Auditor quality and the presence of audit committees : an association with income smoothing

Income smoothing is the intentional reduction of reported earnings fluctuations with respect to some "target" level or trend. This study investigates whether auditor quality or the presence of audit committees is associated with income smoothing by managers of Australian firms. It is motivated by the lack of evidence of an association between income smoothing and corporate governance structures. Discretionary accruals, estimated using a :- cross-sectional accruals model, are used as a proxy for earnings management, and smoothing is measured as the excess of (a) the difference between actual reported operating profit before taxes and targeted operating profit before taxes over (b) the difference between targeted operating profit before taxes and pre-managed earnings. The smaller the excess, the more smoothing takes place. This study is mostly inconclusive about whether auditor quality is associated with income smoothing. In contrast, the presence of an audit committee has no association with smoothing. While they are inconclusive, the results generally do not support predictions that the more firms use audit committees and high quality auditors, in combination, the less likely they are to smooth reported income. Australian firms tend to smooth reported earnings more than their US counterparts. While the difference may be attributable to international differences in requirements for the use of an audit committee, again the results are not conclusive.