Abstract

In this study, I investigate whether auditors are a good external control mechanism to restrain management from intentionally increasing CEO compensation through earnings management. To examine this, I regress variations of CEO cash and total compensation on changes in auditors after controlling financial, stock market, industry and year variables. There are two sample periods. In the period 1993–2004, I examine the impacts of overall auditor changes and auditor changes that are classified by the audit failure or auditor brand names. In the period 2000–2004, I check the influences of auditor resignations and of auditor dismissals due to accounting disagreements.

The empirical results show that changes in cash compensation is positively related to the existence of auditor changes and this relationship actually comes from auditor changes from big 5 auditors to non-big 5 auditors. Meanwhile, changes in total compensation is negatively associated with the appearance of auditor switches from non-big 5 auditors to big 5 auditors. These findings are consistent with the notion that big 5 auditors are more active at discouraging earnings management. Overall speaking, the empirical evidences support my belief that auditors do not function very well to monitor managers’ opportunistic behaviors.

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