Impact of Audit Quality on Real Earnings Management: Moderating Role of Corporate Governance

Abstract

Purpose: This study aims to examine the effectiveness of audit quality in restricting earnings management in the presence of country’s governance system. Methodology: The data was collected from 195 Pakistani-based and 150 UK based non-financial companies. The sampling period is ten years from 2010 to 2019. To test the hypotheses, the Generalized Method of Moments was applied. Findings: The results showed that firms switch from accrual earnings management to real earnings management in developed economies which are characterized by strong governance mechanism. Moreover, the negative association between governance mechanism and earnings management is increased in the presence of Big-4 auditor. Conclusion: It is concluded that audit quality restricts the firms to use real earnings management especially in those countries where governance mechanism is strong.