How Do Auditors' Social Ties and Their Industry Specialization Affect Earnings Management of IPO Firms?

ABSTRACT This study investigates how engagement auditors' social ties with investment bankers and engagement auditors' industry specialization affect earnings management among initial public offering (IPO) firms. Using proprietary data from Taiwan—a relationship-oriented market characterized by reciprocal exchange and a high degree of auditor accountability—we explore whether social connections lead to favoritism bias or facilitate effective information sharing. Our findings reveal significantly less accrual-based and real earnings management when engagement auditors are socially connected with investment bankers. Furthermore, the mitigating effect of these ties on earnings management is more pronounced when the auditors are industry specialists, suggesting that industry-specialized knowledge enhances the quality and efficiency of information exchange. Overall, our results highlight the importance of social networks and auditor expertise in promoting audit quality and constraining opportunistic financial reporting in the IPO setting. JEL Classifications: M42; M49; G30.