The impact of audit committee existence and external audit on earnings management

Purpose – This study aims to examine the combined effect of audit committee existence and external audit on earnings management. Design/methodology/approach – The paper uses ordinary least squares regression model to examine the effect of audit committee existence, external audit and the interaction between these two monitoring mechanisms on earnings management for a sample of 33 non-financial listed Portuguese firms-year from 2003 to 2009. Findings – In contrast to results of most previous studies, which assume that audit committees and external auditor act independently from one another, the paper finds a positive relationship between both audit committee existence and external audit and discretionary accruals. However, this study suggests that the existence of an audit committee and external auditor jointly reduces earnings management. Practical implications – The findings based on this study provide useful information for regulators in countries with an institutional environment similar to that of Portugal. In addition, the results also provide useful information to investors in evaluating the impact of audit committee existence and external audit on earnings quality, especially under concentrated ownership. Originality/value – The major contribution of the current study is that in contrast to previous studies, which have implicitly assumed that audit committees and external auditors act independently from one another, this study also examines the combined effects of audit committee existence and external auditors on earnings management. In addition, this paper is the first empirical study to investigate the effect of audit committee existence and external audit on earnings management in Portugal.