The relation between earnings management and audit quality.
Recent high-profile earnings management cases (e.g., WorldCom) and the collapse of Enron have put the role and quality of external audit in ensuring the quality of corporate earnings under considerable scrutiny. Much research has been conducted on the determinants of earnings management, such as a firm’s financial characteristics and audit quality. Since earnings management is inherently unobservable, most studies used measures of accruals as proxies for earnings management. The purpose of this study is to examine the relationship between audit quality and a more direct measure of earnings management – earnings restatements. Contrary to the concerns of many in accounting practice and research, as well as the results in prior research, this study finds no statistically significant relationship between earnings restatements and non-audit fees. This does not support the claim that non-audit fees paid to the auditor are the primary reason for auditor independence impairment that results in lower audit and earnings quality. On the other hand, this study provides evidence that total fees and audit fees are positively associated with earnings restatements.
American Academy of Accounting and Finance
Li, J. & Lin, J.W. (2005). The relation between earnings management and audit quality. Journal of Accounting and Finance Research, 12(1), 1-11.
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