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The impact of audit quality on earnings predictability

Author

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  • Khaled Hussainey

Abstract

Purpose - The purpose of this paper is to examine the impact of audit quality, measured by financial statements audited by the big four accounting firms, on the investors' ability to predict future earnings for profitable and unprofitable firms. Design/methodology/approach - The paper uses the returns-earnings regression model and interacts all independent variables in this model with a dummy variable, AUDIT, which is set to equal one if financial statements audited by the big four accounting firms, zero otherwise. Future earnings response coefficient is the measure of earnings predictability. Findings - The paper finds that investors are able to better anticipate future earnings when financial statements are audited by the big four accounting firms. However, the findings are not applicable for unprofitable firms. Practical implications - The findings of the paper have implications for auditing related academic research and the users of financial statements. In particular, the study shows that the big four accounting firms have not lost their audit quality advantage and that financial statements audited by the big four accounting firms are arguably of higher quality than those audited by non-big four accounting firms. Originality/value - It is believed that there is no UK study to date examining the association of the quality of financial statements audited by the big four accounting firms and the returns-earnings association. Consequently, this paper significantly contributes to the limited literature on the perceived value relevance of audit quality.

Suggested Citation

  • Khaled Hussainey, 2009. "The impact of audit quality on earnings predictability," Managerial Auditing Journal, Emerald Group Publishing, vol. 24(4), pages 340-351, April.
  • Handle: RePEc:eme:majpps:v:24:y:2009:i:4:p:340-351
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    References listed on IDEAS

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    1. Eng, L. L. & Mak, Y. T., 2003. "Corporate governance and voluntary disclosure," Journal of Accounting and Public Policy, Elsevier, vol. 22(4), pages 325-345.
    2. repec:bla:joares:v:6:y:1968:i::p:67-92 is not listed on IDEAS
    3. Russell Lundholm, 2002. "Bringing the Future Forward: The Effect of Disclosure on the Returns-Earnings Relation," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 809-839, June.
    4. Titman, Sheridan & Trueman, Brett, 1986. "Information quality and the valuation of new issues," Journal of Accounting and Economics, Elsevier, vol. 8(2), pages 159-172, June.
    5. repec:bla:joares:v:6:y:1968:i:2:p:159-178 is not listed on IDEAS
    6. Collins, Daniel W. & Kothari, S. P. & Shanken, Jay & Sloan, Richard G., 1994. "Lack of timeliness and noise as explanations for the low contemporaneuos return-earnings association," Journal of Accounting and Economics, Elsevier, vol. 18(3), pages 289-324, November.
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    Cited by:

    1. repec:hur:ijaraf:v:7:y:2017:i:4:p:216-231 is not listed on IDEAS
    2. Chi-Chun Chou & C. Janie Chang, 2010. "Continuous auditing for web-released financial information," Review of Accounting and Finance, Emerald Group Publishing, vol. 9(1), pages 4-32, February.
    3. Khaled Hussainey & Khaled Aljifri, 2012. "Corporate governance mechanisms and capital structure in UAE," Journal of Applied Accounting Research, Emerald Group Publishing, vol. 13(2), pages 145-160, September.
    4. Redhwan Ahmed al-Dhamari & Ku Nor Izah Ku Ismail, 2013. "Governance Structure, Ownership Structure and Earnings Predictability: Malaysian Evidence," Asian Academy of Management Journal of Accounting and Finance (AAMJAF), Penerbit Universiti Sains Malaysia, vol. 9(1), pages 1-23.
    5. Persakis, Anthony & Iatridis, George Emmanuel, 2016. "Audit quality, investor protection and earnings management during the financial crisis of 2008: An international perspective," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 41(C), pages 73-101.
    6. repec:eur:ejmsjr:351 is not listed on IDEAS

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