Several studies (see e.g. Burgstahler & Dichev, 1997; Degeorge, Patel & Zeckhauser, 1999; Gore, Pope & Singh, 2001; Holland & Ramsay, 2003) document statistically significant discontinuities in the distribution of reported earnings figures around certain targets (i.e., zero earnings, s' earnings forecasts and prior year's earnings). These discontinuities are ascribed to threshold-induced earnings management. Relying on a sample of listed UK firms and employing a similar methodology, the author examines whether high-quality audits serve as a constraint on earnings management practices.The author relies on the traditional brand name proxy (i.e., BigN vs. non-BigN auditors) and a proxy for auditors' industry expertise to capture audit quality. While results suggest that high-quality audits constrain loss avoidance, this is not true for earnings management aimed at meeting last year's earnings figure. This discrepancy of results is attributed to the fact that the latter type of earnings enhancement will often not be quantitatively material and the auditors (i.e., both high- and low-quality auditors) neglect qualitative factors to assess materiality.

According to McNichols (2000), three popular research designs are employed in the empirical earnings management1 literature: Those based on aggregate accruals (see e.g. Healy, 1985; DeAngelo, 1986; Jones, 1991; Dechow, Sloan & Sweeney, 1995); those based on specific accruals (see e.g. McNichols & Wilson, 1988; Petroni, 1992; Beaver & Engel, 1996; Beneish, 1997); and those based on the distribution of earnings after management (see e.g. Burgstahler & Dichev, 1997; Degeorge, Patel & Zeckhauser, 1999; Gore, Pope & Singh, 2001; Holland & Ramsay, 2003). While the former two research designs have already been employed to assess the impact of audit quality on earnings management (see e.g. Petroni & Beasley, 1996; Becker et al., 1998; Francis, Maydew & Sparks, 1999; Gaver & Paterson, 2001; Krishnan, 2003; Balsam, Krishnan & Yang, 2003), the latter research design has yet not been used for these purposes. Inspired by the fact that the results obtained from the aforementioned studies, are rather inconclusive, I decided to examine whether differences in audit quality affect the distribution of reported earnings after management around both zero earnings and prior year’s earnings.To proxy for audit quality, the author relies on the traditional brand name variable (i.e., BigN vs. non-BigN auditors) and a proxy for auditors’ industry expertise. The results show that high-quality audits serve as a constraint on loss avoidance, but this is not true for earnings management aimed at meeting last year’s earnings figure. This discrepancy of results might be attributed to the fact that the latter type of earnings enhancement will often not be quantitatively material and that auditors (i.e., both high- and low-quality auditors) neglect qualitative factors for assessing materiality. The main contributions of this paper can be summarized as follows: First, I rely on an alternative research design in an attempt to assess the impact of audit quality on earnings management. Secondly, I relate my research to the ongoing materiality debate (i.e., qualitative versus quantitative materiality).