market efficiency and credibility. Whether the audit improves the performance of firms is a widely investigated topic. Expectations are that in presence of credibility and reliability of audited financial reports the financial performance of the firms is improved. In presence of information asymmetry this may not be the case. This paper aims to investigate the impact of audit quality on firm performance. The focus is on 2051 North-American listed corporations on a time span from 2001-2018. A two-step approach is followed in order to estimate the impact. The first stage estimates audit quality as the residuals of a regression of audit fees on size, risk, complexity of the firms, as well as a dummy variable of auditor size. The second regression estimates the effect of the audit quality, book value per share, earnings per share, dividends per share and dividend yield on stock prices. The rationale behind this approach is that audit quality is not measurable, but it surely affects the price of the audit in a positive way. As such, it is part of the error term in a regression that explains audit fees, which is how it is estimated. The residuals from the first regression are the proxy for Audit Quality, and will be used in the second regression as one of the explanatory variables. The results indicate that audit quality has a significant and positive effect on firm performance as measured by stock prices. In addition, there is evidence that book value per share and earnings per share also have a significant and positive effect on stock prices, as expected. However, dividends per share and dividend yield are not significant determinants of stock prices.