Earnings Management and Audit Quality in Europe: Evidence from the Private Client Segment Market

Abstract

This paper contributes to the recent literature on financial reporting quality in private (i.e. non-listed) companies (Ball and Shivakumar, 2005 Ball, R. and Shivakumar, L. 2005. Earnings quality in UK private firms. Journal of Accounting and Economics, 39(1): 83–128. [Crossref], [Web of Science ®] , [Google Scholar]; Burgstahler et al., 2006 Burgstahler, D. C., Hail, L. and Leuz, C. 2006. The importance of reporting incentives: earnings management in European private and public firms. The Accounting Review, 81(5): 983–1016. [Crossref], [Web of Science ®] , [Google Scholar]) by examining whether in these types of companies Big 4 audit firms, as high quality auditors, provide a constraint on earnings management. Considering incentives of auditors to supply a high audit quality in private firms, we expect that Big 4 auditors have an incentive to constrain earnings management only in high tax alignment countries, where financial statements are more scrutinized by tax authorities and the probability that an audit failure is detected is higher. Using data on private firms in European countries, this study provides evidence consistent with this expectation.