The impact of audit committee existence and external audit on earnings management

Abstract

Purpose – This study aims to examine the combined effect of audit committee existence and external audit on earnings management. Design/methodology/approach – The paper uses ordinary least squares regression model to examine the effect of audit committee existence, external audit and the interaction between these two monitoring mechanisms on earnings management for a sample of 33 non-financial listed Portuguese firms-year from 2003 to 2009. Findings – In contrast to results of most previous studies, which assume that audit committees and external auditor act independently from one another, the paper finds a positive relationship between both audit committee existence and external audit and discretionary accruals. However, this study suggests that the existence of an audit committee and external auditor jointly reduces earnings management. Practical implications – The findings based on this study provide useful information for regulators in countries with an institutional environment similar to that of Portugal. In addition, the results also provide useful information to investors in evaluating the impact of audit committee existence and external audit on earnings quality, especially under concentrated ownership. Originality/value – The major contribution of the current study is that in contrast to previous studies, which have implicitly assumed that audit committees and external auditors act independently from one another, this study also examines the combined effects of audit committee existence and external auditors on earnings management. In addition, this paper is the first empirical study to investigate the effect of audit committee existence and external audit on earnings management in Portugal.

Audit quality and earnings management: evidence from Jordan

“…Furthermore, this research finding showed that large firms have higher levels of EM, indicating that larger firms are better able to manage earnings and camouflage actual performance (Alves, 2013;Chen et al, 2007). This study also showed significantly positive association between EM and leverage.…”

“…However, greatly indebted companies might be less capable to exercise EM as they are monitored by lender assessment. Prior authors found a positive association between leverage and EM (Alves, 2013;Gerayli et al, 2011;Sweeney, 1994), while others reported a negative relationship (Park and Shin, 2004;Peasnell et al, 2000). For this study, leverage (LEV) is the total debt divided by the total assets (at the start of the year).…”

“…However, larger companies might have greater motives to manage earnings since they are conditional on nearer inspection through the exploitation of banks and specialist groups (Chen et al, 2007). Some earlier research found a negative association between size of company and discretionary accruals (Gerayli et al, 2011;Peasnell et al, 2000), while other studies found positive association (Alves, 2013;Chen et al, 2007). For this research, firm size (FRMSIZE) is the natural logarithm of total assets.…”

“…This paper employed the modified cross-sectional Jones model (Alves, 2013;Becker et al, 1998;Davidson et al, 2005). Bartov et al (2000) displayed that the cross-sectional model would perform better than the time-series model for identifying EM.…”

“…Such situations would permit the manager to control other managers and utilise his discretion in order to enhance his benefits by EM practices (Lipton and Lorsch, 1992). On the contrary, other studies advocated the supposition that a great number of board members decreases EM since this board permits attaining advantage from different expertise of various board members (Alves, 2013;Klein, 2002;Peasnell et al, 2005). Some authors documented that size of board has no influence on the absolute value of discretionary accruals (Cornett et al, 2009;Taktak and Mbarki, 2014).…”