Audit Hour Budget Variances, Budget Ratcheting, and Audit Quality

ABSTRACT This study utilizes a large proprietary audit hour dataset from Korea to examine target ratcheting (the practice of adjusting future targets based on prior performance) and the ratchet effect (how employees react to target ratcheting) within the audit industry. We test whether previous findings (e.g., Ettredge et al. 2008) hold in a larger dataset covering both Big 4 and non-Big 4 firms. Consistent with the target ratcheting theory, we find empirical evidence of target ratcheting across all firms. However, unlike Ettredge et al. (2008), our results do not indicate the presence of asymmetric ratcheting. We also find that audit hours increase following favorable budget variances (i.e., actual budgeted hours), consistent with the ratchet effect. Finally, although higher budgeted audit hours are associated with greater audit quality as measured by absolute discretionary accruals, we do not find evidence that increases in actual audit hours are associated with improved audit quality. JEL Classifications: M42; M41; G34.