Audit Effort and Earnings Management

This research investigates the relationship between audit effort as measured by audit hours and earnings management as measured by the absolute value of the discretionary accruals. Using the data from DART, the effect of audit hours on earnings management is tested. The final sample consists of 3,427 companies-years listed in KOSPI from 2007 to 2012. The results reveal that high audit effort is related to less earnings management. We also found that highly leveraged firms tend to increase discretionary accruals more. The size of audit firms do not have any impact on the discretionary accruals. This result is consistent with the previous studies made by Caramanis and Lennox (2008) and Kwon et. al. (2006). Additional regression analyses also reveal that high audit hours curtail earnings management when discretionary accruals are income-increasing or income-decreasing, when IFRS is included as one of the independent variables, and when company size is small, medium, or large. The results for leverage variable indicate that the direction of the discretionary accruals for highly leveraged firms is statistically significant for both income-increasing and income-decreasing discretionary accruals. Another variable BIG4 which represents if the financial statements are audited by one of the big four auditors or not were all statistically insignificant in all the regression models in this study.