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

Ahrum CHOI, Byungcherl Charlie Sohn*, Desmond Yuen

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    21 Citations (Scopus)

    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.

    Original languageEnglish
    Pages (from-to)21-41
    Number of pages21
    JournalAsia-Pacific Journal of Accounting and Economics
    Volume25
    Issue number1-2
    DOIs
    Publication statusPublished - 10 Jan 2018

    Scopus Subject Areas

    • Accounting
    • Finance
    • Economics and Econometrics

    User-Defined Keywords

    • accrual-based earnings management
    • audit fees
    • Real earnings management

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