Abnormal Audit Fees and Earnings Management Using Classification Shifting

Abstract

Unlike accrual-based earnings management, earnings management through classification shifting does not change the bottom-line numbers and thus involves lower litigation costs. Using data from years 2000- 2010, we find a significant and positive cross-sectional association between the magnitude of abnormal audit fees and the level of classification shifting, suggesting that greater abnormal audit fees allow for more classification shifting. Further, this result indicates that using abnormal audit fees to purely measure audit effort or economic bonding might be questionable as the effect of abnormal audit fees on opportunistic accounting practices could differ, depending on the specific form of earnings management
activities.