The Influence of Auditor Independence Regulation on Earnings Quality: An Empirical Analysis of Firms Cross-Listed in the US#
Universiteit Antwerpen and Universiteit Maastricht
Corresponding author is Ann Vanstraelen. E-mail address: email@example.com. Adress for correspondence: Department of Accounting and Information Management, Faculty of Economics and Business Administration, Universiteit Maastricht, P.O. Box 616, 6200 MD Maastricht, The Netherlands. This paper has benefited from helpful comments of accounting seminar participants at the 2003 Euroconference on ‘Financial Reporting and Regulatory Practices in Europe’ in Corsica and the 2003 International Symposium on Audit Research (ISAR) in Pasadena. The authors thank METEOR (Maastricht Research School of Economics of Technology and Organizations) for financial support.
The Influence of Auditor Independence Regulation on Earnings Quality: An Empirical Analysis of Firms Cross-Listed in the US
This paper addresses the question whether the quality of earnings of firms cross-listed in the US is a function of the strictness of auditor independence regulation. Our assumption is that firms cross-listed in the US face similar earnings management incentives as well as enforcement and litigation. Our results contribute to the auditing literature by providing evidence that companies subject to similar capital market pressures report higher quality earnings when domiciled in a country with more stringent auditor independence regulation. In particular, our results suggest that cross-listed firms domiciled in countries with stricter auditor independence regulation have more informative accruals, engage less in accrual-based earnings management and are less likely to avoid small losses and earnings decreases. In the aftermath of recent business failures, our results may be useful in the current debate whether more stringent statutory regulation of the auditing profession is helpful.
auditor independence, auditor quality, earnings management, cross-listing
The business failures of the past years, which are considered to be the biggest in business history, have put the auditing profession in a serious credibility crisis. As a response, the US passed the Sarbanes-Oxley act, which is aimed at cleaning up the auditing process (The Economist, November 30th 2002). In a similar spirit, the NYSE issued in August 2002 proposals for improving corporate governance at NYSE-listed companies. Following the evolutions in the US, the Commission of the European Communities (EC) formulated in May 2002 a recommendation with a set of fundamental principles on statutory auditors’ independence in the EU. A key issue of these regulatory changes is the safeguarding of auditor independence. The Sarbanes-Oxley act, for example, prohibits the offering of non-audit services to audit clients, and requires rotation of the lead audit or coordinating partner and the reviewing partner every 5 years. The Commission of the EC, for example, recommends public disclosure of audit fees. It is clear that the current crisis of the accounting profession has revived the debate on auditor independence and auditor regulation. Indeed, “at the heart of the audit failures lies a set of business relationships that are bedeviled by perverse incentives and conflicts of interest. In theory, a company’s auditors are appointed independently by its shareholders, to whom they report. In practice, they are chosen by the company’s bosses, to whom they all too often become beholden.” (The Economist, February 9th 2002). Hence, auditors might be more inclined to allow aggressive and opportunistic reporting of accruals, resulting in lower quality audits and thus lower quality earnings. On the other hand, regulation is...
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