An empirical analysis of the effect of audit quality on financial reporting fraud

Abstract

Several highly publicized financial reporting fraud cases (e.g., Enron, Tyco International, and WorldCom) have put the role of external auditors and quality of their audit in ensuring corporate financial reporting quality under considerable scrutiny. Much research has been conducted on the determinants of earnings management. Since earnings management is inherently unobservable, most studies use various measures of accruals as proxies for earnings management. This study examines the relationship between audit quality and a more direct measure of earnings management – financial reporting fraud. Contrary to the concerns that nonaudit services are the primary reason for auditor independence impairment that results in lower audit and earnings quality, this study finds no significant relationship between reporting fraud and fees paid to auditors for various services.