Abstract
Earnings management that misrepresents the firm’s financial picture and misleads investors is a persistent problem. One role of the auditor is to efficiently monitor the accounting reports so as to better inform investors as to the true status of the firm and help close the asymmetric information gap between owners and management. Auditors, however, operate within the constraints of social and legal environments that often display vast international differences. Using sample data from around 50,000 firm-year observations in 42 countries, the paper shows that in the United States the Big Four auditors more effectively monitor overstated earnings than their smaller counterparts, while elsewhere they tend to be more effective in monitoring both overstated and understated earnings. An important policy implication of the results is that uniform worldwide audit and financial reporting standards may not be as effective as might be hoped, because international differences in ownership structures and the resultant agency issues create different reporting incentives.
Highlights
The California energy crisis that ushered in the new millennium and brought about the Sarbanes-Oxley Act of 2002, in tandem with the 2008-2009 worldwide financial crisis that made “bailout” an international byword, moved adverse selection and moral hazard from esoteric academic journals onto the front pages of even the most reader-friendly newspapers
An important policy implication of the results is that uniform worldwide audit and financial reporting standards may not be as effective as might be hoped, because international differences in ownership structures and the resultant agency issues create different reporting incentives
This paper argues that big auditors’ monitoring mechanism is different between countries because of different reporting incentives, which are caused by international differences in ownership structures and resultant agency issues
Summary
The California energy crisis that ushered in the new millennium and brought about the Sarbanes-Oxley Act of 2002, in tandem with the 2008-2009 worldwide financial crisis that made “bailout” an international byword, moved adverse selection and moral hazard from esoteric academic journals onto the front pages of even the most reader-friendly newspapers. In both instances, considerable blame can be placed on misleading and misstated financial statements, and managements that failed to provide owners and potential investors with a true picture of the firms’ financial situations and risk portfolios.
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