Ann Vanstraelen

Earnings management under German GAAP versus IFRS

Abstract This paper addresses the question whether voluntary adoption of International Financial Reporting Standards (IFRS) is associated with lower earnings management. Ball et al. (Journal of Accounting and Economics, 36(1–3), pp. 235–270, 2003) argue that adopting high quality standards might be a necessary condition for high quality information, but not necessarily a sufficient one. In Germany, a code-law country with low investor protection rights, a relatively large number of companies have chosen to voluntarily adopt IFRS prior to 2005. We investigate whether German companies that have adopted IFRS engage significantly less in earnings management compared to German companies reporting under German generally accepted accounting principles (GAAP), while controlling for other differences in earnings management incentives. Our sample, consisting of German listed companies, contains 636 firm-year observations relating to the period 1999–2001. Our results suggest that IFRS-adopters do not present different earnings management behavior compared to companies reporting under German GAAP. These findings contribute to the current debate on whether high quality standards are sufficient and effective in countries with weak investor protection rights. They indicate that voluntary adopters of IFRS in Germany cannot be associated with lower earnings management.

Earnings management and audit quality in Europe: evidence from the private client segment market

This paper contributes to the recent literature on financial reporting quality in private (i.e. non-listed) companies (Ball and Shivakumar, 2005; Burgstahler et al., 2006) by examining whether in these types of companies Big 4 audit firms, as high quality auditors, provide a constraint on earnings management. Considering incentives of auditors to supply a high audit quality in private firms, we expect that Big 4 auditors have an incentive to constrain earnings management only in high tax alignment countries, where financial statements are more scrutinized by tax authorities and the probability that an audit failure is detected is higher. Using data on private firms in European countries, this study provides evidence consistent with this expectation.

Earnings management within Europe: the effects of member state audit environment, audit firm quality and international capital markets

Abstract This paper studies earnings management in a European context. More specifically, the effects of three factors on earnings management within Europe are studied: member state audit environment, audit firm quality and presence in international capital markets. The national audit environments within Europe vary strongly in terms of independence rules and auditor liability. Hence, it can be expected that the restrictions imposed by national audit environments on earnings management vary. However, there are two factors that can mitigate the national audit environment effect: Big Four audit firm quality and a companys reliance on international capital markets. Using data for the period 1992–2000 from listed firms in three EU countries with clearly distinct audit environments (France, Germany and the UK), we have the following main findings. First, a stricter audit environment reduces the magnitude of earnings management, irrespective of the type of auditor (Big Four audit firm or non-Big Four audit firm). Second, there is no evidence of an international Big Four audit quality effect in Europe. Third, a companys reliance on international capital markets does not limit its earnings management. The evidence provided in this study is relevant for the current debate in the European Union on the harmonisation of auditing. For the comparability of earnings, not only is the standardisation of financial reporting important but also the standardisation of enforcement mechanisms, as embodied in the national audit environment and the quality of audit firms. The results of this study suggest that the enforcement of financial reporting still varies strongly across member states of the EU.

Does the Identity of Engagement Partners Matter? An Analysis of Audit Partner Reporting Decisions†

This study examines the persistence and economic consequences of variations in reporting style across audit partners in individual engagements. Our results show that both aggressive and conservative audit reporting, measured by the pattern of prior Type 2 and Type 1 audit reporting error rates in auditor-specific clienteles, persist over time and extend to other clients of the same partner. Analyses of abnormal accruals and persistence of client firms’ accrual estimates corroborate this finding, and hold both for private and publicly listed companies. Further, our results also show that the market penalizes client firms susceptible to aggressive audit partner reporting decisions. In particular, we find that our proxies for aggressive audit reporting are related to higher interest rates, worse credit ratings and less favorable forecasts of insolvency for private client companies, and a lower Tobins Q for publicly listed client companies. Collectively, these results imply that audit partner aggressive or conservative reporting is a systematic audit partner attribute and not randomly distributed across engagements.

Going-concern opinions, auditor switching, and the self-fulfilling prophecy effect examined in the regulatory context of Belgium

Previous studies have demonstrated that auditors are reluctant to issue going-concern opinions. Some suggest this reluctance is strategic and stems from the auditors desire to avoid loss of clients or reputation. This paper investigates the threat of loss resulting from auditor switching and client bankruptcy in the regulatory context of Belgium. Belgium requires companies to engage an audit firm for a three-year period. Consequently, the clients threat of switching auditors is potentially more credible in the third year than in the first two years. The empirical results support the hypothesis that going-concern opinions significantly increase the probability of bankruptcy. Thus, going-concern reports remain relevant even in a country where debt financing is dominant. In addition, clients are four times more likely to switch auditors at the end of the mandatory term if they receive a going-concern opinion in the final year of the term relative to the previous two years. This strongly suggests that mandatory terms influence the association between going-concern opinions and auditor switching.

Auditor economic incentives and going-concern opinions in a limited Litigious Continental European business environment: empirical evidence from Belgium

Abstract Theory predicts that auditor reporting behaviour may be influenced by the perceived consequences of disclosing going-concern uncertainty in the audit report (DeAngelo 1981, Watts and Zimmerman 1986). Krishnan and Krishnan (1996) and Louwers (1998) have addressed this issue empirically in a US context. The results of Krishnan and Krishnan (1996) suggested that one of the important factors in the auditors opinion decision is the risk of litigation. The purpose of this study is to examine the relationship between auditor economic incentives and the propensity to issue going-concern opinions in a limited litigious business environment, Belgium. In spite of the low risk of litigation and the fact that most Belgian companies are privately held, various regulations have been put into effect to safeguard audit quality in Belgium. However, the results suggest that the auditors going-concern opinion decision in Belgium is associated with factors relating to the perceived consequences of disclosing a going-concern opinion. Specifically, the results suggest that auditors in Belgium are significantly less likely to issue going-concern opinions to clients that pay higher audit fees, and when the audit firm has lost a relatively high proportion of its clients in the preceding year. The auditors going-concern opinion does not appear to be significantly influenced by the length of the auditor-client relationship, year of the auditor engagement period, and auditor type. The results of this study are to some extent different from the study by Louwers (1998), in which none of the incentive variables related to the auditors loss function was significant.

The Audit Reporting Debate: Seemingly Intractable Problems and Feasible Solutions

While the audit reporting debate has a long history, a number of recent regulatory initiatives and policy reviews increase the likelihood of change in this area. The purpose of this study is to use this momentum and examine whether there is consensus between audit report users and auditors with regard to the form and content of the audit report. This seems necessary because past audit reporting reforms have failed due to a lack of common ground. Based on interviews with users and auditors, we conclude that reaching a level of consensus seems feasible. Using these insights, we propose an alternative audit reporting model that may significantly reduce the information gap between users and auditors and improve transparency on the quality of audit practice.

The Auditor's Going Concern Opinion Decision: A Pilot Study

This research attempts to find empirical evidence of ex ante factors relating to the economic trade?offs that an auditor faces when deciding whether or not to disclose going concern uncertainties in an audit report in a non?litigious continental European setting, Belgium. The research methodology consists of univariate and logistic regression analysis. The results of the study confirm the belief that the auditors going concern opinion decision is not only a question of competence but also of independence. A significant moderating factor appears to be recent client loss on the part of the auditor. The legal obligation for Belgian auditors to refer to the report of the Board of Directors in their own audit report seems to significantly influence their reporting behaviour. The disclosure by the Board of Directors of bad news regarding the state of affairs of a company diminishes any conflict of interest that may exist between the Board and the auditor. However, no evidence was found to justify the fear for a self?fulfilling prophecy effect.

Research opportunities in auditing in the EU

SUMMARY: This article presents a number of research opportunities in auditing in the EU that have come along with changes in the EU regulatory framework for financial reporting and auditing during the past decade. In doing so, we build on Schilder (1996), who raised a number of key research questions, and conclude that some of those questions remain unanswered and are still relevant today. At the same time, new opportunities arise in the changed EU landscape. We identify some important areas where research can help advance our knowledge and provide relevant information for policy makers. These research areas include: public oversight, audit market concentration, audit quality, audit firm ownership structures, audit firm operating structures, audit firm governance, and auditor liability. The research questions that we raise are of global interest, but the EU market provides some unique natural experimental settings to address these questions.

Auditing private companies: what do we know?

The purpose of this article is to provide an overview of the literature on what we currently know about the costs and benefits of auditing private company accounts. Our main conclusions are the following. First, there is much heterogeneity in factors driving audit demand in private companies and the value derived from the audit. Second, research provides support for improved financial reporting quality due to, and real economic benefits from, private company audits. Third, the cost–benefit analysis for private company audits is firm-specific and mandating the audit does not seem to be cost-effective and thus economically optimal for all private companies. Alternative services may better meet the needs of especially smaller private companies. Furthermore, mandating the audit is not necessarily an optimal solution since private companies with low demand for a high-quality audit are able to find an auditor that meets their requirements even under a mandatory regime. Hence, having a mandatory audit in place is no guarantee for universally high-quality audits and this seems most salient for private companies where auditors may be more prone to independence issues. We conclude by providing a number of directions for future research.