The initial objective of this thesis was to determine what the effects of the newly introduced measure of mandatory audit firm rotation are on the measured auditquality by providing evidence from a regime in which mandatory audit firm rotation already exists for many years. The initial dataset which was to be used for this research consisted of 150 Italian, non-financial, publicly listed companies. However, due to the relatively small amount of observed audit firm rotations in the sample, combined with the lack of a normal distribution of the dataset, the assumptions for performing powerful parametric tests such as a linear regression analysis were not met. As a result, testing the stated hypotheses about the expected relationship between the variables audit firm rotation and auditquality became technically impossible and thus, conclusions based on strong evidence can’t be drawn yet. Although several prior studies have attempted to draw conclusions based on datasets with similar limitations, sometimes by heavily transforming the data to make it suitable for regression analysis, the results of these studies are therefore arguably questionable. By not wanting to compromise the reliability of the results, no attempt to reject or accept the stated hypotheses has been made. Instead, the decision was made to discuss the linear regression model in order to exemplify the intended research method, which as soon as suitable data presents itself will function as a format for future research into the effect of mandatory audit firm rotation on auditquality.
Audit involves performing procedures to obtain evidence about amounts and disclosures in the financial statements so as to evaluate the appropriateness of accounting estimates made by management (KPMG, 2008). The Auditquality therefore, is a basic ingredient in enhancing the credibility of financial statements to users of accounting information. Consequently, studies (Fairchild, 2008; Coate, Florence and Kral 2002) note that audits add credibility to the financial information by providing an independent verification of management-provided financial reports, thus reducing investors information risk. Financial reporting credibility is partly reflected in the confidence of users in audited financial reports (Watkins, Hillison, and Morecroft. 2004). As noted by Levitt (2000), the perception of auditquality plays a critical role in maintaining systematic confidence in the integrity of financial reporting. The higher the perceived auditquality, the more credible the financial statements. This will consequently improve user’s confidence in those financial statements. Concerns about auditquality have gained increased ascendancy especially as a result of the spectacular financial reporting scandals in major corporations, such as Enron, WorldCom and other companies. The aftermath of these scandals has led to the identification of a perceived “expectation gap” in the auditquality as many users of audited financial statements have different expectations of the audit function from what it actually delivers (Beattie, Brandt and Fearnley, 1999).Therefore, there has been a call for sweeping changes in the auditing profession to ensure improved auditquality (Auditing Profession 2002).
According to Geiger and Rama , any effort to ensure that public interest is protected while the needs of users of audit works are truly met, must be founded on authentically functioning auditquality mechanisms. It is all a matter of res- ponding to healthy standards of accountability required of state or parastatal bodies. When audit reports or findings are free from misrepresentations, distor- tions, or bias, it is more than likely that thoroughly-documented audit analyses will ensure stakeholders’ or public adhesion or approval, leading in turn to en- hanced levels of trust, confidence and assurance . These writers claimed that, in the process, auditquality is sure to demonstrate that principles of good go- vernance are truly functioning in the best interest of a country and its people.
Our study has provided an overview of the impact of the corporate governance quality on auditquality in Malaysia during the period from 2003 to 2012 (i.e., pre-and post-2007 Code period), using the effectiveness of the board and AC to proxy for corporate governance quality and audit fees to proxy for auditquality. The timeframe is interesting and appropriate as the Code was revised in 2007 and the 2007 Code was aimed at strengthening the roles and responsibilities of the board and AC. The sample has focused on 457 non- financial companies that had listed and traded their shares on the main board of Bursa Malaysia from 2003 to 2012. There is no evidence to show that the effectiveness of AC has a significant influence on audit fee in the pre- and post-2007 Code period. The results also show that the effectiveness of the board does not has a significant influence on audit fees in the pre-2007 Code period but it has significant influenced on the audit fees in the post-2007 Code period. This suggests that the existing corporate governance framework particularly on the board has an influence on the quality of audit process, but the corporate governance framework in relation to audit committee has limitation in its governance role on audit process. Our results partially support the regulatory initiatives intention at enhancing role and responsibilities of the board and AC in order to improve the audit process.
In recent decades, there has been a noticeable increase in the practice of earnings management (EM) as a proxy for financial reporting, especially real activities, with effect on the quality of financial statements. The role of the audit committee in mitigating EM remains ambiguous because of inconclusive findings. Therefore, this study examines the moderating effect of auditquality and audit committee on financial reporting quality, also known as real earnings management in Malaysian companies. The results show that corporate governance mechanism such as financial accounting expert, meeting and indicate significant results with real EM while, audit committee independence and size, shows an insignificant result on real EM. In addition, the results show that auditquality of the audit committee leads to less aggressive EM practice in real activities. The findings also show that auditquality and audit committee has a significant role in restricting the real EM. Auditquality is found to significantly moderate the relationship between audit committee with financial reporting quality proxy. Overall, this study provides a reference point for the relevant parties such as regulatory bodies, policymakers and standard setters towards improving the quality of earnings and corporate governance practices in ensuring credible accounting information.
A framework for the analysis of audit firm size, non-audit services and auditquality dynamics is the agency theory. The demand for audit and auditquality is driven by agency cost. The audit function serves a fundamental purpose of promoting confidence and enhancing trust in financial statement. The principal–agent contract which is the basis of the agency theory helps in understanding the audit function. Agency theory according to ICAEW (2005) is a vital economic theory of accountability which helps to trace the evolution of the audit function. Audit provides an independent check on the duties of an agent and helps to reinforce trust and promote confidence. In the simple agency model of audit, the auditor is considered an expert appointed to resolve the likely conflict between the principal and the agent even though there are other stakeholders who are interested in the report of the audit. The interest of these other stakeholders will however complicate the simple audit model an issue which is beyond our cope.
Auditor data are obtained from Audit Analytics and financial data are obtained from the Compustat fundamentals annual file. 18 After ensuring that both the firm and its auditor have non-missing MSA data, I obtain 110,364 observations. I then exclude financial services firms (SIC codes 6000-6999) as these firms operate in regulated industries. Next, 469 observations are deleted because the firm hires an auditor in a different MSA than where the firm is headquartered. Finally, 54,511 observations are lost due to insufficient data to calculate the variables used in the audit fee analysis (Eq. 1). This leaves me with a final sample of 44,085 observations spanning 2000-2011 for the audit fee analysis. For the auditquality analysis, the sample is considerably smaller because I exclude firm-years after 2010. I choose to end the sample two years before the most recent year of data available when I began the study (2012) to allow for a sufficient amount of time for a firm to subsequently restate its earnings. I leave two years for the client to restate its earnings because Cheffers et al. (2010) find that the average time
Whilst one view from the outset is that the emergence of peer review was a consequence of the failures of the profession, also under threat of external oversight, to provide ‘sufficient’ auditquality, the discussion in section 4.1 suggests that a number of additional factors converged to also play a role in the form of that intervention which was to come. Again, these influences are important to keep in mind as they helped to shape both the conception of the ‘problem’, and within this constellation in particular, the ‘solution’ deployed to address it. In turn, this predisposed a very particular meaning and understanding of quality. The concept of peer review was not altogether a new invention within auditing when it started appearing in the discourse with more regularity from the mid-1970s onwards. The initial seeds of the idea have been traced back to as early as 1962 with the AICPA’s practice review committee establishing a program designed to monitor standard practice and reporting (Sperry et al, 1987). In 1971, and quite very separate from the then emergent regulatory discourse on quality control, was a tentative initiative with what was termed ‘firm quality reviews’. With its roots in a working paper improvement project initiated by the Kentucky Society of CPAs to ascertain the extent to which its members were following the guidelines for audit working papers, the Accounting Research Committee upon consideration of the program determined that only the state CPA societies or the AICPA could implement and administer the types of programs being recommended. At that time, the three possible courses of action were determined to be: appointing a separate working paper review committee; drawing a committee from practice review boards on consultation or else, developing a professional development course or program (Rea, 1975). A quality review program, to include a comprehensive review of working papers, was subsequently developed.
Table 6 shows the regression results of testing the association between audit related fees (ARFEE) and earnings quality, where |DWCA|, DWCA + and DWCA – are used as the dependent variables. The empirical findings for ARFEE demonstrate a significant positive association with |DWCA|. The results imply that provided audit- related services are not related to client-specific knowledge spillover effects, respectively are not substantial enough to outweigh the negative effects on auditor independence. As we can learn from the descriptive statistics in Table 3, the non-audit service category of audit-related services has the highest proportion on total fees (12.02 percent), when compared to the other two non-audit fee categories. Therefore, we conclude that the economic auditor-client bonding with negative consequences on auditor independence is at the highest level for this category. As we are not able to find significant knowledge spillover effects that compensate or even outweigh the negative impact of high audit-related fee ratios on auditor independence, we are unable to reject Hypothesis (2). In contrast to |DWCA|, we are neither able to report significant results for ARFEE with DWCA + nor with DWCA – . The insignificant results imply that the negative impact of audit related services on auditquality does not systematically differ between income increasing and income decreasing accrual management. Overall, with regard to |DWCA|, our results in Table 6 are considerably different to those of Quick & Sattler (2011), who report insignificant results for the relation of audit related services on auditquality. We assume that the different estimation results are mainly based on unequal sample compositions of both studies with regard to sample size and sample period.
Furthermore the view of opponents of MAFR is reinforced by a study carried in Italy, the research concluded that MAFR was hurtful to auditquality since it increased start-up costs and caused disruptions in the appointment phase (Kwon, Lim and Simnett, 2010). Ruiz-Barbadillo et al (2009) examined the impact of MAFR on auditor behaviour in the Spanish context and found no proof that a mandatory rotation requisite is allied with a higher probability of issuing going-concern opinions.In addition to the prior discussion, Mandatory audit firm rotation causes audit risk, below standard audit implementation, in the early years of audit engagements, because an auditor may has not comprehensively understood his/her clients (Beatty, 1989; Craswell, Francis, and Taylor, 1995). DeAngelo (1981) believed that auditquality is the combination between auditor’s independence and competence. Therefore Said and Khasharmeh (2014) predicted that there is a positive relationship between the auditor’s competency and tenure. Thus, the longer the tenure, the higher the auditor’s competency since the auditor gets a better understanding of the firm’s specific risks, accounting information system and internal controls (Said and Khasharmeh, 2014). Also Al-Thuneibat et al (2011) pointed out that, there is a negative correlation between MAFR and the quality of auditing in companies listed at the stock exchange of Jordan between 2002 and 2006.
The table reveals that the tenure of partner-CEO calculated on the basis of firm-year of the contract has a significant relationship at the level of 5% to auditquality using the proxy of discretionary accruals (ABSDAC). This is implied in p-value/2 of 0.014, indicating that Partner-CEO has a significant effect on ABSDAC with the significance level of 5%. The direction of the relationship between partner-CEO and ABSDAC is positive, as expected in this study. The significance and coefficient in a whole are in line with the hypothesis proposed in this study. Results of the study reveal that tenure of public accounting firm’s partner and client’s CEO will have a positive effect on firm’s discretionary accruals, leading to negative impact on firm’s auditquality in a whole. This is because the interpersonal relationship between the public auditing firm’s partner and client’s CEO tend to reach the interaction level that allows the auditor to lose the independence as the auditor leading to the lower auditquality. Results of this study are consistent to results of previous studies conducted by previous researchers such as Ball et al. (2015) who found that lower auditquality would result when the interpersonal relationship between partner and client’s CEO is established. Results of this study are also consistent to the study conducted by Novianti, Sutrisno and Irianto (2009) who also found the same results, where lower auditquality may result when the tenure of partner and CEO is longer.
In addition to the two theories previously mentioned, Ettredge et al. (2014) examines “the existence of downward audit fee pressure, and the consequences of fee pressure on auditquality, during the economic downturn that is often referred to as the ‘Great Recession’” (247). Using financial reporting misstatements as the proxy, their research found that “downward fee pressure on audit fees is positively associated with decreased auditquality in 2008” (Ettredge et al. 2014, 250). Ettredge et al. considers this association to be restricted to times of economic hardships. However, Asthana and Boone (2012) suggest that auditors may experience pressures during times other than a recession. For example, when negotiations occur between the client and auditor, research has shown that the party with greater bargaining power will win such negotiations. Assuming the client is a large revenue-generating client for the auditor, the auditor may succumb to client’s viewpoints. The auditors may feel pressure in this type of situation and may fear that the client will hire different auditors. In this scenario, the client has greater bargaining power and thus expects the auditor to concede. Such research supports the theory on client bargaining power which suggests that auditquality will decrease as negative abnormal audit fees increase. Furthermore, this research shows that downward fee pressure may result in lower quality audits, regardless of the economy.
Methods for controlling endogeneity include the Heckman selection model (2SLS), the propensity score matching technique, the before and after comparison method, and the paired t-test. Lawrence et al. (2011) argued that studies should utilize the propensity score matching technique, which is an advanced version of the paried t-test, since the Heckman selection model cannot control endogeneity effectively. However, since the propensity score matching technique analyze endogeneity by finding similar paired sample, if there is no proper substitution sample, the result may be distorted and it will face variable selection issues. Moreover, although there are many differences in audit compensation and audit time according to industry characteristics, the propensity score matching technique does not match similar samples in the same industry. Therefore, the before and after comparison method is the most reasonable method to analyze the effect of non-audit service. Accordingly, this study compares audit compensation, audit time and auditquality by years for the companies which received non-audit service at least once according to the before and after comparison method.
However, using going-concern opinions as a proxy to measure auditquality is challenging, because the business failures of clients can be consequences of unforeseen business situations in the future (Tritscher, 2013). It may be related to business forecasting rather than analyzing facts obtained from historical financial reporting (Tritscher, 2013). Further, going-concern opinions can contribute to a client’ business failures when banks and suppliers refuse credits to this client (Tritscher, 2013). In addition, inappropriate going-concern opinions only contribute a small portion of low auditquality as many types of material misstatements are not related to a going-concern opinion (Tritscher, 2013). Therefore, whether going-concern opinions is an appropriate measure of auditquality depends on each cases (Tritscher, 2013). 2.2.2 Material misstatements. The two most commonly used misstatement measures in prior studies includes restatements and Accounting and Auditing Enforcement Releases (AAERs) (DeFond and Zhang, 2014). Accounting restatements refer to the corrections of material misstatements in the client’s previously issued financial statements (Alyousef and Almutairi, 2010). Restatements and AAERs are actually direct measures of auditquality because they indicate that the auditor issued an unqualified opinion on materially misstated financial statements, and the audit opinion is the auditor’s full responsibility and directly under his or her control (DeFond and Zhang, 2014). Empirical studies (e.g. Raghunandan et al., 2003) show that there is an implicit relationship between financial statement restatements and low auditquality. For instance, Raghunandan, Read, and Whisenant (2003) asserted that their examination of the relationship between non-audit fees and subsequent restatements indicates a direct relationship between non-audit fees and auditquality. Palmrose and Scholz (2000) studied auditor litigation resulting from restatements which are at the intersection of financial reporting quality and auditquality. Further, misstatements arise from not adequately identifying of high-risk accounts and transactions by the auditors (Palmrose and Scholz, 2000). Restatements in their sample identified accounting issues such as revenue recognition could have been identified by the auditors as high risk in their audit planning and performance.
Despite five years, audit firm can still be run on a client assignment, with no breaking the rules of the finance minister. This is done by the audit firm to change the name during the first assign- ment. Therefore, they can continue during the next assignment. Formally, the audit firm does not vio- late the rules and still be able to run on a client as- signment. Although formally in the assignment period has been a change of audit firm with their rotation, substantively the relationship between client-audit firms was maintained. This phenome- non indicates artificial rotation. Rotation artificially was done by simply changing the name of audit firm. Although an audit firm rotation has made appropriate government regulation, but the audit firm just renamed, or is affiliated with a foreign firm audit the same, so that substantially no rota- tion occurs. Therefore, the rotation is only to abort an obligation, and not as to maintain auditquality.
Citron and Taffler (1992) reveal that auditquality has valued when both technically independence and competence are attributed to the audit process. Wolnizer (1987) expressed, the motto “independent in fact and independent in appearance” served as objectivity and attitude of impartiality i.e. the “ mental” process of the auditor and the “competence” as the perception of investors, shareholders, clients, regulatory board and financial market on Big Accounting Firms. Flint (1988) observed in fact and in appearance to independence as trust and capacity of judgment between the clients and higher auditquality. The competence and independence of Big Accounting Firms should be considered as reliable information, qualification, sufficient knowledge, and experience to deliver higher auditquality (Flint, 1988). Lee and Stone (1995) documented the probable of Big Accounting Firms’ competence to be followed by higher quality in independence. The more probable the local accounting firm is incompetent, the more is probably the low quality is dependent. Hence, auditor competence dominates the evaluation of auditquality.
In the literature conducted in Vietnam, the quality of the audit, the improvement of auditquality control and the factors affecting the quality of the audits, mainly focused on the financial statement auditing, have also been attractive to some researchers in the country. It can be mentioned as Ngo (2002), Ha (2011), Bui (2013) and others. These studies pointed out the external factors such as the regulatory environment, the internal control of the client company; internal factors such as the independence of auditors, professional capacity, compliant standards and others. These researches focus on the quality of financial statement audits conducted by independent audit firms; Moreover, the impact of the factors on the quality of the audit is mostly through interviews and the use of statistical descriptions of the mean, so the persuasiveness is certain and does not make readers satisfy about the level of influence. The recommendations are somehow unconvincing.
Over the past years, many studies have investigated the factors influencing auditquality and fee. Few studies have examined the effect of ownership concentration, especially family ownership and control on audit fee and quality. Studies show that there are two views about the effect of family control and ownership on audit fee and quality. The agency theory states that family firms may decrease or increase agency problems (Khan and Subramaniam, 2012). According to this theory, however, there are motives for family firms to maximize personal interests and to influence the process of financial reporting which result in increased agency costs. As a result, increased agency costs require risk evaluation and high audit efforts and therefore a higher audit fee. On the other hand, family ownership can also be considered for the improvement of internal monitoring and reduction of conflicts of interests between manager and owner, therefore resulting in decreased audit risk evaluation and audit fees (Khan and Subramaniam, 2012).
auditors (GAO 2003), limiting auditor tenure destroys client-specific knowledge essential for an effective and efficient audit, thus increasing audit failures at initial years of audit engagements (PricewaterhouseCoopers 2002, 2007, 2010). Extended tenure, however, increases auditquality over time as the auditor gains a better understanding of the client‟s system, business and industry environment, and internal controls (AICPA 1978; Dunham 2002; Hills 2002). Proponents, in contrast, believe that auditquality deteriorates after a certain number of years of auditor-client relationship due to lack of independence (Doty 2011; PCAOB 2011). A new audit, however, brings a „fresh look‟ to the audit engagement. To emphasize the negative consequences of extended auditor-client relationship, Doty (2011) describes a case where the auditor was willing to raise the materiality threshold to help his client meet or beat earnings targets. During the eight years of inspection work on big public company audits since 2004, the PCAOB has repeatedly noticed instances where auditors with lengthy tenure have a bias toward accepting management‟s viewpoints without developing an independent view and challenging management‟s assumptions and assertions (PCAOB 2011).
The correlation coefficient between accounting conservatism and the variables display the expected sign. As with previous studies, the highest correlation coefficient is for FAGE. Further, AUDBIG4, AUDISA and FAGE have positive correlation with ACCR. In contrast, LEVE has a negative correlation with ACCR. Variables exhibiting insignificant results are OCFL and SAGR. Table 2 displays that there are no correlation coefficient values above 0.90; this reveals that there is no sign of potential multicollinearity (Hair, Anderson, Babin, & Black, 2010). Next, this study discusses the multivariate analysis used to test the developed hypotheses. According to the findings reported in Table 3, for auditquality measured by brand name auditor and industry specialist auditor and control variables (OCFL, LEVE, FAGE and SAGR), the values are 90.74, 0.11 and 0.16 of the total variance of accounting conservatism at the 1% level of significance in Model 1, Model 2 and Model 3.