The Impact of IFRS on the Role of Auditors in Earnings Quality of European Companies

Prior studies suggest earnings quality increases when audit quality increases. We test whether such a relation is affected by institutional factors, such as the use of International Financial Reporting Standards (IFRS), which is regarded as a superior set of accounting standards. We use and analyze data of firms in the European Union from 2000 to 2007. Our findings are consistent with previous research that earnings quality has improved after the adoption of IFRS. However, our further tests indicate that IFRS have more impact on earnings quality of companies with non-Big 4 auditors. We also find the difference in earnings quality between Big 4 and non-Big 4 audited financial statements is reduced under IFRS. Our explanation for the results is that IFRS allow less alternative accounting treatments than local standards, which restrict managers' opportunity for earnings management. Financial reports under IFRS are more comparable, transparent and investors have more confidence in IFRS. Thus, there is less demand for large auditors to reduce information asymmetry between managers and investors in an IFRS dominated reporting environment. Our evidence suggests the relationship between audit quality and earnings quality varies with institutional factors. In our context, the positive association of high quality audits and high quality earnings weakens as the strength of accounting standards increases. Our results are robust when we control for other influences on earnings quality, particularly for managerial incentives for earning management