The Effect of Audit Quality on Earnings Management

Posted: 6 Aug 1998

See all articles by Connie L. Becker

Connie L. Becker

affiliation not provided to SSRN

Mark L. DeFond

University of Southern California - Leventhal School of Accounting

James J. Jiambalvo

University of Washington - Michael G. Foster School of Business

K.R. Subramanyam

University of Southern California - Leventhal School of Accounting

Multiple version iconThere are 2 versions of this paper

Abstract

This paper examines the relation between economic incentives to manage earnings and discretionary accruals and the modifying effects of audit quality on this relation. We hypothesize that incentives to smooth earnings and incentives created by debt agreements motivate managers to strategically bias earnings. However, we expect that earnings manipulation is tempered by the quality of the firm's external auditor. The findings indicate that companies with non-Big Six auditors (a proxy for lower audit quality) report discretionary accruals that significantly increase income compared to companies with Big Six auditors. We also find that managers respond to debt contracting and income-smoothing incentives by strategically reporting discretionary accruals. In addition, companies with incentives to smooth earnings upwards (downwards) report significantly greater income-increasing (decreasing) discretionary accruals when they have non-Big Six auditors. However, we do not find that audit quality affects earnings management that occurs in response to high leverage.

JEL Classification: M41

Suggested Citation

Becker, Connie Lynn and DeFond, Mark and Jiambalvo, James J. and Subramanyam, K.R., The Effect of Audit Quality on Earnings Management. Available at SSRN: https://ssrn.com/abstract=112868

Connie Lynn Becker

affiliation not provided to SSRN

No Address Available

Mark DeFond (Contact Author)

University of Southern California - Leventhal School of Accounting ( email )

Accounting Building, Room 206
Los Angeles, CA 90089-0441
United States
213-740-5016 (Phone)
213-747-2815 (Fax)

James J. Jiambalvo

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States
206-543-9132 (Phone)
206-685-9392 (Fax)

K.R. Subramanyam

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States
213-740-5017 (Phone)
213-747-2815 (Fax)

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