Auditor Conservatism and Audit Quality: Evidence from IPO Earnings Forecasts

Abstract

We investigate the relation between a proxy for differential audit quality and both the (ex post) accuracy and conservatism of audited earnings forecasts provided in Australian initial public offering (IPO) prospectuses. For the period we examine, most Australian IPO prospectuses include an earnings forecast (i.e., disclosure is not ‘voluntary’), and the auditor must be satisfied prior to signing off on the prospectus. After controlling for other factors associated with forecast error, there is some evidence that forecasts audited by Big 6 auditors prove more accurate than those audited by a non‐Big 6 auditor, although this result is not robust across alternative measures of forecast accuracy. In contrast, our finding of significantly less optimistic bias for forecasts associated with Big 6 auditors is robust to alternative measures of forecast bias. We interpret these results as being consistent with the argument that the economic demand for differential audit quality reflects the same factors that underlie the demand for conservative financial reporting.