Effect of Audit Quality on Earnings Management of Firms Listed on the Industrial Goods Sector of Nigerian Stock Exchange

Abstract

This study examined audit quality effect on earnings management of firms listed in Nigeria for 2012-2017 period. The study population consist of all firms listed in the industrial goods sector of the Nigerian Stock Exchange. Four hypotheses which seek to find out whether an audit quality has significant effect on earnings management were tested. Data relating to audit quality proxy by audit fees, audit firm size, auditor tenure and auditor industry specialization, and earnings management proxy by magnitude of total accrual relative to operational cash flow were extracted and computed from the published financial statements of sampled firms. The data were subjected to various diagnostic tests such as correlation, multicollinearity, normality and heteroskedasticity tests. The test results confirmed absence of multicollinearity among the independent variables and normality of the data. However, heteroskedasticity presence was confirmed based on BreuschPagan/Cook-Weisberg test results. This led to the conduct of fixed and random effect regressions based on Haussman specification test. Results from both tests showed that the error terms and independent variables are not correlated, confirming absence of heteroskedasticity. We proceeded with pooled ordinary least square, random effect and fixed effect tests and found out that the fixed effect regression result was better than the other two models. The fixed effect regression result was finally used for the analysis. The result confirms that audit fees, audit firm size, auditor tenure and auditor industry specialist have significant negative effect on earnings management. The study recommends that firms should endeavour to engage any of the big 4 audit firms, industry specialist auditors, consider audit fees and retain auditors not more than the mandatory three years prescribed by Security and Exchange Commission code 2011.