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Do auditors care about real earnings management in their audit fee decisions?

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  • Ahrum Choi
  • Byungcherl Charlie Sohn
  • Desmond Yuen

Abstract

This study investigates whether auditors incorporate the implications of potential litigation risk arising from their client firms’ using real earnings management (REM) to manage earnings. Using a large sample of US firms, we find that REM is positively related to audit fees and that this relation is incremental over and beyond the effects of accrual-based earnings management and other control variables. We also find that the positive relation between REM and audit fees is stronger for firms with sophisticated investors or higher stock price sensitivity to accounting earnings. Finally, we find that this positive relation is more pronounced for firms with financial constraints where REM is more likely to stem from managerial opportunism and is perceived as riskier by auditors. These findings are robust to endogeneity controls and various sensitivity tests.

Suggested Citation

  • Ahrum Choi & Byungcherl Charlie Sohn & Desmond Yuen, 2018. "Do auditors care about real earnings management in their audit fee decisions?," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 25(1-2), pages 21-41, January.
    • Handle: RePEc:taf:raaexx:v:25:y:2018:i:1-2:p:21-41
    DOI: 10.1080/16081625.2016.1231580
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    Cited by:

    1. Singh, Harjinder & Sultana, Nigar & Islam, Ariful & Singh, Abhijeet, 2022. "Busy auditors, financial reporting timeliness and quality," The British Accounting Review, Elsevier, vol. 54(3).
    2. Bhuiyan, Md. Borhan Uddin & Rahman, Asheq & Sultana, Nigar, 2020. "Female tainted directors, financial reporting quality and audit fees," Journal of Contemporary Accounting and Economics, Elsevier, vol. 16(2).
    3. Lee, Eugenia Y. & Ha, Wonsuk & Park, Sunyoung, 2023. "Auditor specialization in R&D and clients’ R&D investment-q sensitivity," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(2).
    4. Marisetty, Vijaya Bhaskar & Moturi, Sairam, 2023. "Boundaries of the firm and real earnings management," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 52(C).
    5. Imen Fakhfakh & Anis Jarboui, 2022. "Earnings Management and Audit Report Lag: The Role of Audit Risk-Tunisian Evidence," Journal of Accounting and Management Information Systems, Faculty of Accounting and Management Information Systems, The Bucharest University of Economic Studies, vol. 21(1), pages 113-135, March.
    6. Wen, Fenghua & Chen, Meng & Zhang, Yun & Miao, Xiao, 2023. "Oil price uncertainty and audit fees: Evidence from the energy industry," Energy Economics, Elsevier, vol. 125(C).
    7. Santanu Mitra & Hakjoon Song & Sang Mook Lee & Shin Hyoung Kwon, 2020. "CEO tenure and audit pricing," Review of Quantitative Finance and Accounting, Springer, vol. 55(2), pages 427-459, August.
    8. Chang, Hsihui & Ho, L.C. Jennifer & Liu, Zenghui & Ouyang, Bo, 2021. "Income smoothing and audit fees," Advances in accounting, Elsevier, vol. 54(C).
    9. Minfeng Yu & Yi Si & Gaoliang Tian & Lei Zhang, 2023. "Climate risk and audit fees: An international study," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 63(5), pages 4989-5025, December.

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