The impact of audit quality, audit regulation and legal enforcement on the trade-off between real and accrual-based earnings management : the European evidence

Based on a representative sample of 4219 listed firms from 15 European countries over the period 2007-2010, we analyze the impact of both national audit regulation (rotation of auditors, provisions of non-audit services, auditors' liability) and investor protection on the association between earnings quality and audit quality (proxied by Big4 and auditor specialization). We show that Big 4 and specialist auditors influence accrual-based manipulations negatively, real manipulations positively. We also show that companies in countries with a strict audit regime engage less in accrual management activities, and more in real management activities, compared to companies in countries with a more flexible audit regime. Finally we show that national audit regulation and audit quality interact so that the impact of audit quality on earnings quality is less pronounced in countries with a strict audit regime, and more pronounced in countries with a flexible audit regime.