Audit quality and earnings management: evidence from Jordan

Abstract

Purpose – The purpose of this paper is to test the association between audit quality and earnings management (EM). Audit quality studies documented that accruals would reduce when the auditor is independent or the audit firm is large. Design/methodology/approach – This paper uses generalised least square regression to investigate the influence of audit quality on EM. The sample contained 86 companies listed on the Amman Stock Exchange from 2007 to 2010. The cross-sectional modified Jones model was employed to measure discretionary accruals as a proxy for EM. Findings – This paper revealed that there is a significantly negative association between audit quality and EM. The result inferred that EM level is significantly lower among companies using the services of independent auditors. Moreover, this study exposed that the level of EM is significantly less among companies hiring a Big 4 audit firm, as compared to companies utilising the service of a non-Big 4 audit firm. Research limitations/implications – The measurement error, which is a rigorous concern for studies on EM, is one of the limitations in this study. Hence, the current study wholly inherited the limits of the modified Jones model. Practical implications – The findings based on the current study would provide beneficial information for regulators in Jordan and other countries with an institutional environment similar to that of Jordan. Moreover, the results provided valuable information to investors in assessing the influence of audit quality on financial reporting quality (FRQ). Originality/value – The current study contributed to auditing and corporate governance literature and its influence on EM among Jordanian companies. This research will be of value to companies seeking to reduce EM and enhance FRQ.