The Impact of Audit Quality on Real Earnings Management: Evidence from the UK

Chowdhury, Syed Numan (2019) The Impact of Audit Quality on Real Earnings Management: Evidence from the UK. [Dissertation (University of Nottingham only)]

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The study evaluates the association between the quality of auditing and real activity-based earnings management from the perspective of the UK firms. Empirical findings suggested that, presence of high-quality auditors constrain companies’ management to pursue earnings manipulation using accruals. Alternatively, motivated by opportunistic behaviours, executives’ resort to more costly real activity-based manipulation which would have negative consequences in relation to future cashflows. This paper extends the examination of Chi et al. (2011) for a sample of UK listed firms under the constituent of Financial Times Stock Exchange Group (FTSE 350) index. This study has been commenced focusing on more recent economic standards in respect to post-adoption period associated with IFRS implementation in the UK. Auditors’ industry specialisation, auditors’ size represented as whether a big four or non-big four firms and auditors’ consecutive tenure periods have been considered as proxies for audit quality. In relation to real earnings management, this paper has followed Roychowdhury (2006) to measure the index associated with real activity-based earnings manipulation. Findings suggest, positive association of auditors’ industry expertise and auditors’ size with the computed index representing real earnings management. From the perspective of auditors’ repeated tenure periods, results advocate that higher tenure periods influence firms by higher abnormal operating cashflows, lower abnormal production costs and higher abnormal discretionary expenses. Moreover, the findings of this study add perceptions to the continuing debate concerning the issue of obligatory alternation of external auditors; illustrating the presumption that management acquire the liberty to disengage from real activity-based earnings management due to higher long-term economic significances and re-engage in accrual-based earnings manipulation. Furthermore, while considering audit fees as a solitary measure for audit quality, this study finds that premium audit fee is a representative of enhanced audit quality, compelling managements’ practice to commit accrual-based manipulation and alternatively encourage them to pursue more real measures of earnings management.

Keywords: Audit quality; Real activities manipulation; Accruals earnings management; Industry specialisation; Auditors’ tenure period; Audit fees.

Item Type: Dissertation (University of Nottingham only)
Depositing User: Chowdhury, Syed
Date Deposited: 02 Dec 2022 15:03
Last Modified: 02 Dec 2022 15:03

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