Do Auditors Perceive Real Earnings Management as a Business Risk?

44 Pages Posted: 28 Mar 2013

See all articles by Adam J. Greiner

Adam J. Greiner

University of Denver - Daniels College of Business

Mark J. Kohlbeck

Florida Atlantic University - School of Accounting

Thomas Joseph Smith

University of South Florida

Date Written: March 20, 2013

Abstract

We examine the relationship between real earnings management (REM) and audit fees. While studies have investigated the influence of accrual-based earnings management on audit fees, empirical research is silent on whether REM activities explain audit fees. We report a positive association between both current and prior period REM and audit fees and show that firms with greater incentives to manage earnings drive this relationship. The prior period REM finding indicates that auditors perceive REM as a business risk, whereas the current period effect could reflect either perceived business risk or auditor effort. To provide more insight on the current period effect, we extend our analysis into the banking industry and examine a REM activity (gains trading) that is less likely to require additional audit effort. We again document a positive prior period REM effect but do not find support for the current period effect. Thus, our banking analysis supports the notion that the prior period effect captures increased business risk, and suggests the current period effect in our main analyses is attributable to increased auditor effort. Our study provides evidence that an ancillary cost of REM is higher audit fees.

Keywords: Audit Fees, Business Risk, Earnings Management

JEL Classification: G21, G34, M41

Suggested Citation

Greiner, Adam J. and Kohlbeck, Mark J. and Smith, Thomas Joseph, Do Auditors Perceive Real Earnings Management as a Business Risk? (March 20, 2013). Available at SSRN: https://ssrn.com/abstract=2239959 or http://dx.doi.org/10.2139/ssrn.2239959

Adam J. Greiner

University of Denver - Daniels College of Business ( email )

2201 S. Gaylord St
Denver, CO 80208-2685
United States

Mark J. Kohlbeck (Contact Author)

Florida Atlantic University - School of Accounting ( email )

777 Glades Avenue
KH 119
Boca Raton, FL 33431-0991
United States
561-297-1363 (Phone)

Thomas Joseph Smith

University of South Florida ( email )

4202 E. Fowler Avenue, BSN 3403
Tampa, FL 33620-5500
United States

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