Effect of Audit Quality on Market Assessment of Earnings and Earnings Components

Accounting earnings includes cash and accrual components. Accrual components can be classified as discretionary accruals and non-discretionary accruals. Dominant literature in earnings management field known discretionary accruals as opportunistic; a feature that weakens earnings Informativeness. Yet, managers can also use discretionary accruals to signal unattainable private information to outsiders; thus, they allow outsiders to assess firm’s future economic value better. Since the reliability of financial statements, including earnings, depends to a large extent on the quality of performed audit, therefore, understanding how market will consider audit quality at the time of earnings and its components valuation is of great importance. For this purpose, and using the data from 125 listed firms in Tehran Stock Exchange during the years 2011 to 2015 and panel data model, this study attempted to investigate the impact of audit quality on capital market’s valuation of earnings and its components. The results showed that net profit and the amount of discretionary accruals directly and significantly affect stock returns; total amount of accruals has a negative reverse impact on stock returns; operating cash flow and the amount of non-discretionary accruals have no impact on stock returns; audit quality mitigates the direct relationship between net profit and stock returns; and audit quality does not affect the relationship between total accruals, discretionary and non-discretionary accruals, and operating cash flow with stock returns.