The joint effect of investor protection and Big 4 audits on earnings quality around the world

The association of a country's investor protection regime with the quality of reported earnings is examined for a large sample of firms from 42 countries. Three attributes of earnings are evaluated: the magnitude of signed abnormal accruals, the likelihood of reporting losses, and accounting conservatism (timely loss recognition). We find that earnings quality increases for firms with Big 4 auditors when a country's investor protection regime gives stronger protection to investors; specifically, signed abnormal accruals are smaller, there is a greater likelihood of reporting losses, and accounting conservatism is greater. In contrast, earnings of firms with non-Big 4 auditors are largely unaffected by different investor protection regimes. The study adds to a growing body of research showing that accounting practices are influenced by a country's institutions. However, our results differ from prior studies by demonstrating that country-level effects on earnings quality are mediated by audit enforcement and, in particular, the incentives of Big 4 auditors to perform higher quality audits in countries with stricter investor protection regimes.