Audit Quality in the European SME Context: Focus on Form Instead of Substance

Abstract

This study examines to what extent auditors focus on form quality (compliance) instead of substance quality (actual audit quality) when auditing the financial statements of European SMEs. As CEOs of SMEs generally have a large influence on the appointment of the auditor and auditors only face a very limited risk of litigation in such context, auditors may be more likely to compromise their independence towards management, in this way reducing the level of audit quality. However, in order to further reduce the risk of litigation and to retain the signaling value of the service they provide, they may keep focusing on the form quality of the financial statements. Using a matched sample of 278 Belgian SMEs, our results indeed indicate that hiring an auditor is positively associated with the form quality of the financial statements but we found no significant association with the substance quality.