Audit committee financial expertise, accrual, and real earnings management

Abstract

AbstractThis study examines the effectiveness of audit committee (AC) financial expertise in mitigating accrual and real earnings management (AEM and REM hereafter). Although extant studies have examined the effects of AC expertise on earnings management, findings are inconclusive. Prior studies have also focused mainly on AEM not REM. We used the data for a sample of Hong Kong Hang Seng Composite Index with 1714 firm‐year observations between 2010 and 2015, which was analyzed using panel fixed effect regression models. The results show statistically significant negative relationship between AC financial expertise and AEM but surprisingly, we find that AC financial expertise is associated with increase in REM. We argue that whilst AC members have developed monitoring skills on AEM, REMs are relatively recent and are more complicated to detect. We argue that management may be shifting their opportunistic use of earnings management from AEM to REM. A possible reason could be a steep AC's learning curve on the nature of REM. Our investigation provides evidence on the impact of AC expertise on both AEM and REM from a unique context.