Industry Specialist Auditor and Client Firms’ Real Earnings Management

This study investigates whether industry specialist auditors restrict the use of excessive real earnings management which is performed through the adjustment of timing or magnitude of real business activities. Auditing standards require auditors to use industry-specific knowledge during auditing process. Indeed, accounting firms recently put great effort into enhancing industry expertise, highlighting the importance of industry specialty in maintaining high audit quality. Therefore, industry specialist auditors may effectively hinder clients from engaging in the real earnings management as they do in relation to client’s accruals-based earnings management. On the other hand, although they tend to constrain clients from engaging in accruals-based earnings management, they may not pay much attention to the real earnings management since restricting real earnings management is not under auditors’ direct jurisdiction. Thus, it is not clear whether industry specialist auditors influence the magnitude of clients’ real earnings management. Using Korean data, we find that clients of industry specialist auditors tend to rely less on real earnings management than those of non-industry specialist auditors. This suggests that industry specialist auditors limit clients‘ use of opportunistic real earnings management as they do for the accrual-based earnings management.