EFFECTS OF AUDITS QUALITY ON EARNINGS MANAGEMENT: EVIDENCE FROM CROATIA

In the contemporary business climate, companies are facing a dynamic, fast-changing, and unpredictable environment, resulting in the need for responsive, adaptable and agile management. Pressured by high standards and expectations regarding environmental, social, and governance (ESG) factors, companies are finding ways of fulfilling stakeholders’ expectations, often challenged by preferable financial position and targeted financial performance. In those circumstances, the company’s agents (management) use various adjustments to balance sheet items and profitability to ensure the disclosure of expected results. Thus, earnings management, usually measured by “abnormal” or discretionary accruals, deviates accurate financial results in annual financial statements and brings earnings quality into question. Corporate governance mechanisms are crucial in ensuring financial stability, sustainable business operations, and building trust with all stakeholders. Corporate governance mechanisms, such as external audits, have a significant role in improving a company’s financial performance and accuracy and positively affect reducing and limiting earnings management. As a result of the research objective of the paper, we have created an audit quality proxy to measure the quality of financial statement audits. Our research covers 69 non-financial companies from the Zagreb stock exchange from 2015 to 2023 (520 observations). To test research hypotheses, we used panel data methods. Results indicate that discretionary accruals are not lower in the case of higher audit quality for Croatian listed companies, which indicates that auditors are ineffective in detecting earnings management. However, those discretionary accruals are lower in the case of a modified auditor’s opinion.