The effect of audit quality on earnings management: An application for companies listed on ISE

Theoretical arguments and research findings suggest that audit quality constrain earnings management. The researches indicating audit quality constrains the earnings management, however, were usually undertaken in such countries (e.g. USA) where there exists effective audit and oversight mechanism for auditors, and such findings has been questioned in an environment (e.g. Turkey) where auditor?s incentives to provide high quality audit is considered to be limited. This study, which intends to contribute the above arguments on the literature by focusing on Turkish case, assesses the effect of audit quality on earnings management.In this study, using ?audit firm size? as proxy for ?audit quality? and ?discretionary accruals? as proxy for ?earnings management?, the hypothesis that ?there is no effect of audit firm size on earnings management?, is tested based on 290 firm-years data comprising manufacturing industry firms listed on the Istanbul Stock Exchange (ISE) for the years 2003-2007. Discretionary accruals are estimated using the Modified Jones Model and the hypothesis is tested by running both non-parametric univariate tests and parametric multivariate regression model. In the multivariate analysis, discretionary accrulas are regressed on a dummy variable indicating audit firm size and some control variables. The results show that audit firm size, as proxy for audit quality, does not have an impact on discretionary accruals. These results indicate that there is no difference in audit quality between Big Four and non-Big Four audit firms for restriction of earnings management in Turkey. These findings are so much in line with the findings of research on Korean case but are different from the findings of researches run in the USA and other developed countries.