There are two opposite effects of audit delay on earnings management. From the auditors’ perspective, spending more hours on auditing and having a longer audit delay would indicate a lower level of earnings management. From the managers’ perspective, spending more time on report preparation and experiencing a longer audit delay would result in more “appropriate” accounting methods that firms could use to manipulate earnings. This paper examines the possible non-linear relationship between audit delay and accruals-based earnings management in the emerging market of China, where publicly listed companies can have twice the time to file their annual reports compared with US accelerated filers.
We use observations from a sample of publicly listed firms in the emerging market of China during the period of 2003–2022. This paper utilizes the Panel Smooth Transition Regression (PSTR) model proposed by Gonzalez et al. (2017) and Fok et al. (2005) to examine the association between audit delay and accrual-based earnings management.
In contrast to prior studies, our results show that there is a nonlinear association between accrual-based earnings management and audit delay in the emerging market of China. The non-linear relationship between audit delay and discretionary accruals is observed in client firms with non-Big 4, non-industry specialist, high internal control (IC) quality and non-state-owned (SOE) client firms. For Big 4, industry specialist, low IC quality and SOE client firms, it is only to be found in the downward earnings management groups.
This paper contributes to the literature in the following ways. First, our results show a nonlinear association between accrual-based earnings management and audit delay, which provides a distinct understanding of the relationship between the two. Second, consistent with corporate disclosure theory, our results indicate that managers tend to delay disclosures when they are motivated to manage earnings upwards but not when they are motivated to manage earnings downwards. Contributing to this literature, our results further suggest that the effect of such a delay on income-creating earnings management exists only in the early stages of the delay and could decline as audit delay lengthens. Our empirical evidence should be of interest to standard setters, regulators, and investors in China, as well as regulatory bodies in other emerging markets.
