Advances in Environmental Biology

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1 AENSI Journals Advances in Environmental Biology ISSN EISSN Journal home page: Studying the Relationship between Aud Qualy and Audor Expertise on Earnings Management 1 Mohammad Hossein Mansouri and 2 Yadollah Noorifard 1 Ms.c student, Department of Accounting, Qom Science and Research Branch, Islamic Azad Universy, Qom, Iran & Department of Accounting, Qom Branch, Islamic Azad Universy, Qom, Iran. 2 Department of Accounting, Qom Branch, Islamic Azad Universy, Qom, Iran. A R T I L E I N F O Article history: Received 10 September 2014 Received in revised form 23 October 2014 Accepted 27 November 2014 Keywords: bubble, stock exchange, free float stock, stock exchange, transaction size A B S T R A T Background: This paper aims to study the relationship between aud qualy and audor expertise on earnings management in firms listed in Tehran Stock Exchange. In this regard, a sample including 77 firms listed in Tehran Stock Exchange for the period of 6 years has been examined. In this survey, earnings management variable has been evaluated according to Jones modified model (1995); two creria of audor size and audor tenure have been used to examine aud qualy variable and audor expertise variable has been examined according to market value index. To test the hypothesis of the research, regression model, t-test, F-test and at 95 percent level of significance have been used. The findings indicate that in general, aud qualy has an impact on earnings managementand an increase in aud qualy would prevent clients from implementing earnings management. Furthermore, the creria of audor size and tenure are considered to be important factors that affect earnings management and cause s decrease. The findings also show that there is no significant relationship between audor expertise and earnings management AENSI Publisher All rights reserved. To e This Article: Mohammad Hossein Mansouri and Yadollah Noorifard., An investigation into the causes affecting price bubble in Tehran stock exchange. Adv. Environ. Biol., 8(19), , 2014 INTRODUTION Among important factors that cause fundamental changes in Iran s economic environment, communalizing the ownership of economic agencies financing via public participation and privatization of public sector and economic corporations can be mentioned. In such circumstances, claryand favorable qualy of financial information, whichare the basis of optimized economic decisions of investors, cred providers and generally those who use financial information, are of particular significance. According to agency theory, managers are shareholders representatives and should act in their interests [7]. Therefore, managers have an exclusive access to some parts of information and they provide and present information such as financial one. However, sometimes they make decisions that harm shareholders interests and cause confounding of financial reports. In fact, earnings management occurs when managers use their own judgments in financial reports in a way that manipulating the content of financial reports misleads some shareholders about the company s economic performance. On the other hand, the prevailing auding context in an economic agency basically plays an essential role in providing favorable qualy of financial information. The general aim of audors is to protect shareholders interests against the significant existing manipulations and mistakes of financial reports[9]. Achieving this favorable goal is completely dependent on aud firms characteristics. Generally in order to maintain their professional credibily and good reputation and avoid legal claims against them, audors seek for increasing aud qualy[9].meanwhile, managers prevent audors from achieving this goal by pursuing their personal interests in reporting earnings. Hence, referring to the point that aud qualy and audor expertise increases information reliabily,the present studyisintended to find an acceptable answer to question that whether high aud qualy and audor expertise can lim the applying of earnings management in firms listed in Tehran Stock Exchange. The remainder of this paper is organized as follows. Lerature reviews and research background are discussed in Section 2. The hypothesis development and research methodology are discussed in Section 3. The orresponding Author: Yadollah Noorifard, Department of Accounting, Qom Branch, Islamic Azad Universy, Qom, Iran. Dr_Y_Noorifard@ yahoo.com Ph:

2 430 Mohammad Hossein Mansouri and Yadollah Noorifard, 2014 Sample selection and Measurement of Variables are discussed in Section 4, and the s of testing the hypotheses and discussion are discussed in Section 5. Section 6 contains the summary and conclusion that includes recommendations based on research findings. 2. Lerature reviews and research background: 2.1. Earnings management: Earnings management involves Targeted intervention in financial reporting process wh regard to the restrictions of accepted accounting principles for getting expected earnings amount [5]. Bidleman defined smoothing income as a manager's attempt to decrease unusual changes in income to the allowed extend based on legal principles of accounting and management. lug also defines two main incentives for earnings management: encouraging investors to buy the company s share and increasing the company s market value [10] Aud qualy: DeAngelo defines aud qualy as market assessment probabily for (a) significant existing manipulations in financial reports which are not detected by the audor and (b) reporting mentioned manipulations. The discovery of a misstatement measures the aud qualy in terms of audor s knowledge and abily while reporting of the misstatement is dependent upon the audor s incentives to disclose [3]. The most important quantative index for measuring aud qualy is audor size and there is a direct relationship between these two. In this study, by audor size we mean the audor s good reputation (commercial name) [3, 4].The other quantative index for aud qualy is the audors professional protection duration and their monoring abily i.e. the audor tenure. The more audor tenure is, the more his familiary wh the employer will be, his expertise in that particular industry will increase and the aud qualy will improve [1, 8, 10] Audor expertise: In the current research, market share has been used as an index for the audor expertise assessment. Since the more audors market share is, the more their industry expertise and experience will be when compared to their rivals. Enjoying high market share also implies that the aud firm has successfully made self distinguished among s rivals in terms of aud qualy [6, 1] Background of the research: A research has been carried out in America by hambers &Payne about aud qualy and accrual ems credibily.in the research, independence, expertise in the industry, risk of credibily and legal claims for aud firms have been mentioned as the aud qualy measurement indices. The conclusion of the research suggests that aud qualy increase has a significant and posive relationship wh credibily of accrual ems of the studied companies financial reports [2]. By studying 4 big aud firms as high qualy audors and examining earnings management in companies auded by these 4 aud firms and comparing wh the other companies auded by other aud firms, Tendeloo and Vanstraelen found out that high qualy auding in countries which pay tax causes a reduction in earnings management[9]. Zgarni examines the relationship between aud qualy and earnings management in Tunisia Stock Exchange over the period of in his research. In the research, discretionary accrual ems have been used as a crerion for earnings management and audor size, tenure and expertise as creria for aud qualy. The findings indicate that there is a significant negative relationship between earnings management and audor size and expertise, while there is no significant relationship between earnings management and audor tenure[10]. Karami & Bazrafshan have used audor tenure as an index for aud qualy and have examined s relationship wh earnings management. The findings show that aud tenure increase has a significant negative relationship wh management flexibily in utilizing discretionary accrual ems. This point indicates that management uses flexibily in a negative way [5]. Pourkarim divides aud firms into two groups' i.e. big aud firms (aud organization) and aud firms that are not big (firms which are members of Iranian Association of ertified Public Accountants) and studies the relationship between aud firms size and aud qualy. The findings indicate that big aud firms at alpha level of 5 % have been successful in detecting and reporting significant misstatements [8]. Alavi et al. found out that aud qualy based on the audor size and expertise has a relationship wh more exact earnings predictions [1].

3 431 Mohammad Hossein Mansouri and Yadollah Noorifard, Hypothesis Development and Research methodology: 3.1. Hypothesis Development: The present paper includes a major hypothesis and 3 minor hypotheses such as the following: Major hypothesis: There is a significant relationship between the impact of aud qualy and audor expertise on earnings management in firms listed in Tehran Stock Exchange. Minor hypotheses are as follows: 1. There is a significant relationship between audor size and earnings management in firms listed in Tehran Stock Exchange. 2. There is a significant relationship between audor tenure and earnings management in firms listed in Tehran Stock Exchange. 3. There is a significant relationship between audor expertise and earnings management in firms listedin Tehran Stock Exchange Research methodology: The current research is type of quasi experimental research in the field of proof accounting researches which is practical in terms of purpose. Since in this survey we seek to determine the relationship between aud qualies, audor expertise and earnings management variables, the research method is of correlative type. 4. Sample selection and Measurement of Variables: 4.1. Statistical population and firms' selection: The studied statistical population consisted in the listed firms in Tehran Stock Exchange. The research sampling was done according to systematic deletion method. The firms which had the following condions have been used as samples: 1. In order to increase comparabily, the fiscal year is finished at the end of Esfand month,the Iranian calendar year. 2. The firms must have no stop in their activy and no change in their fiscal period during 2008 to In order to standardize all the data financing and financial firms and banks have been deleted from statistical population. After implementing mentioned above restrictions, 77 firms over the period of were finally selected as the statistical sample of this paper. Therefore, the number of the whole observations amounts to years-firms Data gathering method: Library method has been used to gather data and information. In library method, theoretical principles of the research have been collected from Persian and English specialized books and journals. The research data of financial reports and explanatory notes related to the companies have been gathered and studied by utilizing software, Tehran Stock Exchange webse and publishers comprehensive database Data analysis method: Multivariable regression method has been used for data analysis. Since the research variables were of distance type, the research method is considered to be a correlative method Research variables: Dependent variable: earnings management: According to conducted researches, Jones modified model is the most powerful model for describing and predicting earnings management. Accordingly, in the present research the mentioned model has been used for discretionary accrual ems [2, 5, 9, 10]. According to Jones modified model, the total accrual ems are calculated such as the following: TA t, i At, i Lt, i ASH t, i STDt, i DEPt, i (1) TA:total accrual ems of firm i in year t A t, i L t,i : changes in current as sets of firm i between the years t to t-1 : changes in the current debts of firm i between the years t to t-1 ASH t, i :changes in the firm i cash between the years t to t-1 STD t,i : changes in current portion of long term debts of firm i between the years t to t-1 DEP t, i : depreciation cost of the firm i in year t After the total accrual emsare calculated, in order to determine non-discretionary accrual ems, of 3, 2, 1 are estimated according to the following formula.

4 432 Mohammad Hossein Mansouri and Yadollah Noorifard, 2014 TA i, t / Ai, t 1 1(1/ Ai, t 1) 2( REVi, t / Ai, t 1) 3( PPE / Ai, t 1) (2) REV : changes in sales revenue of firm i between the years t to t-1 PPE : gross property, plant and equipment of firm i in year t A : total book value of firm i assets in year t-1 i, t 1 : unclear effects of accidental factors 3, 2, 1 : estimated of firm i After of 3, 2, 1 are calculated, non-discretionary accrual ems are determined according to the following formula: NDA 1(1/ A 1) 2[ REV RE ) / A 1] 3(PPE / A 1) (3) NDA : Non-discretionary accrual ems of firm i in year t RE : hanges in the accounts receivable of firm i between the years t to t-1 And finally discretionary accrual ems (DA) is calculated after the of determination of NDA such as the following: DA (TA / A 1) NDA (4) Independent variable: aud qualy: Audor size: Aud firms have been divided into two groups of Auding Organization of Iran (as a major aud firm wh and wh highaud qualy) and aud firmswhich are members of Iranian Association of ertified Public Accountants (small aud firms).earnings management implemented in companies auded by these two groups has been examined Audor tenure: In the present survey, audor tenure is once less than 4 years and once 4 years and more. The number 1 isused for companies which are auded for 4 years and more by the audor otherwise the number 0 is used Audor expertise: In this study, market share has been used as an index for the audor expertise in the industry. Market share is calculated such as the following: square root of sum of assets book value ofaud firm s customers in the industry divided by square root of sum of assets book value of all the customers of that aud firm.(mayhew& Wilkins, 2002) 4.5. Regression model: DA 0 1Audsize. 2DUMi 3ISPE DA: discretionary accrual ems (using Jones modified model) Audsize: audor size / DUMi: audor tenure / ISPE: audor expertise RESULTS AND DISUSSION 5.1. Descriptive statistics for all variables: Descriptive statistics related to the research variables are shown separately in table 1.Since the mean and median values of the variables are approximately equal, distribution of variables is symmetric. Table 1: Descriptive statistics related to research variables. Standard deviation median mean observations Variables discretionary accrual ems audor size audor tenure audor expertise 5.2. Hypotheses testing: First hypothesis testing : First hypothesis: There is a significant relationship between audor size and earnings management in firms listed in Tehran Stock Exchange.

5 433 Mohammad Hossein Mansouri and Yadollah Noorifard, 2014 Table 2: (first hypothesis). significant and negative significant and posive Probabily value t value Probabily value of F Durbin-Watson coefficients amount Audsize In the above hypothesis testing, significance probabily value of F is equal to which is less than 0.05.Therefor, null hypothesis is rejected at confidencelevel of 95% i.e. atconfidence level of 95% there is a significant model. oefficient of determination rate is equal to 0.27 i.e. about 27% of dependent variable changes areexpressed by the independent variable.the value of t statistic for audor size is equal to 6.34(significant and posive) which indicates thatthere is a posive and significant relationship between audor size and earnings management. The above posive relationship suggests that aud organization as a reputable and credible aud firmhas a posive impact on the firms earnings management.it can be concluded that big aud firms (aud organization) are along the same line wh earnings management. Furthermore, the firms which are auded by high qualy aud firms (bigger ones) implement earnings management in order to get expected earnings predictions Second hypothesis testing : Second hypothesis: There is a significant relationship between aud tenure and earnings management in firms listed in Tehran Stock Exchange. Table 3: (second hypothesis). significant and posive significant and negative Probabily value t value probabily value of F Durbin-Watson coefficient amount DUMi In the above hypothesis testing, significance probabily value of F equals to which is less than i.e. there is a significant model atconfidence level of 95%.oefficient of determination equals to 0.17 i.e. about 17% of dependent variable changes is expressed by the independent variable.onsidering that the t statistic value for the audor tenure equals to (significant and negative), the opposehypothesis can be accepted. Therefore, there is a negative and significant relationship between earnings management and audor tenure. According to the s of this hypothesis testing can be concluded that as the audor tenure increases, earnings management decreases.this suggests that aud firms in Iran have been successful in detecting and controlling earnings management through the increase of cooperation period wh the employer, being familiar wh the employer s work and acquiringexpertise in the employer s professional industry Third hypothesis testing : Third hypothesis: There is no significant relationship between audor expertise and earnings management in firms listed in Tehran Stock Exchange. Table 4: (third hypothesis) probabily value t value probabily value of F Durbin-Watson coefficients amount ISPE In the above hypothesis testing, significance probabily value of F equals to which is more than 0.05 i.e. there is no significant model at confidence level of 95%.oefficient of determination equals to 0.03 i.e. about 3% of dependent variable changes is expressed by the independent variables. The t statistic value for y- intercept equals to 1.43 which at confidence level of95% is located innon-rejecting null hypothesis area i.e. y- intercept is not significant.onsidering thatthe t statistic value for ISPE equals to -0.91(), so the mentioned hypothesis cannot be accepted.the findings of the research suggest that audor expertise has had no significant impact on earnings management in firms listed in Tehran Stock Exchange The major hypothesis testing : Major hypothesis: There is a significant relationship between the impact of aud qualy and audor expertise on earnings management in firms listed in Tehran Stock Exchange.

6 434 Mohammad Hossein Mansouri and Yadollah Noorifard, 2014 Table 5: (major hypothesis). significant and posive significant and negative probabily value t value probabily value of F Durbin-watson coefficients amount Audsize DUMi ISPE In the above hypothesis testing, significance probabily value of F equals to which is less than 0.05 i.e. there isa significant modelat confidence level of 95%. oefficient of determination equals to 0.38 i.e. about 38% of dependent variable changes is expressed by the independent variable. The t statistic value for the audor size, audor expertise and audor tenure equal to 5.68(significant and posive), () and (significant and negative) respectively.onsidering that audor size and audor tenure variables exist in the significant area, the major research hypothesis, i.e. existing a relationship between dependent variable of earnings management and the independent variables of aud qualy and audor expertise, is accepted and confirmed. 6. onclusion: The findings indicate that there is a significant relationship between the impact of aud qualy and audor expertise on earnings management in firms listed in Tehran Stock Exchange.Earnings management is one of popular topics among the investors, law makers,analysts and the general users of financial reports.according to Fisher, earnings management is the purposeful intervention of managers in the process of financial reporting out of the organization. One wayto reduce earnings management is to improve aud qualy as firms which manipulate and manage earnings are more subject to have modified aud report (not accepted).wh regard to the mentioned findings, studies and topics, can be concluded that aud qualy causes a reduction in the discretionary accrual ems rateas well as earnings management. The research findings indicate that there can be three reasons for those clients who have been auded by the audors (including aud organization and other aud firms) for more than one year and are not willing to change their audors: A) Suchfirms (including aud organization and other aud firms) require longer aud tenures for performing a more careful and higher qualy supervision in order to reduce managers use of accrual ems and restrict earnings management (posive reason). B) Theclients have to use aud firms services according to the rules and regulations and other requirements (posive reason). ) The clients are such firms accessories (negative reason) Recommendations based on research findings: 1) Wh regard to the first hypothesis testing s, Stock Exchange is recommended to adopt rules and regulations which give access to firms listed in Stock Exchange to utilize different audors for auding their financial reportsduring thesuccessiveyears. Obligatory formation of big firmsor a network of firms by the Stock Exchange can cause a reduction in negative effects of obligatorycycle andimprove aud qualy. 2) Wh regard to the second hypothesis testing s, can be concluded that in firms which have been auded by an audor for several years, earnings management rate is lower if audor tenure is determined by the aud organization.therefore, users of financial reports should pay attention to the audor tenure in their analysis. Furthermore, when determining these firms share values,stock Exchange should consider this point. 3)Wh regard to the matter that there can be two types of earnings management in Iran stock Exchange i.e. good and bad earnings management, users of accounting information are recommended to pay attention to the firm s growth and high qualy audors according to s two measurement creria (audor tenure and size).the reason is that if the existing earnings management is goodand aud qualy is high, this is considered to be an acceptable and required matterin the firm and out of as obtaining tableand predictable s and posive earnings procedure through good planning and operational motives is neher illegal nor unprincipled.rather is indicative of the expertise and progress that the market seeks and praises and if expressed appropriately, the created procedure would not be misleading. REFERENES [1] Alavi, S.H., Auding qualy and earnings prediction. Accounting Research Quarterly, 3: [2] hambers, D. and J. Payne, Aud qualy and accrual persistence: evidence from the pre and post Sarbanes Oxley periods. Managerial Auding Journal, 26: [3] De Angelo, L.E., Audor size and aud qualy. Journal of Accounting & Economics, 3(3):

7 435 Mohammad Hossein Mansouri and Yadollah Noorifard, 2014 [4] Hassas Yeghaneh, Y. and A. Jafari, Factors affected on the Independence and ompetence members of the Iran's official accountants in the presenting of certification service. Quarterly Accounting Studies, 10: [5] Karami, G.R. and A. Bazr Afshan, Investigation on the relation between Audor Authory and earnings management. Accounting Knowledge Magazine, 4: [6] Mayhew, B.W. and M.S. Wilkins, Aud Firm Industry Specialization as a Differentiation Strategy: Evidence from Fees harged for Firms Going Public. A Journal of Practice & Theory, 22(2): [7] Myers, J.N., L.A. Myers and T.. Omer, Exploring the Term of the Audor-client Relationship and the Qualy of Earnings: A case for Mandatory Audor Rotation?.The Accounting Review, 78: [8] Pourkarim, Y., Investigation on the auding qualy influence on the accrual ems reliabily. Master of Science Thesis, Islamic Azad Universy, Tabriz. [9] Tendeloo, B.V. and A. Vanstraelen, Earnings Management and Aud Qualy in Europe: from the Private lient segment. European Accounting Review, 17(3): [10] Zgarni, I., Aud Qualy and Earnings Management in the Tunisian ontext. International Journal of Accounting and Financial Reporting, 2(2):