PERCEIVED AUDITOR QUALITY AND THE EARNINGS RESPONSE COEFFICIENT

An auditor's reputation lends credibility to the earnings report that he audits. An unresolved issue is whether auditor size is correlated w ith auditor quality, where a high-quality auditor is defined as one wh o brings about more credible earnings reports. According to basic intu ition and a modified Holthausen-Verrecchia (1988) model, investors' re sponse to an earnings surprise will depend on the perceived credibilit y of the earnings report. In this study, we examine whether the earnin gs response coefficient (ERC) differs between Big Eight (B8) and non-B ig Eight (NB8) audited firms. This provides a test of the joint hypoth eses that auditor size is a proxy for auditor credibility and of the m odified H-V model. Consistent with the joint hypotheses, we find that the ERCs of Big Eight clients are statistically significantly higher t han for non-Big Eight clients. The result obtains in both a matched sa mple of firms paired according to industry membership, and a switch sa mple of firms grouped according to shifts from and to B8 and NB8 audit ors. Furthermore, the result is robust with respect to the inclusion o f other explanatory factors for ERC that have been suggested by previo us studies: growth and persistence, risk, firm size, and predisclosure information environment.