Is Enhanced Audit Quality Associated with Greater Real Earnings Management?
46 Pages Posted: 4 Aug 2011 Last revised: 18 Feb 2013
Date Written: November 2010
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.
Keywords: real earnings management, audit quality, industry expertise, auditor tenure, audit fees
JEL Classification: M40, M41
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