Is Higher Status an Indicator of Higher Quality? Evidence from Japanese Audit Industry, 2002-2014

Does Vacheron Constantin, a luxury Swiss manufacture of mechanical watches, hold an esteemed status for having produced matchless watches for over two hundred years or for being highly valued by celebrities? Are people willing to pay millions of dollars for entering top-ranked schools for the higher quality of education they offer or for the association with famous alumni? Since the association between status and quality is difficult to identify and measure, people tend to associate status with quality and worth. With their mere belief or superstitious learning, people assume that “status and quality must move in tandem” (Sorenson, 2013).

However, in reality, status does not always positively correlate with quality. Status can deviate from actual quality because the relationship is, in essence, constructed socially rather than through the strict scrutiny of quality (Lynn, Podolny and Tao, 2009). Previous research has given us insight into how market participants tend to rely on the producer’s status to make inferences regarding the underlying quality when faced with uncertainty about the underlying quality of a producer and the producer’s product (e.g., Podolny, 1993, 2005). However, the empirical dynamics of the association between status and underlying quality has not been explored adequately yet. 

To fill the gap in research, we longitudinally explored how the social status of organizations and individuals has evolved because of real changes in quality. We chose the Japanese audit industry to empirically investigate the issue for two reasons: First, Japan is a status-based society, where decisions and quality inferences made by market participants are supposedly based on the social status to a large extent. Second, audit service, which is different from search goods or experience goods, is a typical example of credence goods that do not allow for an ex ante or ex post assessment. Because of such characteristics of the service, the relative social standing of certified public accountants, as individuals or due to their affiliated organizations, could influence the inferences drawn about the quality of their services.

Using restatement reporting of securities filings issued by Japanese listed firms from 2002 to 2014, we first identified material errors amended by restatement reporting issued in the later period and subsequently created a measure of the frequency of errors made by individual certified public accountants as a proxy for the quality of their service. We then statistically tested the effect of social status, such as their organizational affiliation and positional standing within their organizations, on the quality of their services.

Our hypothesis was that accountants affiliated with high status, big audit firms provide better quality of audit services. However, our empirical study suggests that the association between status and quality differs over time. This suggests that the status does not function properly to signal the underlying quality. Our results advance a mechanism of how the underlying quality could deviate from social status.