Academic journal article International Journal of Business and Information

Can Auditors Restrain Firms from Earnings Management?

Academic journal article International Journal of Business and Information

Can Auditors Restrain Firms from Earnings Management?

Article excerpt

ABSTRACT

This paper focuses on Taiwanese companies that applied for Gre Tai Securities Market / Taiwan Stock Exchange (GTSM-TWSE) transfer through simplified batch-reviews between 2000 and 2011. Since the listing-transfer companies were likely be motivated by earnings management, this study, which consists of 444 observations, examines whether audit firm sizes (measured by Big5) and audit industry specialization are associated with lower earnings management during the year before and the year of GTSM-TWSE transfer. The empirical results show: (1) that Big5 and SPEC generally cannot constrain listing-transfer firms' discretions over earnings any more than non-Big5 can; and (2) that listing-transfer firms audited by industry specialist auditors do engage less in income increasing-accruals than listing-transfer firms audited by non-industry specialist auditors in the year prior to transfer year. In sum, the results show that the simplified batch-review procedures seem to be over-confident of the abilities of CPAs to restrain earnings management engaged in by GTSM-TWSE transfer firms.

Keywords: Listing-transfer, earnings management, industry specialist, Big5

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Since Taiwan became a member of the World Trade Organization (WTO) and relaxed regulations on investments in China in 2002, there has been a dramatic increase in the number of domestic companies setting up factories and entering the market on the Mainland and in Hong Kong in order to reduce the costs of production. This shift led to a decline in 2006 in the number of firms listed on the Taiwan Stock Exchange (hereafter, TWSE), a fact that adversely affects development of the capital market in Taiwan. As indicated in Table 1, the volume of funds entering the capital market has fallen progressively, with the annual stock turnover in the secondary market falling from its peak of 37.7 trillion in 1997 to 24.2 trillion in 2006. In addition, the average P/E ratio dropped from 41.77 in 2002 to 15.31 in 2007.

In order to expand the financial services industry, Taiwanese government agencies strive to provide a stable and secure financial environment by strengthening the administration system and creating a diverse, globalized, and reliable financial market. The first phase of a three-year sprint plan, named "Financial Market Packages," was launched by the Executive Yuan on September 27, 2006. The plan reviewed the criteria for listing on the stock exchange and simplified its process. It also called for expanding the scale of the stock market by listing 90 more companies by the end of 2009. The Taiwan Securities Exchange, in trying to meet the targets, has held many conferences with business leaders to encourage OTC companies traded on Gre Tai Securities Market (hereafter, GTSM) to get listed on the TWSE. In 2007, TWSE again implemented the previously halted simplified regulation for transferring listings by revising the "Criteria for Review of Securities Listings" to eliminate on-site inspections and to greatly reduce the batch-filing review periods for listingtransfer applications.

The TWSE implemented a simplified review process for GTSM companies transferring to TWSE between 1990 and 2004. During this period, a total of 204 GTSM companies made the transfer, of which 195 satisfied the criteria for transfer to TWSE. The listing-transfer firms were expected to make up a large portion of the newly listed companies when the government promoted the simplified review policy to encourage transfer listing, especially when the market was booming. In 1999, the average P/E reached a peak at 47.7. The data in Table 2 indicate that 78.75% and 73.85% of the newly listed firms were made up of listing-transfer firms in the years 2000 and 2001, respectively. Between 2002 and 2004, the percentage of listing-transfer firms in the newly listed firms exceeded 50%, which is not surprising.

There were some unexpected consequences, however. …

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