Audit Quality and Earnings Management by Seasoned Equity Offering Firms

Abstract

We investigate the relationship between audit quality as measured by audit firm size and industry specialization, and earnings management as measured by discretionary current accruals, for companies making seasoned equity offerings (SEOs). Earnings management in the SEO process is of concern because of the underperformance of seasoned equity offering firms. We find evidence that Big 5 auditors are associated with lower earnings management in the years before, during, and subsequent to the SEO. Industry specialist auditors are associated with lower earnings management only in the year of the SEO. Our study contributes to the literature by demonstrating that audit quality reduces earnings management by SEO companies, and that industry specialization, as a measure of audit quality, also constrains earnings management.

Keywords: Audit quality, earnings management, seasoned equity offering

JEL Classification: M41, M43, M49