Auditor Conservatism, Dissymmetric Monitoring And Earnings Management

Earnings management of listed companies is a problem faced by many countries,and is a important issue in academia of accounting.The end result of earnings management will be reflected in financial reports.While accounting choices are the joint outcome of income-reporting incentives faced by corporate managers and external auditors.Reported earnings reflect the interaction of income-reporting incentives faced by two issuers of financial statements,corporate managers and external auditors.External auditing can monitor and examine business financial reports.In this paper,we investigate whether,and how,audit effectiveness differentiation between Top10 and non Top10 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 indicate that Top10 auditors have incentives to be more conservative than non Top10 auditors in determining reported earnings.And our results show that only when managers have incentives to prefer income-increasing accrual choices are Top10 auditors more effective than non-Top10 auditors in limiting opportunistic earnings management.Contrary to conventional wisdom,we find Top10 auditors are less effective than non Top10 auditors when both managers and auditors have incentives to prefer income-decreasing accruals choices and thus no divergence of reporting incentives exists between the two issues.Evidence reported in this paper is consistent with the notion that the divergence of reporting incentives over income-increasing accounting choices between the two sides,coupled with reputation loss associated with audit failure to detect income overstatement,motivates Top10 auditors to exercise a heightened degree of professional suspicion on managers' income-increasing accounting choices.In contrast,the compromise of reporting incentives over income-decreasing accounting choices between the two sides,coupled with the lack of litigation risk associated with income understatement, eliminates Top10 auditors' incentives to deter income-decreasing accrual choices.Our results shows that Top10 clients are allowed to have more flexibility for income decreasing accrual choices than non Top10 clients.And the divergence of reporting incentives or the lack is a key issue determining audit quality.In a word,our results strongly show that audit effectiveness differentiation between Top10 and non Top10 auditors,is sensitive to the direction of managers' incentives for earning management.The above findings are robust to different proxies for opportunistic earnings management.