Auditor independence, auditor expertise and bargaining power: impact on abnormal accruals

Abstract

This study empirically examines the relation between two quality characteristics of the auditor - independence and expertise and the magnitude of earnings management. The analysis is further extended, drawing on Porter's [1985J competitive strategy, to consider the possible mitigating influence of a client's absolute size and relative size of bargaining power. Using 2003 data, hand collected from 298 publicly listed firms in Singapore, the authors find no significant association between the non-audit/total fee ratio and the magnitude of earnings management. It is found that a firm which engages an industry expertise audit firm, has significantly lower levels of absolute abnormal accruals than a firm using non-specialist services. Finally, the authors demonstrate that it is the client's absolute size bargaining power and not the client's relative size of bargaining power that mitigates the association between auditor's expertise and earnings management. Specifically, the authors find smaller [larger] firms purchasing services from a specialist have [do not have] significantly lower levels of earnings management than smaller [larger] counterparts using non-specialist services. The main findings of the study are robust to various sensitivity checks. These findings have implications for various stakeholders. For example, the findings suggest policymakers and reformists need to consider more clearly the costs and benefits of moves to limit concentration in the audit market industry.