Comparison of results between the two types of buyout

Audit committee characteristics have different impacts on AEM prior to MBOs when compared with IBOs.

The percentage of non-executive directors on an audit committee

(Ned%AudCom) has no impact on AEM prior to either MBOs or IBOs, which is

perform little or no real monitoring role as they lack the independence, time, expertise, and information they would need in order to challenge management activities effectively (Patton and Baker, 1987; Gilson and Kraakman, 1991).

Prior to MBOs, the financial expertise of an audit committee (FinancialExp) has no impact on AEM, which is inconsistent with hypothesis H1-2b. This might be

because even financially literate directors are usually particularly focused on avoiding positive AEM. They may perceive negative AEM as accounting conservatism, which is good news even in the case of an MBO, and therefore they do not intervene. Prior to IBOs, the financial expertise of an audit committee is associated with less AEM, which is consistent with hypothesis H1- 2b. Financial expertise makes an audit committee’s internal control judgements

more like those of experts, effectively facilitating the reporting process (DeZoort and Salterio, 2001). Audit committees with financial expertise are better equipped to understand auditing issues and risks, as well as the procedures that are proposed to address and/or detect them (DeZoort and Salterio, 2001). In addition, knowledgeable audit committees are more likely to comprehend an internal audit program and its results, which in turn, increase the effectiveness of internal controls in preventing or detecting AEM (Abbott et al., 2004).

Prior to MBOs, equity ownership by audit committee members (AudShare) has no impact on AEM, which is inconsistent with hypothesis H1-2c. Furthermore, the

presence, on an audit committee, of an outside blockholder with over 3% shareholding (3%holdAudCom) has no impact on AEM, which is inconsistent with hypothesis H1-2e. Audit committees might not take sufficient care of the

incoming MBO context, and thus they might focus on traditional positive AEM, in order to mitigate managers’ attempts to boost earnings, rather than on spotting negative AEM. Hence, audit committee members may be unable to spot AEM behaviours prior to MBOs.

Prior to IBOs, higher levels of equity ownership by audit committee members are associated with more AEM, which is consistent with hypothesis H1-2d. The

results also suggest that the presence, on an audit committee, of an outside blockholder with over 3% shareholding is associated with more AEM, which is consistent with hypothesis H1-2f. The independence of audit committee

members might be impaired by high share ownership. Members of audit committees with higher equity ownership might be less likely to perform active monitoring. Hence audit committee members with higher equity ownership might compromise to upwards AEM, leading to higher levels of AEM preceding IBOs.

Prior to MBOs, audit committee size (AudComSz and AuditSz2BoardSz) has no impact on AEM, which is inconsistent with hypothesis H1-2g. Prior to IBOs, audit

committee size has no impact on AEM, which is inconsistent with hypothesis H1-2g. As the responsibility of audit committee might be appropriate assigned,

the size of audit committee might have no impact on functions of AEM detection.

Overall, the results suggest that audit committees perform little or no real monitoring roles prior to MBOs. This might be because that audit committees are not aware of the incoming MBO context, and they traditionally focus on limiting positive AEM to mitigate managers’ attempts to boost earnings. Prior to IBOs, the financial expertise of an audit committee and equity ownership by audit committee members is positively correlated with earnings management. These results suggest that audit committees do perform their intended role in governance prior to IBOs. Therefore, including a director with financial expertise in a firm’s audit committee and reducing the level of equity ownership by audit committee members can lead to a lower level of AEM prior to IBOs.

Audit quality has different impacts on AEM prior to MBOs and IBOs. Prior to MBOs, the presence of a Big 5 auditor (Big5) has no impact on AEM, which is

inconsistent with hypothesis H1-3a. External auditors might not take sufficient

care that an MBO is about to happen, and thus they might focus on limiting traditional positive AEM in order to mitigate managers’ attempts to boost earnings, rather than to spot negative AEM. Prior to IBOs, the presence of a Big 5 auditor is associated with less AEM, which is consistent with hypothesis H1-3a. Larger audit firms tend to deliver higher quality audits, because they are

less willing to accept questionable accounting methods and are more likely to detect and report errors and irregularities (e.g. Becker et al., 1998). Larger audit firms have more resources to invest in improving the quality of their work (DeAngelo, 1981). Hence larger audit firms have greater incentives to detect and reveal management misstatement, leading to audit quality differentiation. Moreover, Big 5 audit firms have lower litigation rates than their peers have (Palmrose, 1986a; Palmrose, 1988), which suggests that they provide audits of a higher quality.

Higher audit fees (LNAudFees and AudFees/AssetsSqrt) are associated with more AEM prior to both MBOs and IBOs, which is inconsistent with hypothesis H1-3b.

The economic rents associated with audit fees create an economic bond between auditors and their clients, which may affect the independence of auditors, and lead them to permit AEM (Frankel et al., 2002). In addition, higher level of AEM is likely to be associated with a higher inherent risk, as assessed by auditors. The higher level of inherent risk requires the more audit effort to reduce detection risk in order to achieve an given level of audit risk (Gul et al., 2003).

Prior to MBOs, higher non-audit fees (LNNonAudFees, NonAudFees/AssetsSqrt

and NonAudFees/TotalFees) are associated with less AEM, which is inconsistent

with hypothesis H1-3c. By undertaking audits and providing consultancy services,

auditors learn more about a client's business, which may improve the quality of all their services (Wallman, 1996). Hence higher non-audit fees might lead to

less AEM. Prior to IBOs, non-audit fees has no impact on AEM, which is inconsistent with hypothesis H1-3c. This might be because the variable of non-

audit fees picks up different things in different circumstances.

Overall, the results suggest that the presence of Big 5 auditors mitigates AEM prior to IBOs. Higher audit fees charged by auditors will lead to more AEM prior to MBOs and IBOs. The economic rents associated with audit fees create an economic bond between auditors and their clients, which may affect auditors’ independence and lead them to permit AEM (Frankel et al., 2002). High non- audit fees mitigates AEM prior to MBOs. This might be because auditors learn more about a client's business by providing both auditing and consultancy services, which may improve the quality of all their services (Wallman, 1996).