Journal of Indonesian Economy and Business Volume 28, Number 1, 2013, 115 – 131 PROSPECTOR-DEFENDER STRATEGY, AUDITOR INDUSTRY SPECIALIZATION, EARNINGS MANAGEMENT THROUGH REAL ACTIVITIES, AND EARNINGS QUALITY Wuryan Andayani Ph.D. Student at Universitas Gadjah Mada, Yogyakarta Brawijaya University, Malang (a_wuryan@yahoo.com) Sony Warsono Faculty of Economics and Business Universitas Gadjah Mada (iarirfan@yahoo.com) ABSTRACT This study observed the influence of the company prospector-defender strategy and auditor industry specialization toward the earnings management through real activities and earnings quality. An important finding in this study confirmed that the auditor industry specialization could not restrict the earnings management and the company‘s prospector strategy could restrict the earnings management. On the contrary, defender strategy could not restrict the earnings management. Another finding proved that the auditor industry specialization influence the earnings response coefficient (ERC) and investors’ response. Besides the auditor industry specialization, as well as the prospector and defender strate- gies, other factors also affected influence ERC are leverage, company size, stock return, beta and market return. The interaction among the prospector and defender strategies and unexpected earnings neither influence the CAR nor the investors’ response. This was probably because the investors pay attention to the strategy used by the company. How- ever, there were any interaction variables: industry specialization auditor, leverage, stock return, beta and market return influence the CAR and investors’ response. Keywords: auditor industry specialization, prospector-defender strategy, earnings response coefficient, earnings quality. INTRODUCTION Research about factors affecting earnings quality is very important to do since earnings quality mechanism can bound managers’ abil- ity to alter their accounting data. In the real world, accounting system provides a space for manager to influence the financial statement data. As a result, outcome on firm’s financial statement information are noisy and bias. Healy & Palepu (2004) pointed out that there are three sources of noise and bias in ac- counting data: 1) The rigidity in the account- ing rules; 2) The random forecast errors; and 3) Systematic reporting choices made by cor- porate managers in order to achieve specific objectives. First, the noisy accounting rule in SFAC No.2 issued by the FASB requires firms to Expend research outlays when they are in-