5. Conclusions
We examine the impact of audit quality on real and accrual earnings management around IPOs. Although prior research has examined accruals earnings management around IPOs (e.g., Friedlan, 1994; Gramlich and Sorensen, 2004; Morsfield and Tan, 2006; Teoh et al. 1998a), and a small number of recent papers have started to investigate real earnings management activities and IPOs (e.g., Darrough & Rangan, 2005; Wongsunwai, 2013), our paper progresses the literature by examining the effect of enhanced audit quality on real and accrual earnings management activities during the IPO year. We contribute to the research in this area by showing IPO firms audited by high quality auditors resort to a higher level of salesbased manipulation but have significantly lower levels of discretionary expenses-based and accrual-based manipulations.
While this finding can only lead to a partial acceptance of our hypothesis, our results are consistent with the approach for detecting real earnings management via the use of ratios, trends, financial and non-financial information, set out in the International Standards on Auditing. The presence of high quality auditors does not constrain sales manipulation. However, discretionary expense manipulation is significantly lower, as a divergent trend between increasing sales and the costs associated with increasing sales would be a signal to high-quality auditors that there may be pervasive manipulation going on. The mere presence of a big-N auditor is not, however, sufficient to constrain all forms of earnings management.
