Key Features:
No of Chapters: 5
No of Pages: 105
Methodology: Panel Data Regression
Introduction:
Audit is a key contributor to financial stability and to re-establishing trust and market confidence. Auditors are entrusted by law with conducting statutory audits and fulfil an important role in offering an opinion(reasonable assurance) on whether the financial statements are stated truly and fairly (Quick, R. 2012). This assurance help to reduce the risk of misstatement, subsequently, reduce the costs of business failures. (Mansi, Maxwell and Miller 2004) identify two roles of an auditor: the information role and the insurance role. As an information intermediary, an auditor is a person who independently and effectively verifies the correctness of company’s financial statements before they are published. As an insurance provider, on the other hand, an auditor is a person who is legally accountable for damages to financial statement users. Auditors therefore carry out primary responsibility for promoting transparency in financial reporting processes that in turn generate high quality financial statements. In other words, auditors are one of the key drivers that help promote the transparency of the stock markets.
Earnings management is a popular subject in the accounting literature and there many slightly different definitions used for it. The earnings management definition used in this study is that of (Healy and Wahlen 1999) who state that Earning management occurs when management use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers.” (Koh et al. 2008) examine earnings management as the propensity of firms to meet or exceed analysts’ expectations in the periods following the Sarbanes Oxley Act. The study finds that managers are less likely to employ accrual based earnings management techniques in the periods following the accounting frauds of the late 1990s and early 2000s. Furthermore, the findings indicate that meeting or exceeding the analyst forecast in the post-Sarbanes Oxley period is more positively associated with future cash flows. This suggests that the decrease in accrual based earnings management techniques has improved the quality of firms’ earnings, as they are more reflective of future performance.
As mentioned above, the choice of auditor has played an important proxy of difficult-to-observe audit quality in different aspects. Previous theoretical and empirical research has generally established that audit has economic value, even in the absence of a mandated audit requirement (Sundem, Dukes, & Elliott,1996). The value of information and audits.( Coopers & Lybrand.). The decision to have an auditor, the selection between different auditors, and the decision to switch auditors are complex choices. Prior research has partially explained auditor choice by using agency theory (DeFond, M. L., & Subramanyam, K. R. 1998). Auditor changes and discretionary accruals. The demand for audit of companies’ accounts is created by the agency problems which are related to the separation of corporate ownership from control (Gerayli, Yanesari & Ma’atoofi, 2011). The agency problem arises from the existence of asymmetric information in the principal – agent contracts (Jensen, & Messier,2000). Theory of the firm: Managerial behavior, agency costs and ownership structure. Findings Show that the existence of information asymmetry between corporate management and company shareholders greatly enhances the easy perpetration of earnings management practice. The audit of a company’s accounts is a monitoring or control apparatus that minimizes information asymmetry and protects the interests of the principal.
1.2 Background of study
Theoretical and empirical research has generally established that an audit has economic value, even in the absence of a mandated audit requirement (Sundem, Dukes, & Elliott,1996),the value of information and audits.( Coopers & Lybrand). The decision to have an audit, the selection of an audit firm, and the decision to occasionally switch auditors are all complex choices. Prior research has used agency theory to partially explain auditor choice and auditor switches (Defond,(1992). The association between changes in client firm agency costs and auditor switching. In the most narrow sense, the basic role of the audit is to improve the quality of financial statements and extensive literature has found that a high quality audit reduces the incidence of earnings management (Becker, DeFond, Jiambalvo, and Subramanyam 1998). On the other hand, some researchers have suggested that demand for quality auditing is multifaceted and depends on more than just a cost of capital argument (Knechel 2001, 2002; Abdel-khalik 1993; Wallace 1981). For example, an audit can help managers improve the efficiency of a firm or remove information asymmetries related to internal reporting. Some firms may place more value on these potential gains that might accrue from the improvement of external financial reporting, especially for firms that are small and/or not public traded. Prior research on audit quality has tended to focus on the differences between Big 5 (Big five) audit firms and smaller audit firms. (DeAngelo, L. E. 1981), Auditor size and audit quality, argued that the Big five provide better quality audits because they have more reputational and legal risk.4 We know from prior research that audits by the Big Six are associated with higher fees , lower levels of discretionary accruals lower litigation rates , higher rates of compliance with GAAP (Krishnan and Schaur,2000), higher earnings response coefficients , more informative signals of financial distress (Lennox, 1999), and less mispricing of IPOs . While these attributes are considered to be manifestations of audit quality, other research has been less successful at finding quality differences among the large firms, e.g., 9 see the extensive literature on specialization (Craswell, Francis, and Taylor (1995).
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