Additional Analyses Results 1 Sample selection

1908 We analyze the relations between audit quality and three components that make up RAM, i.e. abnormal CFO, production costs and discretionary expenses. The results in Table 4are as set out below: Variable Intercept PROXY_AQ 1 if audited by Big4, and 0 otherwise LEV ln_SIZE GROW F Value Adj. R 2 CFO 2.167 37.73 0.001 0.17 0.152 8.82 -0.090 -29.60 0.002 20.03 76.19 0.2924 PROD 0.969 5.84 0.095 4.51 0.614 12.33 -0.020 -2.28 0.004 14.03 38.34 0.1702 DE 2.159 44.96 0.025 4.12 0.002 0.18 -0.097 -38.27 0.002 26.25 142.07 0.4397 Table 4 Relationship between Components of RAM and Big4 The components of RAM and Big4 are positively correlated; for the Big4, we get higher values of RAM. 2 Analysis of Including Abnormal Cash Flows from Investing Activities within RAM As stated above, the value of RAM consists of abnormal CFO, production costs and selling and administrative expenses, which are components of the income statements. This means that although there may be some possibility of real-activity earnings management through items within the category of selling and administrative expenses in the income statements, these types of earnings management tend to be excluded. Therefore, to supplement to these facts in this study, we include real-activity earnings management, which is exercised through 1909 within the category of selling and administrative expenses in RAM, and the equation of the model is as follows: CFI it A

i,t-1

= a [1A

i,t-1

] + b 1 [Sales

i,t-1

A

i,t-1

] + it 8 In this above equation, it is implied that managers carry out earnings management by using acquisitions of assets like equipment and gains or losses on disposal of assets. We calculate expected CFI on the assumption that cash flows from investing activities have a linear relation with sales, and we deduct the expected CFI from the real CFI, which results in abnormal CFI Ab_CFI being included in RAM. The results are as follows: Variable Intercept PROXY_AQ 1 if audited by Big4, and 0 otherwise LEV ln_SIZE GROW ∑Year F Value Adj. R 2 Number of Samples Predicted Sign + - + Actual Result 1.833 13.73 -0.051 2.62 0.79 18.18 -0.04 -5.89 0.01 26.60 - 296.94 0.285 5087 Table 5 Analysis of the Relationship between the Reputation of Auditors Whether auditors are BIG4 or not and the RAM Containing Ab_CFI Although we include abnormal CFI, the robustness of our results is effective, i.e. the coefficient of Big4 is positively correlated with RAM. And, adjusted R-square is found to be 0.285 which is a higher value compared to the basic model. 1910

5. Conclusion

Audit quality may be seen as combination of the possibilities that auditors may detect errors or frauds and one that they may report their findings in full. For the estimation of this the reputation or size of the auditors and the degree of earnings management are used as proxies for audit quality. In prior research studies, discretionary accruals have been used to measure earnings management, but this method is only a fraction of measurements of earnings management, which is irrelevant to cash flows of a firm. Therefore, in this study, we examine whether real-activity earnings management as an alternative to discretionary accruals can be used as a proxy of audit quality. We find that the reputation of auditors is positively correlated with the size of RAM. Meanwhile, DAM and RAM when exercised by managers tend in Korea toward a relationship that is complementary rather than one of substitution. This implies that that Korean managers tend to make use of DAM and RAM at the same in order time to adjust their earnings. REFERENCE Bartov, E. 1993. The Timing of Asset Sales and Earnings Manipulation. The Accounting Review 68October: 840-855. Burgstahler, D., and Dichev, I. 1997. Earnings Management to Avoid Earnings Decreases and Losses. Journal of Accounting and Economics 24 December: 99-126. Cohen, D., Dey A., and Lys. T. 2008. Real and Accrual Based Earnings Management in the Pre and Post Sarbanes Oxley Periods. The accounting Review 83: 757-787. Cohen, D., and Zarowin, P. 2008. Accrual-based and Real Earnings Management Activities around Seasoned Equity offerings. Working Paper, New york University. 1911 Chung, H., Kallapur, S. 2003. Client Importance, Non-audit Service, and Abnormal Accruals. The Accounting Review 78: 931-955. DeAngelo, L.E. 1981. Auditor Size and Audit Quality. Journal of Accounting and Economics 3: 183-199. Dechow, P., and D. Dichev, 2002., The Quality of Accruals and Earnings: The Role of Acrual Estimation Errors. The Accounting Review, 77Supplement: 35-59. Dechow, P.M., Kothari S.P., and R. Watts. 1998. The Relation between Earnings and Cash Flows. Journal of Accounting and Economics 25: 133-168. Dechow, P. M., R. G. Sloan, and A. P. Sweeney. 1995. Detecting Earnings Management. The Accounting Review 70: 193-225. DeFond, M. L., and J. Jiambalvo. 1994. Debt Covenant Effects and the Manipulation of Accruals. Journal of Accounting and Economics 17: 145-176. Gunny, K. 2005. What are the Consequences of Real Earnings Management? Working Paper, University of Colorado. Jones, J. 1991. Earnings Management during Import Relief Investigations. Journal of Accounting Research 29: 193-228. Khurana I.K., and Raman K.K. 2004. Litigation Risk and the Financial Reporting Credibility of Big 4 versus Non-Big 4 Audit: Evidence from Anglo-American Countries. The Accounting Review 79: 473-495. Mizik, N., and Jacobson, R. 2008. Earnings Inflation through Accruals and Real Activity Manipulation: Its Prevalence at the Time of an SEO and the Financial Market Consequences. Working Paper, Columbia University. Raman, K., Wilson, E. 1994. Governmental Audit Procurement Practices and