Understanding earnings quality - MIT Sloan School of Management

income increasing restatement firms have director turnover rates of 18% and 28%, respectively, and
pre-restatement turnover is 14-16% in all three samples. 77 Menon and Williams (2008) find
evidence of abnormally high turnover for CEOs and CFOs following auditor resignations. Engel,
Hayes, and Wang (2003) find a stronger sensitivity of turnover decisions to accounting information
when earnings is more informative, where informativeness is measured by asymmetric timeliness.
Taken together, the evidence suggests significant negative labor market consequences for
individuals involved in accounting misstatements. However, these public announcements of
misstatements have direct implications for the firm’s credibility, which may be an additional factor
in the turnover decision. Moreover, these studies may not provide evidence that is useful for
understanding whether a Board would view earnings management within the boundary of GAAP as
impairing earnings quality. Engel et al. (2003) is the only study that provides evidence on the
turnover consequences of earnings informativeness rather than extreme, and detected, earnings
management.
6.2.4 Consequences of earnings quality for audit opinions
Francis and Krishnan (1999) find that high-accrual firms are more likely to get modified
audit opinions, particularly from Big-six auditors and when the accruals are income-increasing.
Bradshaw, Richardson, and Sloan (2001), however, find no evidence that abnormally high working
capital accruals are associated with adverse audit opinions or auditor turnover. 78 Butler, Leone, and
Willenborg (2004) find that the relation between accruals (total accruals or abnormal total accruals)
77 While the results directionally suggest higher director turnover following restatements relative to a matched sample,
the significance of the difference is not reported. Moreover, the increase in turnover for the matched sample from 14-
16% in the hypothetical pre-restatement period to 33% in the post-restatement period is unexplained and raises questions
about the impact of calendar time data clustering on the results.
78 One explanation for the mixed results is that Francis and Krishnan (1999) examine reports in 1987 - 1988, which
precedes the issuance of SAS 58 and 59, whereas Bradshaw et al. examine reports in 1988 – 1998.
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