Does Big 6 Auditor Industry Expertise Constrain Earnings Management?

Abstract

Earnings management remains a popular topic of debate and discussion among investors, regulators, analysts, and the public. One mechanism that might mitigate earnings management is auditors' industry expertise. Using a large sample of clients of Big 6 auditors, this research examines the association between auditor industry expertise, measured in terms of both auditor market share in an industry and an industry's share in the auditor's portfolio of client industries and a client's level of absolute discretionary accruals, a common proxy for earnings management. Clients of non-specialist auditors report absolute discretionary accruals that are, on average, 1.2 percent of total assets higher than the discretionary accruals reported by clients of specialist auditors. This finding is consistent with the notion that specialist auditors mitigate accruals-based earnings management more than non-specialist auditors and therefore, influence the quality of earnings.

JEL Classification: M41, M43, M49