The Determinants and Implications of Audit Quality: A Self-Selection Analysis from the U.S. Credit Union Industry

This study investigates the reasons for selecting a CPA audit in a voluntary audit environment and the associated benefits. The setting for the paper is the credit union industry, which is a sector of the US economy has allowed voluntary audit choice. Despite frequent regulatory audits, mandated annual audit committee reviews, and the availability of relatively inexpensive non-CPA dudit services, one-quarter of US credit unions complete independent CPA audits. I find that credit unions with higher business risk, size, legal liability and certain agency costs are more likely to engage CPA auditors. The paper examines two potential benefits from choosing a CPA audit (1) lower probability of financial distress, and (2) decreased earnings and/or balance sheet management. No association was discerned between audit choice and financial distress for credit unions operating in 1992-1997. Additionally, I find little evidence that key financial ratios are managed by credit unions, regardless of audit quality. Hence, regulatory examinations and the use of non-CPA services may be cost-effective alternatives for monitoring the financial health and quality of financial reporting. Since reducing financial distress and earnings management are not unique benefits of independent CPA audits, the paper suggests that legal liability may be the major factor contributing to the voluntary decision to complete CPA audits.