Auditors’ quality, footnotes, and earnings persistence
ISSN: 0307-4358
Article publication date: 29 May 2019
Issue publication date: 18 March 2020
Abstract
Purpose
The purpose of this paper is to investigate the role of auditors in financial statement readability. Using a simple proxy for financial statement obfuscation (number of footnotes), the authors examine the relationship between auditor quality, financial statement readability and earnings persistence.
Design/methodology/approach
The authors use regression analysis to test two hypotheses. In the first hypothesis, the authors investigate whether firms audited by Big 4 auditors have a lower number of footnotes than firms audited by non-Big 4 auditors. In the second hypothesis, the authors show that the firms with more footnotes have less earning persistence in comparison to the firms with less footnotes.
Findings
The authors find that firms audited by Big 4 auditors have fewer footnotes than firms audited by non-Big 4 auditors, and a larger number of footnotes reduces earnings persistence one-year and two-years ahead of the financial statement, although a larger number of footnotes does not reduce earning persistence when firms use Big 4 auditors. Overall, firms that use non-Big 4 auditors tend to obfuscate annual reports by using more footnotes and, in turn, reduce earnings persistence.
Originality/value
This is the first paper that has used number of footnotes in 10Ks as a proxy for financial statement readability. This paper shows how auditors’ reputation plays a key role in the readability of the financial statement. Prior studies related to readability have ignored the importance of auditors’ quality with respect to the readability of financial statements.
Keywords
Acknowledgements
The authors thank the Editor, Erik Devos, and anonymous reviewers for comments.
Citation
Karim, M.A. and Sarkar, S. (2020), "Auditors’ quality, footnotes, and earnings persistence", Managerial Finance, Vol. 46 No. 2, pp. 267-282. https://doi.org/10.1108/MF-11-2018-0569
Publisher
:Emerald Publishing Limited
Copyright © 2019, Emerald Publishing Limited