Does earnings management mediate the relationship between audit quality and company performance? Evidence from Jordan

Abstract

Purpose The purpose of this study is to look at the direct relationship between audit quality, earnings management (EM) practices and company performance, as well as the indirect influence (mediation) of EM practices in the relationship between audit quality and company performance. It offers empirical evidence from the Jordanian market, which is considered an emerging market. Design/methodology/approach The population of this study is represented in Jordanian service companies listed on the Amman Stock Exchange (ASE), with a total of 344 company-year observations. Furthermore, panel data analysis was used in this study, and data for the study were acquired from yearly reports as well as the ASE’s database. Findings Based on generalized method of moments model, the present findings demonstrate that the size of the audit firm and the tenure of the audit firm have a positive and negative influence on EM practices, respectively, but that industry-specialist audit firm has a negative and insignificant effect. EM practices have a negative impact on two company performance proxies (ROA and ROE), but have no effect on earnings per share (EPS). Furthermore, the size of the audit firm has a positive and significant influence on the performance proxies of the company [i.e. return on assets (ROA) and return on equity (ROE)]. The presence of an industry-specialist audit firm has a positive and significant influence on two proxies of company performance (ROE and EPS), but a negative and significant impact on ROA. An audit firm’s tenure has a negative and significant impact on two performance proxies (ROA and EPS), but a positive and significant impact on ROE. Then, EM practices either fully or partially mediate the relationship between audit quality proxies and company performance as assessed by ROA, ROE and EPS. Research limitations/implications The current study’s limitation is that it only searched in Jordanian service companies listed on ASE from 2012 to 2019 to meet the study’s objectives; thus, the authors recommend that future work investigate the study model for other sectors, whether in Jordan or other emerging markets such as the Middle East and North Africa. Another limitation of this study is that the study models lack important variables, which may affect EM and company performance, such as corporate governance and ownership structure characteristics; as a result, the authors recommend that future work includes such variables in future research models to have more explanations in this context. Practical implications Analysts, investors and other strategic decision makers may use the findings of this study to improve the efficiency and efficacy of Jordan’s financial market. These findings will enhance policymakers’ willingness to establish appropriate regulations, which might improve Jordan’s financial market performance and efficacy. These findings may help investors make better judgments by using audit quality proxies and EM indicators, which can forecast business success. Originality/value First, this study distinguishes itself from prior studies through establishing a new research model, by investigating the mediating effect of EM in the relationship between audit quality and company performance. It provides empirical evidence from the Jordanian market; hence, it increases the body of the knowledge in this context. Second, to the best of the authors’ knowledge, this is the first study to look into the link between audit quality, EM and company performance together; hence, the model of this study is developed using agency theory and information asymmetry theory. Third, the current study adds new evidence to the role of audit quality and EM in companies, as well as how audit quality and EM practices affect company performance in emerging markets such as Jordan.

Mediating influence of earnings management in the nexus between audit quality and company value: new proof from Jordanian market

“…However, other empirical studies (Afifa et al, 2021b) noted that company accomplishment is negatively affected by EMP, where managers use earnings management by accruals to reduce the company performance to avoid paying taxes and fees, therefore, negatively affects CV. Martowidjojo et al (2019) concluded that high earnings quality reduces rather than raises the market value of shares but that companies that pay dividends are priced considerably higher.…”

“…Consequently, many business-relevant decision-makers have become involved in the issues of governance, auditing, monitoring and ensuring the business efficiency to minimize the level of EMP (Inaam and Khamoussi, 2016). Inaam and Khamoussi (2016) and Afifa et al (2021b) have shown that both audit and control efficiency negatively affect EMP in businesses. The high auditing and monitoring quality helps to improve the credibility of the fiscal information disclosed, which guides to improving the levels of confidence that shareholders, funders and other involved parties give to these businesses (Krishnan, 2003;Wijaya, 2020).…”

“…Inaam and Khamoussi (2016) and Afifa et al (2021b) have shown that both audit and control efficiency negatively affect EMP in businesses. The high auditing and monitoring quality helps to improve the credibility of the fiscal information disclosed, which guides to improving the levels of confidence that shareholders, funders and other involved parties give to these businesses (Krishnan, 2003; Wijaya, 2020).…”

“…Moreover, the audit quality (AQ) in Jordanian companies is under the low level, because most them are audited by same non large-sized audit firms for a period of more than three years (Alsufy et al , 2020), and the rise in EMP leads to deceptive users of accounting information (Almasarwah et al , 2021). Saleh et al (2020a) concluded that the quality of accounting information in Jordanian companies is favorably associated with their performance, that the enhanced degree of institutional supervision to boost the quality of accounting information, which taking advantage of feasible investment opportunities and make their operational performance better (Afifa et al , 2021b). This is consistent with the organizational theory.…”

“…Our contributions of this study come from; First, we initiate a new proposed model by exploring the role of EMP with a mediating role in the AQ-CV nexus. Second, our study is the first attempt to address the complicated nexus between AQ, EMP and CV together, using some theories are broadly used in accounting research (Nour et al , 2020; Afifa et al , 2021b) and the behavior of companies and individuals (Al-Absy et al , 2020; Upadhaya et al , 2014). Third, this study gives some explications on the role of AQ in firms and how it acts a momentous role in raising companies’ value in developing countries, such as Jordan.…”