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Earnings Management and Auditor Quality

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Listed:
  • Savita Sahay
  • Harry ZviDavis
  • Meyer Peikes

Abstract

This paper analyzes the relationship between a firm’s demand for different quality auditors and opportunities for earnings management.In our model, the firm simultaneously chooses the bias it introduces into its pre-audited earnings and the quality of its auditor. We show that firms that choose a highlevel of bias also choose a low-quality auditor, even though the market-maker makes a correction for the level of residual bias in audited reports. Firms that choose a low level of bias choose a high-quality auditor.We also study the effect of changes in the regulatory environment on the market equilibrium.Our analysis shows that stricter regulation leads to more firms choosing low-quality auditors, thus it is not in the interest of high quality auditors to support such measures.

Suggested Citation

  • Savita Sahay & Harry ZviDavis & Meyer Peikes, 2012. "Earnings Management and Auditor Quality," Accounting and Finance Research, Sciedu Press, vol. 1(1), pages 1-38, May.
    • Handle: RePEc:jfr:afr111:v:1:y:2012:i:1:p:38
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    References listed on IDEAS

    as
    1. Simunic, Da, 1980. "The Pricing Of Audit Services - Theory And Evidence," Journal of Accounting Research, Wiley Blackwell, vol. 18(1), pages 161-190.
    2. Gil Sadka, 2006. "The Economic Consequences of Accounting Fraud in Product Markets: Theory and a Case from the U.S. Telecommunications Industry (WorldCom)," American Law and Economics Review, Oxford University Press, vol. 8(3), pages 439-475.
    3. Craswell, Allen T. & Francis, Jere R. & Taylor, Stephen L., 1995. "Auditor brand name reputations and industry specializations," Journal of Accounting and Economics, Elsevier, vol. 20(3), pages 297-322, December.
    4. Carl Shapiro, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(4), pages 659-679.
    5. 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.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

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