Voluntary joint audit and earnings quality: evidence from Italian SMEs

Abstract

The purpose of this paper is to analyze the effect of a joint audit system on the quality of a firm’s financial statements, investigating the association between the presence of a double auditor and the occurrence of small positive earnings, which can be considered as the consequence of earnings management practices and as a signal of poor earnings quality. Furthermore, we develop a second research question, in order to assess the factors that determine the choice of voluntarily resorting to a joint audit system. This paper uses a sample of Italian industrial non-listed SMEs [1] , stratified in order to fulfill certain requirements (in terms of asset value, turnover and number of employees) that make it mandatory to appoint at least one audit body (the statutory board) according to the Italian law. Logistic regression models have been used to test the research hypotheses. The main finding is the confirmation that a joint audit system does positively affect earnings quality and the reliability of firms’ financial statements. Regarding the decision to be audited by two different auditors, the main determinants are more linked to the size and organizational complexity of the firm than to agency conflicts or leverage ratio. [1] “SME” stands for small and medium-sized enterprises as defined in EU law by the EU recommendation 2003/361. This category consists of enterprises which employ less than 250 persons and which have either an annual turnover not exceeding 50 million euro, or an annual balance sheet total not exceeding 43 million euro.