Audit Firm Size, Industry Specialization and Earnings Management by Initial Public Offering Firms

Abstract

This paper investigates the relationship between audit quality (as measured by audit firm size and industry specialization) and earnings management (as measured by discretionary accruals) in the initial public offering process. Earnings management in the IPO process is of particular concern given the information asymmetry between management and investors and the incentive of management to engage in earnings management. We find that Big 5 auditors and industry specialist auditors are related to less earnings management in the IPO process. Our study contributes to the literature in two ways: (1) we show that audit quality is an important determinant for earnings management in the IPO process; (2) we show that industry specialization, as a measure of audit quality, also constrains earnings management.