The impact of audit quality on real and accrual earnings management around IPOs

We examine the relation between audit quality and the earnings management activities of IPO firms. The impact of high quality auditors on real earnings management has been researched in a number of settings e.g. SEOs. However, to date, there has been no work on the effect of high quality auditors on real activities-based manipulation around IPOs. We examine UK IPOs between 1998 and 2008 and find evidence that high quality auditors constrain the use of real activities manipulation that occurs via the management of discretionary expenses. We also find evidence, consistent with prior research, that high quality auditors constrain the manipulation of discretionary accruals. Crucially, we find IPO firms audited by high quality auditors undertake sales-based manipulation in order to manage earnings upward at the end of the IPO year. The presence of high quality auditors is not, therefore, sufficient to constrain all forms of earnings management.