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Audit Firm Tenure and Earnings Surprise Management
Li - Chin Jennifer Ho,
University of Texas at Arlington
Chao - Shin Liu, University of Notre Dame
Thomas Schaefer, University of Notre Dame
ABSTRACT. This study examines the relationship between the length of audit-firm tenure and how client-firms manage the surprise element in annual reported earnings. Negative earnings surprises are to be avoided because they can adversely affect both the firm’s stock price and assessments of managerial performance. Managers therefore have incentives to either manage reported earnings upward or manage analysts’ projections downward. A firm’s annual audit, however, is designed to constrain managers’ ability to overstate earnings and may cause them to turn their efforts to downward expectations management to avoid negative earnings surprises. Our empirical results show that firms with longer audit tenure are less likely to manage earnings upward but more likely to guide analysts’ forecasts downward, suggesting a substitution of downward forecast guidance for upward earnings management as audit-firm tenure lengthens.
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