Voluntary audit and earnings management: the case of small Portuguese companies

Abstract

In some small Portuguese companies the audit is required while in others companies the audit is voluntary, and our goal is to verify if the voluntary adoption of audit improves the earnings quality. Starting from a sample of small Portuguese companies for a period from 2007 up to 2014 we analyze if the voluntary adoption of audit reduces the earnings management and therefore increases the earnings quality. The small companies can manipulate the earnings for example for reducing the income taxes to pay or to finance as also reducing the interest rate of those finance. The small companies are an important part of businesses, either in terms of employees and number. The voluntary audit is not very studied subject. The results suggest that the voluntary adoption of audit do not reduce the earnings management, and thus do not increase the earnings quality. These results may be due to the fact these companies are not visible and therefore the audit firms could not allocate as much resources to the audit.