Effects of audit quality on earnings quality and cost of equity capital: evidence from India

Abstract

In this paper, using a large sample covering the 10 years from 1998 to 2009, we examine the role of audit quality in earnings quality (discretionary accruals and income smoothing) and cost of equity capital of Indian firms. We find evidence that firms employing high quality auditors experience higher earnings quality and lower cost of equity capital. We find that firms belonging to business groups have higher earnings quality and lower cost of equity capital than their non-business group counterparts. The results do not change after utilising alternative proxies for audit quality, earnings quality and cost of equity. Our findings contribute significantly to the literature on the role of audit quality as an effective monitoring mechanism as reflected in firm level earnings quality and cost of equity capital of listed firms in India which has distinct institutional features in relation to ownership structures and operations.