Earnings management and audit quality in Europe: Evidence from the private client segment market

This paper contributes to the recent literature on financial reporting quality in private (i.e. non-listed) companies (Ball and Shivakumar, 2005; Burgstahler et al., 2006) by examining whether in these types of companies Big 4 audit firms, as high quality auditors, provide a constraint on earnings management. Considering incentives of auditors to supply a high audit quality in private firms, we expect that Big 4 auditors have an incentive to constrain earnings management only in high tax alignment countries, where financial statements are more scrutinized by tax authorities and the probability that an audit failure is detected is higher. Using data on private firms in European countries, this study provides evidence consistent with this expectation.