Essays on financial reporting quality and auditor attributes

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This dissertation consists of three stand-alone essays in the areas of financial reporting quality and auditor attributes. The first essay investigates how test power impacts research relevance and uses earnings management research as the case. I argue that the relevance of accounting research outside of academia is often limited because researchers typically place far greater weight on the relative cost of type I versus type II errors. To illustrate the extent of this problem, I examine the performance of a simple financial ratio-type analysis for detecting earnings overstatements when the total misclassification costs are minimised subject to the relative cost of type I versus type II errors. I then contrast the likelihood of type I versus type II errors from this approach with those arising from several widely used measures of unexpected accruals. The results illustrate how commonly-used unexpected accruals measures reduce the type I error rate by sacrificing the type II error rate. Since accounting information users and auditors typically face much higher costs with respect to type II errors, I explicitly identify why unexpected accruals models are likely far less useful in detecting earnings overstatements than a relatively simple approach using financial statement analysis red flags. The results highlight the fundamentally contrasting incentives facing accounting researchers relative to those who might otherwise use the results from empirical research in practice, and serve as a warning when the broader relevance of accounting research is increasingly under question. The second essay explores whether auditor industry specialisation is associated with the quality of voluntary non-GAAP earnings disclosures. Industry-specialist auditors are expected to influence the measurement and reporting of non-GAAP earnings due to their greater understanding of industry-specific accounting issues. More generally, the role of auditors is expected to extend beyond the narrow GAAP compliance perspective (DeFond et al. 2018). Consistent with this notion, the results show that the exclusions from GAAP earnings (i.e., non-GAAP exclusions) tend to have less predictive ability for future operating earnings when the firm is audited by an industry-specialist auditor, indicating a higher degree of non-GAAP earnings quality. Further, non-GAAP earnings quality is relatively higher in clients from industries where non-GAAP disclosure is more prevalent, since clients from prevalent industries are more likely to have comparable non-GAAP earnings benchmarks which limit their motivations and abilities to report aggressive non-GAAP earnings numbers. Hence, I predict that the role of industry-specialist auditors is more important in industries where non-GAAP disclosures are less prevalent, as the non-GAAP quality is relatively lower among these firms. The results support the prediction, and demonstrate that industry-specialist auditors enhance not only the quality of mandatory disclosures, but also the quality of voluntary disclosures. The final essay investigates the association between audit partner change and the quality of non-GAAP earnings voluntarily disclosed by firms. The results show that non-GAAP exclusions tend to be more conservative for clients with new audit partners. I also find that the association between audit partner change and non-GAAP earnings quality is more pronounced among client-firms within industries where non-GAAP disclosures are less prevalent. Finally, the results reveal that non-GAAP earnings are more conservative when audit partner change occurs among Big 4 clients and clients with less independent and smaller boards. Overall, the results provide important insights as to the possible consequences of audit partner changes extending to the quality of voluntary disclosures, in addition to the effect on voluntary disclosure of GAAP-compliance information.
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