The Audit Quality Effects of Small Audit Firm Mergers in the United States

Increased audit regulation, coupled with reports of frequent mergers among smaller audit firms, creates a dynamic environment in which to assess changes in the U.S. audit market. We examine the audit quality consequences of audit firm mergers among small audit firms that audit public clients, a topic about which little is known. We find consistent evidence that post-merger audit quality decreases when PCAOB-identified audit deficiencies and audit fees are used as proxies for audit quality. However, we find only weak evidence of lower post-merger audit quality when examining discretionary accruals and no conclusive post-merger audit quality effect when estimating the probability of misstatements. We find some evidence that observed effects are pervasive across client types. Finally, tests of investor reactions at the time of the merger event produce insignificant results. Our findings provide initial evidence regarding the consequences when small audit firms merge in the United States.