• No results found

Chapter 3 : Development of hypotheses

3.4 Hypotheses for assessing the association between audit firm tenure and FRQ

3.4.3 Audit firm tenure and Big4 versus non-Big4 auditors

Auditor differentiation research first started, as Francis (2004) reviews, with the dichotomy between large [now categorised as Big4] and small [now categorised as non- Big4] firms back in 1981 when DeAngelo argued that audit firm size is one of the determinants of auditor independence or audit quality as no single client is important to a large auditor and they have a greater reputation to lose (DeAngelo 1981, p. 117). Other corroborative evidence in favour of the large firm auditors include Feroz et al. (1991) and Palmrose (1988) who respectively report that large firms were sued and sanctioned relatively less frequently than their smaller counterparts. Weber and Willenborg (2003) demonstrate that companies associated with Big4 firms have more predictive accuracy than smaller firms in forecasting future stock returns and subsequent de-listings. In the UK context, Lennox (1999) finds Big4 auditor reports with greater accuracy.

99

almost absolute domination by Big4 audit firms, the House of Lords Select Committee on Economic Affairs (2011) was assessing if the provision of joint audit in the UK would help dilute this concentration and make it more competitive. The committee was not convinced in favour of the joint audit with evidence from countries where it is enforced51. However, the Committee notes that “if it [joint audit] were promoted in the

UK as a means to reduce market concentration, it should be on the basis that at least one joint auditor was a non-Big Four firm” (Paragraph 40, House of Lords Select Committee on Economic Affairs 2011).Prior to the issue was raised by the House of Lords Select Committee on Economic Affairs (2011), the FRC published a report in May 2009 titled “Choice in the UK audit market- Third progress report” where market concentration by the Big4 was investigated with significant coverage. The executive summary of the report made an explicit concern over the dominance of the Big4 firms in the UK audit market. It observes that “the implementation of the MPG‟s [Market

Participants Group] 15 recommendations forms part of the FRC Audit Choice project, which aims to mitigate the risks to confidence in corporate financial reporting caused by the concentration in the audit market for the largest companies” (FRC 2009, p. 1), in

apparent contrast to the empirical evidence from the academic research. Another regulator more recently joined in this debate is the Competition Commission (CC) (currently the Competition and Markets Authority). In its 2013 Report, the Commission addressed the barriers to entry, expansion and selection for non-Big4 firms as one of the remedy packages and considers tendering audit process to offer more competitive environment for them (Paragraph 16.10, CC 2013). The Commission expressed concerns in its 2012 Report as it observed that there is a significant difference between the switching rates for Big4 and non-Big4 clients and attributed this difference to high switching costs for Big4 clients in addition to the quality of audit (Paragraph 2, CC 2012).

This study, therefore, investigates the aspect of quality differentiation between Big4 and non-Big4 to understand if non-Big4 firms have a similar capacity of handling audits of FTSE clients. And following the dichotomy between Big4 and non-Big4 audit firms (DeAngelo 1981), this study examines if the quality differentiation holds for longer and

51 Andre et al. (2015) examine the cost and audit quality of French companies where joint audit is

mandatory. The study finds significantly higher audit fees in France compared to that in the UK and Italy. More importantly, the study does not find statistically significant difference in the audit quality between these countries even after controlling for auditor, client and engagement attributes. Another study by Francis et al. (2009) examines the auditor-pair choice of French companies in the joint audit regime.

100

shorter audit firm tenure. Inspired by the inquiries of prior research considered above, this study argues that with higher resources the Big4 firms have more efficient and effective information systems, personnel training, and quality control systems in place that enable a better learning process. This can allow knowledge transfer and information sharing in such a way that utilizes longer tenure in delivering more independent audit services leading to better FRQ. On the other hand, non-Big4 firms can be argued to be smaller in size and have relatively weaker logistics and systems including a lower number of qualified personnel. These limitations may obstruct the non-Big4 auditors from benefitting from extended auditor tenure unlike their Big4 counterparts. Based on the above discussion, the sixth set of hypotheses is as follows:

H6: The association between audit firm tenure and the magnitude of discretionary accruals is conditional on audit firm size.

H6a: There is a negative association between audit firm tenure and the magnitude of discretionary accruals for companies audited by Big4 firms.

H6b: There is a no association between audit firm tenure and the magnitude of discretionary accruals for companies audited by non- Big4 firms.

3.5 Conclusion

Having been motivated by the extant literature review and regulatory initiatives enforced as noted in chapter 2, this chapter develops the hypotheses in three categories to test a number of associations to facilitate responses to the research questions: first, the association between two different parameters of auditors‟ economic dependence and

FRQ as proxied by the magnitude of discretionary accruals; second, the causal effect of the APB ES on FRQ in terms of an expected lower level of discretionary accruals as a result of restricted NAS provision. In the final phase, the association between audit firm tenure and FRQ; the impact of APB ES on FRQ reflected in the magnitude of discretionary accruals as a result of more frequent rotation of auditors; and between auditor tenure and FRQ conditional on the firm size. The next chapter will now discuss the research methodology to be applied for the empirical investigations and analyses.

101