Auditor quality and earnings management: Singaporean evidence

Abstract

PurposeThe purpose of this paper is to examine the association between the magnitude of earnings management and auditor quality. It focuses on earnings management in response to mounting pressure amongst investors, policy makers and corporate governance reformists for mechanisms to curb excessive opportunistic behavior amongst corporate management. Auditor quality is the main focus of this study analysis as this factor is considered to be a key determinant of earnings management.Design/methodology/approachThe cross‐sectional modified Jones model is used to measure discretionary accruals (the proxy for earnings management). Following prior studies (Pearson and Trompeter, Craswell et al., Hogan and Jeter, DeFond et al., Ferguson and Stokes), the author uses audit firm industry specialization to proxy auditor quality.FindingsThe paper presents evidence of a negative association between auditor quality and the earnings management indicator. This finding infers that the magnitude of earnings management amongst firms engaging the services of a specialist is significantly lower than firms purchasing audit services from a non‐specialist auditor. In addition, this study also reveals that the magnitude of earnings management is significantly lower amongst companies engaging a Big 4 specialist audit firm relative to companies using the audit services of a Non‐Big 4 specialist.Originality/valueInsights drawn from this study may be of assistance to policy makers as they consider the costs and benefits associated with varying levels of audit market concentration. The findings provide stronger support for allowing the audit market to operate in a basic laissez‐faire manner without any overbearing interference by policy makers. Given industry specialization is likely to play an increasingly important role in audit value in the future, policy makers and reformists play an important role in encouraging firms to use the services of, especially, Big 4 specialist auditors.