Auditor Conservatism and Audit Quality: Evidence from IPO Earnings Forecasts

Abstract

We examine the relation between the accuracy and bias of earnings forecasts provided in Australian initial public offering (IPO) prospectuses and a proxy for differential audit quality. For the period we examine, most Australian IPO prospectuses include an earnings forecast, with which the auditor must be satisfied prior to signing off on the prospectus. Our evidence suggests that forecasts associated with Big 6 auditors are more accurate than those for which a Non-Big 6 auditor is used, although this result is not robust across alternative measures of forecast accuracy. We also find significantly less optimistic bias for forecasts associated with Big 6 auditors, but this result is robust to alternative measures of forecast bias. Although the distribution of forecast errors is strongly suggestive of earnings management to avoid reporting earnings below the forecast figure, the distribution of forecast errors for Non-Big 6 clients indicates a substantially greater proportion of large, optimistic forecast errors than for Big 6 clients. This supports our conclusion that Big 6 auditors are more conservative than their Non-Big 6 counterparts.