Tajik PDF

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May
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2016
INTERNATIONAL JOURNAL OF HUMANITIES AND

CULTURAL STUDIES ISSN 2356-5926
The Effect of Audit Quality on the Relationship between Free Cash Flow
and Earnings Management in Listed Companies in Tehran Stock
Exchange, Iran
Majid Tajik
M.S., Accounting, Islamic Azad University, Noor Branch, Iran
Email: Tajik_m1980@yahoo.com
Javad Ramezani
Faculty Member, Islamic Azad University, Noor Branch, Iran
Email: Javad.ramezani58@gmail.com
Abstract
This article aims to study the effect of audit quality on the relationship between free cash flow
and earnings management in listed companies in Tehran Stock Exchange (TSE). In other
words, the objective outlined here is based on the following question: Can high audit quality
weaken the relationship between free cash flow and earnings management in listed companies
in TSE or not? To this end, a total of 64 listed companies were studied from 2009 to 2013. In
this study, audit quality variable is studied using two criteria (auditor size and auditor
specialization). Lehn and Poulsen model was also employed to determine the free cash flow in
a commercial unit. The results showed that a significant and direct relationship is found
between free cash flow and earnings management. The audit quality is found to have a
reverse and significant relationship with free cash flow and earnings management. It means
that audit quality leads to reduced relationship between free cash flow and earnings
management.
Keywords: Audit Quality, Free Cash Flow, Earnings Management, Tehran Stock
Exchange, Durbin-Watson Test.
http://www.ijhcs.com/index.php/ijhcs/index
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Introduction
An independent and skillful audit firm is capable of recognizing misrepresentation and
financial statement items. The firm can be correctly effective in its employer so that reliable
financial information is reported. Achieving such desired goal is entirely dependent on the
characteristics of audit firms. These audit firm characteristics can be positively or negatively
related to audit quality (Titman & Truman, 1989). Higher quality auditor improves the
accuracy of presented information and allows investors to have a more accurate estimation of
firm value (Pour Karim, 2009, p 3). Overall audit objective is to protect the interests of
shareholders against the important distortions and errors in financial statements. In order to
maintain professional reputation and avoid litigation against them, auditors seek to enhance
the audit quality (Tevdello & Vanstralen, 2008, p449). Meanwhile, the managers` incentives
to apply their personal interests in earnings quality prevent auditors from reaching to their
goals. One of the main objectives of establishing accounting standards is to enable the users to
make a correct decision using financial statements. Therefore, accounting profession requires
such a reporting that the interests of all consumers to well met. As it is inferred from the
earnings management definition, mangers report earnings in a way that they meet the public
interests of a certain group in order to achieve certain objectives of specific people. Auditors
are required to verify the financial statements within the auditing standards, while managers
are free to select accounting method in some accounting standards. Earnings management, in
fact, sometimes misleads financial statements; however, financial statements are within
accounting standards. As a result, auditors cannot find mistakes in financial statements in this
regard. Since earnings management is one of the most important decision-making factors, the
awareness of users considering earnings reliability can help them make good decisions
(Mashayekhi and Safari, 2006, p 36). Free cash flow is a criterion to measure the firm
performance. It shows the cash of companies spent for maintenance or development of assets.
Free cash flow is important because it allows firms to search opportunities increasing the
shareholder value. The development of new products, cash dividends payment, and debt
reduction are not possible without cash. Mangers` decisions, however, are not sometimes in
favor of shareholders, leading to distorted financial statements. Earnings management occurs
when mangers insert their judgment in financial reporting and financial statements in a way
that some shareholders are misled concerning the economic performance. On the contrary,
auditors can detect the earnings management by enhanced audit quality and put mangers
under pressure concerning earnings management practices. According to above mentioned
issues, this article aims to study the effect of audit quality on the relationship between free
cash flow and earnings management in listed companies in TSE. In other words, the objective
outlined here is based on the following question: Can high audit quality weaken the
relationship between free cash flow and earnings management in listed companies in TSE or
not?
Literature Review
Audit Quality:
There are multiple definitions for audit quality. In the professional literature, audit quality is
defined in accordance with the level of following audit standards. In contrast, accounting
researchers consider multi dimensions for audit quality. Such dimensions usually lead to
different definitions. The most common definitions of audit quality are as follows:
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The possibility of significant errors in the financial statements that the auditor can
detect and report them
The probability that an auditor does not issue conditional report for financial
statements with major and important errors
Measures for auditor`s ability to reduce biased distortions and improve accounting
data quality
The accuracy of information reported by the auditor
In most empirical studies on audit quality, it is defined in relation with audit risk. Audit risk
refers to the risk that an auditor may issue unqualified report due to the auditor's failure to
detect material misstatement either due to error or fraud. For example, De Angelo (1981)
defined audit quality as market risk assessment from a- important misstatement in financial
statements which is not detected by the auditor and b- the report of misstatement. Despite
differences, most other definitions reflect some characteristics of De Angelo definition. As
stated in previous section, audit quality is defined in two sections (the auditor's ability to
monitor and auditor`s reputation). The auditor's ability to monitor is related to the capability
to improve the quality of information and prove the problems of direct measurement.
Auditor`s reputation is based on the knowledge of stakeholders. Theoretically, there are
multiple reasons for the expected direct relationship between auditor`s reputation, whose
indicator is the size of audit firm, and the auditor`s ability to monitor.
Credibility of the information
Credibility of the information is related to the auditor`s ability to influence the position of
users concerning the information in financial statements. As stated in the previous section, De
Angelo defined the audit quality with auditor`s reputation. He claimed that stakeholders can
take advantage of audit firm size as the successor auditor's reputation. He argues that if
appointing a certain employer is similar among audit employers, then larger auditors, who
have more employers, have little incentive to disclose the distortion and misstatement in order
to retain and maintain the employer. Dopach and Simonich state that since brand name
auditors have experienced specialized training and more accurate revisions, it is expected that
their stakeholders see them as a supplier of credit for financial statements. The common
theory among the bankers and underwriters is that brand auditors add to the credibility of
financial statements. This theory also supports the results of studies conducted by Dopach and
Simonich. Some studies concerning the audit quality argue that brand auditors offer more
credible information. For instance, in studies related to the initial public offering (IPO), the
credibility of information is mostly defined as the auditor`s ability to influence the previous
assessment of value uncertainty for new issues. Brand auditors are assumed to offer more
reliable information in new issues. Empirical studies usually support such claim. Initial
studies showed that when employers change their auditors, this direct information influences
the auditor`s reputation through measuring stock price reaction. In these studies, a limited
support was found to prove the fact that brand auditors offer more credible information.
Beatty (1999), for example, found out that IPO returns is lower fir employers who take
advantage of brand auditors (8 Large Accounting Institute) compared to others (except 8
Large Accounting Institute). Wang and Neo (1993) selected a more direct approach and found
out that the reaction of investors to profitability shocks depends on their perception from the
reputation of profitability report. They found out that earnings response coefficient is greater
for those who take advantage of brand auditors. Similarly, Jeng and Lin (1993) found out that
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the volume of transactions was found higher for employers who took advantage of brand
auditors in the first day of IPO. Within the next days, the volume of transactions is lower for
employers audited by brand auditors. Using the study conducted by Jeng and Lin, Krishan
(2003) created a stronger measurement for auditor`s reputation in order to increase the
credibility of information. Krishan studied the role of audit quality in precautionary reserve
pricing. He divided the profit into cash flows resulting from operation, precautionary and nonprecautionary reserves. Then, he deducted the stock returns from these three parts and offered
dummy variable to display the audit quality (6 large Audit Institute versus other audit
institutes). He found out that precautionary reserves of employers who take advantage of
brand auditor have a more accurate relationship with market returns compared to others. This
shows that brand auditors add to the credibility of reported reserves.
Article
DeAngelo(1981)
Dopach
and
Simonich (1982)
Fort
and
Smith(1992)
Davidson and
Neo (1993)
Becker
(1998)
et
al.
Francis
and
(1999)
Mido
Sparks
The scope of
study
Auditor`s
reputation
and
auditor`s ability to
monitor
Auditor`s
reputation
and
monitor
Auditor`s
reputation
and
monitor
Auditor`s
reputation
and
monitor
Auditor`s
reputation
and
monitor
Auditor`s
reputation
and
monitor
Summary and Results

Theoretical argument offers that auditors involved in
large projects endanger their independence due to
reputation loss of other auditors and display
opportunistic behavior.
It shows that the audit quality is function of audit
procedure size and level. They argue that large official
audit firms have larger resources to direct such
procedures. Therefore, they offer higher quality.
Using IPO market data in New Zeland, researchers were
not able to find the relationship between the correctness
of management predictions and auditor's reputation (8
large/ except 8 large)
The results show that they are in relation with larger
audit institutes even after controlling for employer
characteristics such as risk of employers who report the
management forecast errors.
The results show that the precautionary reserves of
employers who use non-brand auditors are higher than
those who take advantage of brand auditors.
The results show that brand name auditors who tend to
deferred items are excluded by employers even if audited
firms by internal brand name auditors have higher levels
of total deferred items. They show precautionary reserves
lower than the actual state.
The relationship between earnings management and audit quality

Heali and Wahlen(1999) defined earnings management as follows: earnings management
occurs when the managers use their own personal judgment for financial reporting. This is
performed to mislead some stakeholders about the actual performance or manipulate the
results of contracts which depend on reported accounting figures. Scott (1997) points out to
earnings management as the authority of manager in the selection of accounting policies in
order to achieve some specific objectives. Kellog (1991) defines two main incentives for
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earnings management: encouraging investors to purchase the shares of the company and
increase the market value. Dye (1988) discussed the interests of shareholders. It seems that
earnings management is usually resulted from the advantages of information asymmetry of
shareholders. This is also the center of definition by Scott. Dye has raised at least two
important topics in this regard. First, the earnings are manipulated in order to increase the
managers` rewards supplied by the investors. Second, actual investors tend market to have a
better understanding from company value. Higher quality audit institute can be effective in
management practices in selecting accounting procedures and incentives for earnings
manipulation. More receivable accounts, payable accounts, and inventory (discretionary
accruals) means increased demand for better monitoring and higher quality auditing. The
quality of audit institute is different. The quality of audit institute cannot be directly
recognized by observation. Therefore, researchers use alternatives to distinct the high quality
and low quality audit institute. According to the above discussion, larger audit and longer
audit tenure are expected to lead to higher quality audit. As the quality of audit is improved,
the level of effectiveness is more on management practices in selecting accounting procedures
and incentives to manipulate earnings in order to achieve higher personal interests. As a
result, the reliability of financial statements would be higher.
Literature Review
Foreign Studies
1. Brenda Tendello Vanstraelen (2008), in their study entitled "Earnings Management and
Audit Quality in Europe: Evidence from Private Sector", studied the relationship between
audit quality and earnings management in European countries. They considered four large
audit institutes as high quality auditors and studied the earnings management. Then they
compared these companies with other companies which were not audited by these four
large audit institutes. The results indicate that a relationship is found between the earnings
management and audit quality. High quality audit in countries with tax alignment leads to
reduced earnings management (Tondlu and Estralin, 2008, p 448).
2. Ferdinand et al. (2009) conducted a study entitled "the Role of Auditor Tenure and
Specialization in Earnings Quality in the Industry of Audit". This study shows that
shorter tenure is associated with lower earnings quality because auditors have less
knowledge and specialization than their employers. The objective outlined here is based
on this question: Is specialization effective in the relationship between auditor tenure and
earnings quality in the industry of auditors? The results show that when specialization is
low in the auditor industry, the relationship is longer with auditor tenure and stronger
with earnings quality and vice versa. It is, therefore, concluded that longer auditor tenure
is dependent on earnings quality when s auditor industry specialization is low. When
auditor industry specialization is high, then the relationship is weakened between auditor
tenure and earnings quality (Chambers & Payne, 2008, p 12).
3. Lixia- Hun (2008), in his study entitled " Market Reaction to Convertible Bonds to Stock:
with Emphasis on Agency Costs of Free Cash flow", studied and evaluated the effects of
underwriting 48 convertible bonds and 430 stock in stock exchange corporations in
China. He observed that the stock price higher in companies with lower distributed cash
and more opportunities of growth than those with more undistributed cash and less
opportunities of growth.
4. Anwar Boumosleh, in Allied Academies International Conference 2009, studied and
raised the agency costs of free cash flow and the manager`s stock option. He studied the
role of manger`s stock option in reduced free cash flow agency problems. He observed
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that rewards in the form of stock option is associated with the accumulation of surplus
free cash flow, making manger`s stock option and stakeholders aligned. This, itself,
shows better management supervision.
Iranian Studies
1. Mola Nazari and Karimi Zand (2007) studied the relationship of firm size and type of
industry with dividend smoothing in listed companies in Tehran Stock Exchange. The
results showed that a strong and reverse correlation is found between firm size (sales)
and dividend smoothing. A significant difference was not found between smoother
companies concerning the type of industry. A significant relationship is found between
dividend artificial smoothening and firm size (Mola Nazari and Karimi Zand, 2007, p
83).
2. Qorbani (2009), in his thesis entitled "the Effect of Audit Institute Size on Audit
Quality", divided audit institutes into two groups (Large Audit Institutes (Audit
Organization)) and non-Large Audit Institutes (Member Institutes of Certified Public
Accountant Society)). He also studied the relationship between the size of audit firms
and audit quality. He concluded that, at 5% error level, large audit institutes are
successful to discover the important distortions and they managed to report important
distortions (Qorbani, 2009, p 3).
3. Bita Mashayekhi and Maryam Safari (2006), in their study entitled "Cash Flow
resulting from Earnings Management in Listed Companies in Tehran Stock
Exchange", studied the relationship between cash flow resulting from operation and
the behavior of discretionary accruals assuming that 12-member set of portfolios based
on cash flow from operations is applied. The results show that when operational
activities are weak (based on cash flow resulting from the operation), companies tend
to use strategies to increase earnings. Concerning companies with acceptable
operational activities (based on cash flow resulting from the operation), reduced
accruals were generally observed. Considering portfolios, it is observed that some a
considerable number of companies with acceptable level of activity also tend earnings
increase policies. Some companies with excellent level of operational activities tend to
earnings reduction policies (Mashayekhi and Safari, 2006, p 35).
4. Tehrani and Hassarzadeh (2009) conducted a study entitled "the Effect of Free Cash
Flow and Financial Constraints on Over-investment and Under-investment". They
used the financial information between 2000 and 2006 in listed companies in Tehran
Stock Exchange. They empirically studied the relationship of free cash flow with overinvestment and under-investment. They also examined the relationship between
constraints in financing and low investment.
Research Method
An applied study was performed. Concerning the nature and content, the study is
correlational. The study was performed in deductive-inductive reasoning framework.
Theoretical principles and literature review were collected from articles and websites within
deductive reasoning. Inductive reasoning was employed to verify or reject the hypotheses.
Data analysis and hypothesis testing were performed through the following methods:
, ,
1. Excel and SPSS were employed to estimate 3 2 1 for determining discretionary
accruals based on modified Jones model.
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2. For hypothesis testing, multivariate linear regression was employed. P-Value (sig.)
was employed for significant correlation among research variables based on
cumulative data as follows:
DAi ,t 1 FCFi ,t 2 Auditori ,t 3 ISPEC i ,t 4 ( ISPEC i ,t Auditori ,t )
5 ( FCFi ,t Auditori ,t ) 6 ( FCFi ,t ISPEC i ,t ) 7 SIZE 8 INTEXPi ,t 9 DUM i ,t

Where
DAi ,t
= i company discretionary accruals in the year t
DAi ,t
= I company free cash flow in the year t
Auditori ,t
= Either zero or one. If the auditor of i company is audit organization, then it is

considered one. If the auditor is one of audit institutes, then it is considered zero.
ISPEC = is the auditor specialization in the audited industry which was explained in the
previous section.
SIZEi ,t
= Logarithm of total asset book value of i company in the year t.

INTEXP= Logarithm of total interest cost of short-term and long-term debts of i company in
the year t.
DUMit = Either zero or one. It is considered one for data if they are prior to 2004. It is
considered zero for the data in 2004 and afterward.
The statistical population consisted of all listed companies in TSE. The companies which
were not active in TSE or had no essential information were excluded. The following criteria
were taken into account to select the sample size. Systematic sampling method was employed.
1. Companies with accessible audit reports. Their audit reports can be studied.
2. Manufacturing companies due to the data homogeneity.
3. The fiscal year is end of March 18th.
4. The companies are listed in TSE until March 2009.
5. Stock trading was continuously performed in TSE and the discontinuity of stock
trading is not more than a month.
Considering above criteria, 64 companies were selected as sample size. Since each company
has 5 sets of extractable financial information in financial statements, total number of
observations was annually reported 320. The data taken from financial statements, initial
information from TSE board (Tadbir Pardaz, Rah Avard Novin, Bureau of Statistics database)
were employed. Based on literature review and theoretical framework of the study, most
conducted studies in this field were annually interpreted. The researcher, therefore, studied,
analyzed, and concluded on the annual basis. The summary of findings is as follows:
Findings
Hypothesis Testing
First Main Hypothesis:
A significant relationship is found between accruals and free cash flow.
H0: Discretionary Accruals (DA) (earnings management) is not found to have a significant
relationship with Free Cash Flow (FCF).
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H1: Discretionary Accruals (DA) (earnings management) is found to have a significant

relationship with Free Cash Flow (FCF). (Researcher's hypothesis)
DA in companies where FCF is one (companies with high cash flow and low growth
opportunity) is significantly lower than those where FCF is zero (low cash flow and high
growth) because FCF is positive and significant. According to the correlation test, null
hypothesis is not verified, indicating that a significant relationship is found between accruals
and free cash flow.
First Secondary Hypothesis: A significant relationship is found between accruals and
auditor specialization in companies with free cash flow and growth opportunity.
H0: No significant relationship is found between Discretionary Accruals (DA) (earnings
management) and ISPEC.
H1: A significant relationship is found between Discretionary Accruals (DA) (earnings
management) and ISPEC.
Null hypothesis is not verified, indicating that a significant relationship is found between
Discretionary Accruals (DA) (earnings management) and ISPEC. According to the regression
analysis test, DA is found to have a significant and negative relationship with ISPEC in
companies with free cash flow and minor growth opportunity. The reverse relationship is
reported -0.077. It means that one unit increase in FCF*ISPEC leads to 0.077 reductions in
DA.
Second Secondary Hypothesis:
A significant relationship is found between accruals and auditor size in companies with FCF
and growth opportunity.
H0: DA is not found to have a significant relationship with Auditor Size in companies with
FCF and growth opportunity.
H1: DA is found to have a significant relationship with Auditor Size in companies with FCF
and growth opportunity (Researcher's hypothesis)
Considering the correlation test, null hypothesis is not verified, indicating that DA is found to
have a significant relationship with Auditor Size in companies with FCF and growth
opportunity. This reverse relationship is reported -0.54. It means that one unit increase in
FCF* Auditor size leads to 0.54 reductions in DA.
Second Main Hypothesis:
A significant relationship is found between DA and audit quality in companies with FCF and
growth opportunity.
H0: DA (earnings management) is not found to have a significant relationship with audit
quality in companies with FCF and growth opportunity.
H1: DA (earnings management) is found to have a significant relationship with audit quality
in companies with FCF and growth opportunity (Researcher's hypothesis).
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According to the regression analysis test, DA is found to have a significant and negative
relationship with Auditor Size in companies with free cash flow and minor growth
opportunity. The reverse relationship is reported -0.54. It means that one unit increase in
FCF*Auditor leads to 0.54 reductions in DA. Therefore, null hypothesis is rejected and the
coefficients show a reverse relationship between the effects of audit quality in FCF-Earnings
Management relationship.
Model Credibility
The level of estimated model credibility is the level of model presuppositions. The most
important presumptions are:
1. The normality of residuals
2. The homogeneity of variance
3. Lack of residual autocorrelation
4. Linear relationship and lack of outlier and effective points
5. Co-linearity between independent variables
The following steps were taken into account to test the above presumptions, respectively:
1. Kolmogorov-Smirnov test was employed to check the normality of dependent
variable.
2. Residual-value diagram was drawn (lack of pattern in this diagram shows the
homogeneity of variance)
3. Durbin-Watson test (values close to 2 show lack of autocorrelation)
4. Scatter Plot was employed to study the outliers.
5. VIF was employed to study the co-linearity. This statistic is called Variance Inflation
Factor. It is lower than 10, the co-linearity is believed to be low.
Discussion and Conclusion
In order to find the effect of control variables on the relationship between dependent and
independent variables, conventional methods were employed to study the level of the effect in
two modes (with control variables and without control variables). A multivariate linear
regression is created among research variables. Based upon the above mentioned issues, the
following conclusions are drawn:
The test result of first main hypothesis
A significant relationship is found between accruals (earnings management) and free cash
2
flow. The correlation ratio or eta squared ( ) is reported 0.298 which is positive and
significant, showing a correlation between two variables. In regression test, it is claimed that
if other variable are controlled, one unit increase in FCF leads to 0.144 increases in DA.
Therefore, null hypothesis is not verified. It means that DA (earnings management) is found
to have a positive and significant relationship with FCF. The results of this study is
inconsistent with those of Mashayekh and Safari (2005) and Kaveh Mehrabi and Karami
(2006). The results are, however, consistent with those of Chang eta l. (1997), Jones and
Sharma in Australia, and a similar study conducted by Jagy and Gol. The managers of
companies with high FCF and low growth use DA which increases the earnings in order to
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eliminate low profits and losses resulting from the investment in negative net present value
projects and improve their weak performance.
The test result of first secondary hypothesis
A significant relationship is found between accruals and auditor specialization in companies
with free cash flow and growth opportunity.
In regression test, it is claimed that if other variable are controlled, one unit increase in auditor
specialization leads to 0.144 reductions in DA. Therefore, null hypothesis is verified. It means
that DA (earnings management) is found to have a negative and significant relationship with
auditor specialization. Therefore, a significant and negative relationship is found between
earnings management and auditor specialization. The results of this study are inconsistent
with those of Don et al. (2000) and May. The results are, however, consistent with those of
Nazemi Ardakani (2009), Krishan (2003), Reynolds and Francis (2000), Balsam Krishan and
Young (2006), and Jenkins Kane and Vellore (2006). According to the results, it is concluded
that the companies with high FCF and low growth audited with specialized auditors have
lower DA and earnings management.
The test result of second secondary hypothesis
A significant relationship is found between accruals and auditor size in companies with FCF
and growth opportunity.
Here, we want to determine the relationship between the quantitative variable of earnings
management and nominal variable of auditor size which has changed into a quantitative
variable using factor analysis. Based upon the correlation test, null hypothesis is not verified,
indicating that a significant relationship is found between accruals and auditor size. According
to regression analysis, DA is found to have a negative and significant relationship with auditor
size in companies with FCF and low growth opportunity. This reverse relationship is reported
-0.54. If other variables are controlled, one unit increase in FCF*Auditor leads to 0.54
reductions in DA. The results of this study are consistent with those of Peyote, Jenin, and
Francis et al. (1999), DaAngelo (1993), Ken Chen et al. (2005), Ming (2007), Chambers and
Payne (2008), Tendello Vanstraelen (2008), Mojtahed Zadeh and Aghaee (2004), and
Qorbani (2009).
Second Main Hypothesis:
A significant relationship is found between DA and audit quality in companies with FCF and
growth opportunity.
According to the results and first and second secondary hypotheses based on regression
analysis, DA (earnings management) is found to have a negative and significant relationship
with ISPEC in companies with FCF and low growth opportunity. This reverse relationship is
reported -0.077. If other variables are controlled, one unit increase in FCF*ISPEC leads to
0.077 reductions in DA. A negative and significant relationship is also found between DA and
auditor size. This reverse relationship is reported -0.54, indicating that, if other variables are
controlled, one unit increase in FCF*Auditor leads to 0.54 reduction in DA. Higher audit
quality means that management is less capable of manipulating the profit. In other words, a
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quality audit can decline earnings management. Therefore, null hypothesis is not verified,
showing a reverse relationship between DA (earnings management) and audit quality.
Recommendations based on the research results
Recommendations based on the first main hypothesis
Based upon the relationship between FCF and earnings management, investors and other
stakeholders are recommended to pay attention to effective factors in company growth and
FCF and change in DA while making decision.
Recommendations based on the results of the first secondary hypothesis
Since specialized auditors are more reliable, specialized auditors are recommended to be
hired.
Recommendations based on the results of second secondary hypothesis
Since larger audit institutes such as audit organizations are more reliable than other institutes,
it leads more reliable financial statements. Based upon the results of the first secondary
hypothesis testing, it is claimed that more accurate earnings forecasting is expected in these
companies due to the efforts made by mangers in order to reduce the gap between the reported
and forecasted earnings in financial statements by higher quality auditors such as audit
organization. Therefore, the General Assemblies of companies are advised to hire larger audit
institutes. Stock Exchange is also recommended to pay more attention to larger audit institutes
in selecting trusted institutes.
Recommendations based on the results of the second main hypothesis
Since earnings management can be an interesting topic in Iran Stock Exchange Organization,
the users of accounting information are advised to pay attention to free cash flow, company
growth, quality auditors, criteria (auditor specialization and auditor size). If earnings are well
managed and they are well audited, it can be acceptable issues within and outside the
company because achieving stable and predictable results as well as positive earnings trend
using accepted incentives are both legal and ethical. It shows the skills and progress followed
and rewarded by the market. If well stated, it would not be misleading.
Considering the importance of earnings management, more studies which take other aspects
into account seem essential. This study can be employed as a model for the upcoming studies.
Studying each single effective factor in earnings management can help better understanding
of earnings management. The following recommendations are proposed:
1. Since modified Jones model is employed to calculate the discretionary and nondiscretionary accruals and accruals, other models are proposed to estimate them in
future studies.
2. Since auditor independence might be effective in earnings management, it is proposed
to be taken into account in future studies.
3. The relationship between auditor size and auditor independence is proposed to be
studied in future studies.
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4. The relationship between auditor tenure and auditor independence is proposed to be

studied in future studies .
Since auditor size and auditor tenure are employed to determine the relationship between
earnings management and audit quality in listed companies in TSE, it is proposed that other
indicators of audit quality need to be used in future studies.
Limitations:
1. Control and intervening variables, identified by conducted studies, are employed in
regression model fitting. Other intervening factors such as stakeholders` behavioral
factors, inflation, and other micro and macro-economic factors in companies and
societies which have not been taken into account can be considered the limitation of
the study.
2. Using factor analysis for converting nominal to qualitative variables can also be
considered a limitation.
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INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

Summary and Results

The relationship between earnings management and audit quality

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

DAi ,t 1 FCFi ,t 2 Auditori ,t 3 ISPEC i ,t 4 ( ISPEC i ,t Auditori ,t )

5 ( FCFi ,t Auditori ,t ) 6 ( FCFi ,t ISPEC i ,t ) 7 SIZE 8 INTEXPi ,t 9 DUM i ,t

= i company discretionary accruals in the year t

= I company free cash flow in the year t

= Either zero or one. If the auditor of i company is audit organization, then it is

= Logarithm of total asset book value of i company in the year t.

INTERNATIONAL JOURNAL OF HUMANITIES AND

H1: Discretionary Accruals (DA) (earnings management) is found to have a significant

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

INTERNATIONAL JOURNAL OF HUMANITIES AND

4. The relationship between auditor tenure and auditor independence is proposed to be

INTERNATIONAL JOURNAL OF HUMANITIES AND

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