Differential Responses of Audit Fees on Earnings Management according to Managerial Incentives concerning Accounting Performance

Prior research still provides inconsistent results on the association between audit fees and earnings management, but it neglects managerial incentives related to accounting performance to be assessed as the determinant of earnings management risk. This paper examines how the association between audit fees and earnings management is moderated by managerial incentives related to accounting performance. The results show that while the association between audit fees and discretionary accruals is significant and positive for the worst performing firms and firms that report small profits, this association is insignificant for the best performing firms. These results suggest that auditors consider earnings management for the worst performing firms and firms that narrowly escape from reporting losses, as the tool used for managers’ opportunistic intentions, whereas that for the best performing firms as the sign used for communicating private value－ relevant information, not audit risk. Consequently, auditors respond differently to earnings management depending on managerial incentives to manage earnings.