The Role of Audit Firm Size, Non‐Audit Services, and Knowledge Spillovers in Mitigating Earnings Management during Large Equity Issues

Abstract

We investigate how audit firm size and large auditor‐provided non‐audit services (NAS) affect accruals quality around large equity issues and acquisitions for Norwegian public companies from 1999 to 2013. We find poorer accruals quality around large equity increases. Big 4 audit firms mitigate adverse accruals quality but only if the provision of NAS is moderate or low. In contrast, non‐Big 4 audit firms are associated with lower accruals quality around large equity increases, but this effect is moderated if the provision of NAS is high. The findings are consistent with joint provision of audit and NAS as an effective learning mechanism to mitigate earnings management for smaller audit firms and a lesser willingness of larger audit firms to protect earnings when the provision of NAS is high. The evidence contrasts with the notion of large audit firms as universally superior audit quality suppliers and establishes new evidence on how knowledge spillovers from NAS may improve audit quality.