Impact of Assurance Level and Tax Status on the Tendency of Relatively Small Manufacturers to Manage Production and Earnings

The number and importance of private companies in the United States indicates that reliable quality of financial accounting reports (QFAR) useful to users of private companies may be important for the growth of the economy. Most previous research examining QFAR addressed earnings management among publicly-traded companies. Our study extends prior literature on earnings management by manufacturing companies by examining whether abnormal production of public and private companies is impacted by (i) assurance type (PCAOB-audit, GAAS-audit, and Review), (ii) tax status (separately taxed versus pass-through entity) of private companies, and (iii) relative size. Overall, publicly traded companies tend to have significantly negative abnormal production while separately taxed private companies have significantly positive abnormal production. Not identified in previous studies, we find that abnormal production of similarly sized public companies and private companies differ. When examining companies that just met the benchmark of prior years' earnings or zero earnings we found positive abnormal production for publicly traded companies and privately held audited-taxable companies. These results indicate that public and private audited-taxable manufacturing companies are most likely to appear to manage earnings upwards and engage in management of production. Our findings provide evidence relevant to the Big GAAP/Little GAAP debate and that public and private company financial statement users may not be well satisfied with one set of accounting standards