Purpose – The purpose of this paper is to investigate, in an Egyptian context, the external auditor type (Big 4 vs local) implications on reporting quality proxied by discretionary accruals (DA) and also examine whether auditor type impacts the market’s pricing of DA, where pricing is considered a proxy for the perceived DA quality. Design/methodology/approach – The sample period is 2012–۲۰۱۵, that is meant to be post the Egyptian revolution financial crisis; all Egyptian stock exchange (EGX) listed firms (except banks and financial institutions) are considered. DA are estimated using modified Dichev and Dechow’s (2002) model (McNicholas, 2002). Ordinary least squares regression tests are used to investigate the external auditor type implications on DA level and the related EGX investors’ pricing. Findings – The findings generally show the external auditor’s minimal role in mitigating DA. Moreover, the findings reflect the EGX investors’ negligence and/or lack of confidence in regards to DA and external auditor type factors in stock pricing. Practical implications – The paper findings highlight to regulators the need for effective monitoring of audit firms earnings management mitigation performance to help reinforce investor confidence in financial reporting quality. Originality/value – This paper is the first that investigates the external auditor monitoring mechanism implications on investors’ perceptions of earnings quality in Egypt. The paper findings would provide important contributions, particularly post the Egyptian revolution crisis, where the EGX market is trying to restore the investors’ confidence.

Introduction

Over the last two decades, the corporate failings (including Enron, Tyco and WorldCom) have interrogated the public trust in the auditing profession and resulted in increased regulatory scrutiny. For instance, the Sarbanes–Oxley Act (SOX) inaction in 2002, to call for reinforced auditor independence and the formation of Public Company Accounting Oversight Board (PCAOB) to monitor the external audit services quality (Lamoreaux, 2016). The audit market dramatic changes have increased the audit requirements demands (e.g. internal controls systems effectiveness assessment) that resulted in shifting from Big 4 audit firms to local audit firms mainly due to enlarged audit fees (Blokdijk et al., 2006; Rama and Read, 2006; Lawrence et al., 2011; Cassell et al., 2013; Comprix and Huang, 2015). Especially after 2002, local auditors are progressively exposed to higher business risk due to their acceptance of bigger size clients approaching from predecessor Big 4 auditors (Hogan and Martin, 2009). However, clients could be hesitant to engage local audit firms because of the apparent variances in name recognition or reputation, practical competences and industry know-how. Market participants’ prospects or assurance requests (e.g. shareholders, creditors, etc.) could be of major significance in their unwillingness to consider local audit firms (Cullinan et al., 2012). Commonly, literature studies have documented the relative high quality of Big 4 audit firms’ services (e.g. Boone et al., 2009; Samaha and Hegazy, 2010; Rutledge et al., 2014; Comprix and Huang, 2015). However, PCAOB suggested no audit quality differences between Big 4 and local audit firms. The US market research supported the PCAOB’s argument, for example, Lawrence et al. (2011) found that controlling for client’s size diminished the differences in audit quality between Big 4 and local audit firms. Jenkins and Velury (2011) found non-significant difference in conservatism between clients of Big 4 and local auditors in either the pre- or post-SOX periods. Moreover, Boone et al. (2010) did not evidence a significant difference in the performance-adjusted abnormal accruals between the clients of Big 4 and local audit firms. Also, Cassell et al. (2013) showed that the financial reporting credibility of local firms audited clients was indistinguishable from Big 4-audited counterparts. Consistently, Geiger and Rama (2006) documented no discretionary accruals (DA) significant differences between clients of Big 4 and local audit firms. Investigating the stakeholders’ perceptions, Gray and Ratzinger (2010) reported that vs Big 4 firms, stakeholders generally agreed that local firms provided comparable audit quality. Moreover, post the SOX, Kao et al. (2013) investigated whether local auditors have enhanced their ability to resist client pressure over accrual reporting. Regressing abnormal accruals on proxies for economic bonding, they found that changes in the association, defined as (post–pre), were significantly negative, implying local audit firms’ independence improvement. Also, Lai (2013) found that Ex-Andersen clients of non-Big 4 auditors had a higher likelihood of going-concern opinions and lower levels of DA.