Does audit quality affect firms’ investment efficiency?

Abstract

This study investigates the effect of audit quality on firm investment efficiency for 125 French-listed companies over 2008–2015. It uses parametric and non-parametric measures of firm investment efficiency, based on residuals extracted from the investment efficiency model and the data envelopment analysis (DEA) approach, respectively, to assess whether audit quality improves investment inefficiency. It analyses this relationship after distinguishing between firms that under-invest and those that over-invest. The results show that investment inefficiency decreases with audit quality. Specifically, auditor knowledge leads to less investment in firms prone to over-investment and more investment in firms prone to under-investment. This relationship appears to be independent of a firm’s financial reporting quality, which indicates that auditors provide value-added services that impact the investment decisions of firm managers, separately from the quality of accounting information.

KEYWORDS:

• Audit quality
• audit expertise
• Big 4
• investment efficiency

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 In contrast to Tobin’s Q, sales growth has no theoretical foundation as a proxy for investment opportunities, but can be justified by the intuition that an increase in sales indicates future increase in demand for products (Morck, Shleifer, & Vishny, 1990). More investment in production facilities may be necessary to satisfy increasing demand (Houcine, 2017).

2 For more details on the DEA, please see Angulo-Meza and Lins (2002), Castelli, Pesenti, and Ukovich (2010), Charnes, Cooper, Lewin, and Seiford (1994), Chen and Zhu (2003), Charnes, Cooper, and Rhodes (1978), Bayraktar, Tatoglu, and Zaim (2013) and Dyson and Shale (2010).

3 The results remain qualitatively the same when we deflate the outputs by total assets instead of total sales.