Auditor Conservatism, Asymmetric Monitoring, and Earnings Management*

Authors


  • *

    Accepted by Dan Simunic. We are grateful to Dan Simunic (associate editor) and two anonymous referees for their insightful comments and suggestions that helped us to improve the quality of the paper. We also thank Gerry Lobo, Chung-ki Min, and participants of the 2002 Annual Meeting of AAA and doctoral/faculty seminars at The Hong Kong Polytechnic University and Curtin University of Technology for their comments. Kim and Chung acknowledge partial financial support from the CERG research grant. The usual disclaimer applies.

Abstract

In this paper, we investigate whether, and how, audit effectiveness differentiation between Big 6 and non-Big 6 auditors is influenced by a conflict or convergence of reporting incentives faced by corporate managers and external auditors. In so doing, we incorporate into our analysis the possibility that managers self-select both external auditors and discretionary accruals, using the two stage “treatment effects” model. Our results show that only when managers have incentives to prefer income-increasing accrual choices are Big 6 auditors more effective than non-Big 6 auditors in deterring/monitoring opportunistic earnings management. Contrary to conventional wisdom, we find Big 6 auditors are less effective than non-Big 6 auditors when both managers and auditors have incentives to prefer income-decreasing accrual choices and thus no conflict of reporting incentives exists between the two parties. The above findings are robust to different proxies for opportunistic earnings management and different proxies for the direction of earnings management incentives.

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