The impact of audit characteristics, audit fees on classification shifting: evidence from Germany

Abstract

Purpose
This paper aims to examine the relationship between audit characteristics (ACs) and audit fees on classification shifting (CS) among German-listed non-financial firms.

Design/methodology/approach
Using a sample of 130 German-listed (Deutscher Aktienindex, Mid Cap dax and Small caps Index) firms from 2010 until 2019, this study investigated the impact of audit committee size, audit committee meetings, audit committee financial expertise and audit fees on CS.

Findings
This study found the evidence of CS, meaning that managers misclassify recurring expenses in the income statement into non-recurring expenses to inflate core earnings. This study also found that the audit fee ratio, audit committee financial expertise and frequency of audit meetings are negatively associated with CS among German-listed firms. However, the audit committee size does not influence CS.

Research limitations/implications
This study will help the board improve its internal auditing practices and provide essential information to investors to assess how ACs affect the quality of financial reporting.

Originality/value
This study focused on a bank-oriented economy, i.e. Germany, with lower investor protection and low transparency. This paper documents new evidence on how ACs and audit fees impact CS among German firms, as most of the previous studies on CS mainly focused on market-oriented economies such as the UK and the USA.