Can prohibitions of non‐audit services and an expanded auditor liability improve audit quality?

Law entrusts auditors to conduct statutory audits. They fulfil a societal role in providing an opinion on the truth and fairness of the financial statements of audited entities and reducing the risk of misstatement. The purpose of an audit is to enhance the credibility of financial reports prepared by management (Watts & Zimmerman, 1986). Thereby, audits contribute to financial stability, trust and market confidence in the economy by protecting investors from agency risk, which in turn reduces the cost of capital for companies (European Commission, 2010). To fulfil this function, auditors need to provide an adequate service quality. According to the generally accepted definition of DeAngelo (1981), audit quality is the market-assessed joint probability that an auditor will discover material misstatements (auditor competence) and report them (auditor independence). This definition stresses that providing a high factual audit quality is insufficient but that users must also perceive audit quality as appropriate. Accounting scandals like Carillion, a UK construction and facility services company, or Wirecard, a German fintech company, raise public suspicion of auditing failures and result in regulatory initiatives, which seek to improve audit quality.