Is Enhanced Audit Quality Associated with Greater Real Earnings Management?

Abstract

SYNOPSIS We examine whether firms resort to real earnings management when their ability to manage accruals is constrained by higher quality auditors. In settings involving strong upward earnings management incentives, i.e., for firms that meet or just beat earnings benchmarks and firms that issue seasoned equities, we find that city-level auditor industry expertise and audit fees are associated with higher levels of real earnings management. We find similar, albeit weaker, results for the Big N auditors. Our paper suggests an unintended consequence of higher quality auditors constraining accrual earnings management, namely, firms resorting to potentially even more costly real earnings management. We also find that longer auditor tenure is associated with greater real earnings management, which could suggest merits of mandating audit firm rotation. JEL Classifications: M40; M41.

Audit Quality and Earnings Management in the Tunisian Context

“…One exception is Kim et al (2003), who provide empirical evidence that Big auditors are less effective than non-Big auditors in monitoring income decreasing earnings management. Yet other few studies have focused on relation between REM and the Big N. Chi et al (2011) find that the presence of a Big N is associated with greater REM. They argue that, as increased audit scrutiny may decrease a firm's accounting flexibility, firms audited by Big N are likely to resort to the more costly real earnings management.…”

“…But, fewer researches indicate that the higher audit quality enhance the real earnings management. Chi et al (2011) investigate the relation between audit quality and real earnings management and find that both auditor industry expertise and the presence of a Big N audit firm are associated with greater real earnings management. They argue that, as increased audit scrutiny may decrease a firm's accounting flexibility, firms audited by Big N are likely to resort to the more costly real earnings management.…”

“…Hence, Abundant research indicates higher audit quality mitigates the earnings management (Becker et al, 1998;Francis and Yu, 2009;Lin and Huang, 2010;Jordan et al, 2010) and there are relatively fewer studies examining the impact of audit quality on real earnings management (Chi and al., 2011;Cohen and Zarowin, 2010). Furthermore, empirical evidence on audit quality measures has been mixed.…”

The Association between Related Party Transactions and Real Earnings Management: Internal Governance Mechanism as Moderating Variables

“…We follow Chi [10] to determine the aggregated value of REM (REMIDX) that is, -Standardized Abnormal CFO + Standardized Abnormal PROD -Standardized Abnormal DISC. Data for RPT are collected from transactions disclosed in the Related Party Transactions section in Notes to the Financial Statements (i.e., acquisition of assets from related party, assets sales to related party, equity sales to related party, trading relationship with related party, and cash payment or loan to related party).…”

EE-(m,k)-firm: Operations Management Approach In Enterprise Environment

“…Consequently, effectively reporting environments do not perforce decrease the entire earnings management. In [19], the authors treated the quality of earnings management when the capacity to manage accruals is constrained by high quality auditors. For firms that meet or just beat earnings benchmarks and firms that issue seasoned equities, the authors find that city-level auditor industry expertise and audit fees are associated with higher levels of real earnings management.…”