K.U.Leuven - Departement toegepaste economische wetenschappen
DTEW Research Report 0053 pages:1-39
Francis et al. (1999) and Becker et al. (1998) report evidence that audit quality acts as a constraint on both income-increasing and income-decreasing earnings management in public firms. These results raise several interesting questions. First, are incentives for and constraints on earnings management independent of whether earnings are above or below target? Second, does audit quality also restrain earnings management in private firms as it does in public firms? Third, does public ownership itself act as a constraint on earnings management? One could argue that, relative to private ownership, public ownership increases the scrutiny of a firm's financial statements which may in turn restrain a firm's earnings-management behavior.Accordingly, we study publicly available financial statements of a matched sample of public and private Belgian firms. Following Francis et al. 1999, DeFond and Subramanyam 1998, Becker et al. 1998, we use discretionary accruals as a measure of earnings management. One finding is that audit quality and public ownership act as constraints on income-decreasing earnings management. We also find that, to a large extent, public ownership and auditor type are substitutes: for example, a firm that is both public and big-6-audited typically does not show more restraint in earnings management than a firm that has only one of these characteristics. Lastly, we do not have any evidence that audit quality and public ownership constrain income-increasing earnings management. Thus, our study contributes to the literatures on audit quality differentiation and especially earnings management. First, we provide supportive evidence of audit quality differentiation between Big 6 and non-Big 6 auditors in the private clients segment of the audit market. Second, we provide evidence on differences in the level of discretionary accruals between public and private firms.