I. Introduction
Prior research has examined the association between corporate governance (outside directors, audit committees, board of directors) attributes and financial reporting quality (Kelton and Yang 2008; Davidson et al. 2005; Abbott et al. 2004; Klein 2002; Beasley 1996). These studies suggest that financial reporting quality could be improved by well-structured governance mechanisms. In this study, we examine whether audit quality, as one attribute of good corporate governance, along with other attributes of corporate governance extends to financial disclosure and more precisely to the choice of management earnings forecast attributes.1 Palmrose (1988) and Krishnan and Schauer (2000) suggest a general consensus that the external audit constitutes a key of corporate governance.2
The extant accounting literature documents mixed evidence that higher-quality audit firms may influence the firm’s forecast choices (Clarkson 2000; Davidson and Neu 1993; Feng et al. 2009; McConomy 1998)3 and corporate governance may be associated with management earnings forecast attributes (Ajinkya et al. 2005; Karamanou and Vafeas 2005). Our study employs audit quality in addition to two widely used measures of corporate governance (the proportion of outside directors, the proportion of aggregate institutional ownership), combined with proprietary costs, and litigation factors (Ajinkya et al. 2005).4 We provide a comprehensive study of these factors using a somewhat a recent sample of observations than employed in the earlier studies.5
V. Conclusion
The focus of this study is to investigate the association between auditor quality and attributes of management earnings forecasts. We extend and refine prior studies of this relationship by employing additional controls (corporate governance, litigation risk, and proprietary cost) and by considering recent data with larger samples. We find that higher audit quality is associated with larger forecast errors, the likelihood of issuing downwardly biased forecasts, and less forecast precision.15 Our results and inferences are consistent with a high quality audit limiting management’s ability to manage earnings and management acting strategically in their choice of forecast precision, forecast error, and level of optimism. Our results appear to be conclusive and robust to the inclusion of control variables found in prior research to impact management earnings forecast errors and precision.
