Do Auditors Allow Earnings Management When Audit Fees are Low?

42 Pages Posted: 10 May 2011 Last revised: 1 Aug 2012

See all articles by Parveen P. Gupta

Parveen P. Gupta

Lehigh University - Department of Accounting

Gopal V. Krishnan

Bentley University

Wei Yu

Hunter College - City University of New York

Date Written: August 1, 2012

Abstract

Much of the extant audit research focuses on the impact of excess audit fees paid to the auditors on earnings management. However, there is limited empirical evidence on whether auditors tolerate earnings management when audit fees are low, i.e., below the level of normal fees. Using a large sample representing post-SOX years 2004-2008, we first estimate abnormal (unexpected) audit fees as a residual from a regression of audit fees on several determinants of audit fees. Next, we run a regression of abnormal accruals and other measures of earnings management on abnormal audit fees and control variables. Our results consistently indicate that earnings management is significantly associated with negative abnormal audit fees. In other words, auditors appear to allow earnings management when audit fees are less than the expected fees. To the best of our knowledge this is the first study to examine the relation between abnormal audit fees and the likelihood of fraudulent financial statements. Our findings have important implications for regulators, members of the audit committee, investors, and others.

Keywords: Earnings Management, Discretionary Accruals, Audit Fee, Fraud-Scores

Suggested Citation

Gupta, Parveen P. and Krishnan, Gopal and Yu, Wei, Do Auditors Allow Earnings Management When Audit Fees are Low? (August 1, 2012). Available at SSRN: https://ssrn.com/abstract=1836829 or http://dx.doi.org/10.2139/ssrn.1836829

Parveen P. Gupta (Contact Author)

Lehigh University - Department of Accounting ( email )

621 Taylor Street
RBC #37
Bethlehem, PA 18015
United States
610-758-3443 (Phone)
610-758-5992 (Fax)

HOME PAGE: http://www.lehigh.edu

Gopal Krishnan

Bentley University ( email )

175 Forest Street
Waltham, MA 02452
United States
781-891-2477 (Phone)

Wei Yu

Hunter College - City University of New York ( email )

695 Park Avenue
New York, NY 10065
United States

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