Audit Quality and the Pricing of Discretionary Accruals
Posted: 19 Sep 2001
Date Written: August 1, 2001
Accrual-based earnings is considered superior to cash flows. Accruals let managers communicate their private and inside information and thereby improve the ability of earnings to reflect underlying economic value. However, managers could engage in aggressive reporting of accruals that can seriously undermine the informativeness of reported earnings. Thus, high-accrual firms face greater agency costs relative low-accrual firms. Auditing plays an important role in mitigating these agency costs by constraining opportunistic management of accruals. This study examines whether there is a linkage between audit quality and pricing of discretionary accruals. The findings indicate that market attaches a higher value to the discretionary accruals audited by Big 6 auditors relative to the discretionary accruals audited by non-Big 6 auditors. Further, discretionary accruals of clients of Big 6 auditors have a greater association with future profitability than discretionary accruals of clients of non-Big 6 auditors.
JEL Classification: M41, M43, M49, G14
Suggested Citation: Suggested Citation