Publication: Is earnings management impacted by audit fees and auditor tenure? An analysis of the Big Four audit firms in the US market
Authors
Martin De Almagro Vazquez, Gema ; Valls Martínez, María del Carmen ; Santos Jaén, José Manuel
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Publisher
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DOI
10.24136 /oc.2023.027
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info:eu-repo/semantics/article
Description
©<2023>. This manuscript version is made available under the CC-BY 4.0 license http://creativecommons.org/licenses/by/4.0/
This document is the Published version of a Published Work that appeared in final form in [Oeconomia Copernicana]. To access the final edited and published work see[10.24136 /oc.2023.027]
Abstract
Research background: Audits are intended to ensure the reliability of financial statements, as
this is fundamental for different stakeholders. However, both auditor tenure and audit fees
could affect the earnings management of companies. In 2014, the European Union established
a mandatory audit firm rotation policy. In the United States, although there is still no manda-tory regulation in this regard, there has been a large public debate over the advisability of this
policy. Another unresolved controversy is whether audit fees determine audit quality.
Purpose of the article: The aim of this research is to study the effect of auditor tenure and
audit fees on earnings management, i.e., to determine whether a longer-term relationship
between the auditor and the audited company, as well as higher audit fees, reduce the audited
company's earnings management, thereby making the financial statements more reliable for
stakeholders and increasing the quality of the audit report. In addition, the Big Four auditing
companies in the United States were analyzed in order to determine the influence of corporate
culture.
Methods: A sample of companies listed in the S&P 500 stock market index was employed for
the analysis, covering the years 2012 to 2021, resulting in a dataset comprising 3,010 observations. To examine the research hypotheses while mitigating the potential bias from omitted
variables, a linear regression analysis was conducted using panel data with fixed effects regression. To enhance the robustness of the results, winsorized variables were also employed.
Findings & value added: Overall, the results confirm that the quality of financial statements
improves as auditor tenure increases, and so implementing a mandatory auditor rotation may
not be in a company’s best interests. The results also support the market segmentation theory,
as higher audit fees are aligned with higher quality financial reporting. Furthermore, by analyzing the Big Four audit companies in the US, it is shown that the influence of audit fees and
auditor tenure on earnings management also depends on the internal aspects of the particular
audit firm, especially its ethical culture. In sum, US policymakers should neither set limits on
audit fees nor enforce a mandatory audit firm rotation similar to that of the EU.
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Citation
Oeconomia Copernicana.Volume 14
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