Big 4 Auditor Office Size, Analysts' Annual Earnings Forecasts and Client Earnings Management Behavior

Document Type

Article

Publication Date

12-2015

Abstract

Prior research finds support for clients of larger Big 4 audit offices having less aggressively managed earnings as evidenced by a lower likelihood of meeting the earnings benchmarks of small profits and small earnings increases. We extend this research by examining the analysts’ forecasts earnings benchmark. The extant literature provides evidence that failing to meet analysts’ forecasts results in severe negative market reactions and auditors are less likely to book audit differences that affect the client’s ability to meet analysts’ expectations. Specifically, we examine the relationship between Big 4 auditor office size and two measures of earnings management relative to analysts’ earnings forecasts: (1) minimization of analysts’ forecast error and (2) just meeting or beating analysts’ forecasts. Using a sample of 9,789 U.S. companies audited by the Big 4 auditors, we find that the reported earnings of clients audited by larger Big 4 offices are associated with increased absolute levels of analysts’ forecast error and a decreased likelihood of just meeting or beating analysts’ earnings forecasts. These results suggest that auditors in larger Big 4 offices are more likely to constrain management’s ability to manage earnings to meet analysts’ forecasts, providing further evidence that auditors of the same Big 4 accounting firm are not achieving consistent audit quality across the firm’s offices. Our results can be useful for investors, researchers, and regulators interested in auditor influence on analysts’ forecast error as well as Big 4 accounting firms seeking to ensure consistency of audit outcomes across offices.

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