Social Capital, Intellectual Capital, and Audit Fee: Conflicting Evidence from Iran

Mahdi Salehi,Mahdi Moradi,Hossein Tarighi,Grzegorz Zimon

doi:10.3390/economies10020039

Abstract

In the current study, we investigate the impacts of social capital (SC) and intellectual capital (IC) on audit fees among the companies listed on the Tehran Stock Exchange (TSE). Since the criteria for the norms and the networks are extremely correlated, we used a principal component analysis (PCA) to construct an index of social capital for each province between 2011 and 2016. The Pulic model is also used as a proxy for measuring value added intellectual capital (VAIC). The ordinary least squares (OLS) regression is employed in this study to test our research hypotheses as well. According to the research literature, on the one hand, investors and lenders can be more confident in the financial reporting honesty of the firms headquartered in areas with high social capital; on the other hand, auditors judge the trustworthiness of their clients based on where the firm is headquartered. Inconsistent with the prior studies, our findings show that companies headquartered in provinces with high social capital pay higher audit fees. Given that Iranian firms are under heavy financial pressure due to economic sanctions, those companies located in areas with higher social capital likely have abused the high level of trust that auditors and other groups in the market have in them and participated in earnings manipulation to mask their weak financial performance. Among the various components of IC, we found strong evidence that employed capital efficiency (ECE) and audit costs correlated positively. In short, this paper sheds light on the fact that severe financial pressures on managers may sometimes lead them to take advantage of the dark side of social capital and intellectual capital when preparing financial reports.

Highlights

In the world of auditing, many articles have investigated the determinants of audit fees
The logic behind this argument is based on the fact that social deviations, such as theft and divorce rates, and other factors, can create false and destructive patterns in society and reduce the value of social capital, while appropriate infrastructure in the fields of education, culture, healthcare, welfare, and sports can increase the quality of social capital
Our findings suggest that the higher the capital employed efficiency (CEE), the higher the audit risk and, the audit fee

Summary

Introduction

In the world of auditing, many articles have investigated the determinants of audit fees. Regardless of examining the linkage between the characteristics of clients and audit institutions with audit costs, special attention should be paid to social norms and networks to figure out what kind of impact they can have on the type of management behavior when preparing financial statements. The quality of financial reporting largely depends on the quality of the social environment (Han et al 2010; McGuire et al 2012). This implies that when the level of social capital in society is high, the auditors’ efforts (and, audit fees) will plummet because social norms and networks reduce the risk of opportunistic behaviors (Callois and Angeon 2004). Social capital seems to decrease the use of earnings manipulation, due to additional costs induced by guilt, monitoring, and punishment

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Conclusion