Higher Audit Quality Research Articles

Fair Value of Earnouts: Valuation Uncertainty or Managerial Opportunism?

ABSTRACT This study investigates the economic consequences of the IFRS 3 (2008) requirement for fair valuing earnouts. Using a hand-collected sample of earnout fair value estimates in acquisitions completed by Australian firms, we find that a significant portion of acquirers overstate initial earnout liabilities and strategically reverse them as operating gains to boost post-M&A earnings. These overstatements are more pronounced when acquirers face investment- and performance-related pressure but attenuated in the presence of high-quality auditors and debt-financed deals. Acquirers also obfuscate earnout-related disclosures, inhibiting investors’ assessment of earnout values. By doing so, managers extend their tenure. Further analysis reveals that IFRS 3 (2008) leads to a significant increase in both the frequency and magnitude of earnouts in public acquirers’ transactions. Overall, we highlight the accounting benefit of earnouts for acquirers under IFRS 3 (2008), with implications for investors, analysts, auditors, and standard setters. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: G34; M41.

The Effectiveness and Efficiency of Auditors’ Remote Work during COVID-19

SUMMARY The COVID-19 pandemic introduced unprecedented challenges to the audits of public companies. Audit firms, in response, dedicated significant resources to maintain high-quality audit procedures. We leverage a difference-in-differences design to examine the effects of the pandemic on audit outcomes. Despite audit firm efforts, we find evidence of a decline in audit quality in the initial months of the COVID-19 pandemic. Further, in the early days of the pandemic, the SEC made available a unique one-time, 45-day extension to file the audited annual report. In this time period, we observe a significant increase in the likelihood of delayed filings, including those attributed to the auditors’ work. Our study informs regulators and audit firms about the broad impact of an unprecedented stressor on the audit process and on the efficacy of remote work. JEL Classifications: M4; M41; M42.

The Effect Of Auditor Competence And Auditor Independence On Audit Quality With Auditor Ethics As A Moderating Variable

Financial statements that have been audited by a public accountant are more trustworthy than unaudited or unaudited financial statements. However, in recent years the quality of audits produced by public accountants has been under scrutiny by the public because there are differences in the auditor's opinion with the actual condition of the company. Auditor competence, auditor independence and auditor ethics have an important role in ensuring audit quality. This research is a quantitative study, using a survey method using purposive sampling with the respondent criteria for each KAP being 1 auditor. Data was collected using a questionnaire instrument which was measured using a Likert scale. The population of this study were auditors working at the Public Accounting Firm (KAP) in South Jakarta with active status at the OJK, totaling 76 KAPs and receiving 55 respondents to a questionnaire. The data analysis used was using the partial least squares (PLS) with the help of the SmartPLS program. The results of data analysis prove that: (1) auditor competence has a significant positive effect on audit quality with an original sample estimate of 0.369, a statistic of 3.594 and a significance <0.05, (2) auditor independence has a significant positive effect on audit quality with an original sample estimate value of 0.567, t-statistic 3.191 and significance <0.05, (3) auditor ethics can positively moderate the influence of auditor competence on audit quality with an original sample estimate value of 0.288, t-statistic 2.445 and significance <0.05, (4) and auditor ethics not can moderate the influence of auditor independence on audit quality with an original sample estimate value of -0.251, a t-statistic of 1.584 and a significance > 0.05. The practical implication of this research is to produce high audit quality, auditors must improve the competence, independence and ethics of their auditors so that the resulting audit report can be the basis for making the right decision.

The more, the merrier? The role of an auditor's certification in loan pricing

PurposeThe purpose of this paper is to explore the role of three different audit characteristics in loan pricing—the most significant credit term for borrowers. Three characteristics include audit reputation, audit tenure and audit specialization.Design/methodology/approachTo examine audit characteristics simultaneously to measure their effect on loan pricing, this study uses a full-rank, three-way interaction model and conducts slope difference tests. It also includes the joint effects of these variables to estimate any incremental benefits of possessing multiple qualifications.FindingsWhen studying the three qualifications together, none of them alone is strong enough to affect the loan interest. But, a Big 4 auditor with tenure can benefit the client by reducing the interest by about 1.98%. The more expertise the auditor has, the better value it brings to borrowers. A highly qualified auditor with additional expertise can significantly reduce loan pricing further by about 2.96 percent.Originality/valueExamining the costs and benefits of hiring certified auditors is crucial for borrowers. While the variables are not exhaustive, an understanding of the added value of hiring high-quality auditors with more than one or two qualifications to their potential premium fees helps borrowers in managers' audit selection decisions. At the same time, the results shed some light on which of the auditor's qualifications lenders might prioritize when pricing a borrower's loan.

Accounting Accruals, Audit Quality, and Audit Pricing

This study examines the impact of the interaction between firms' accounting choices and auditors' audit effort choices on audit pricing. In a multi-period model, I focus on a central feature of accounting: reversing accruals. I find that initial low-balling, defined as lower audit fees than audit costs, arises independently from the direction of accruals, but increases with more conservatism in the first engagement period. The reason is that a conservative accruals strategy implies understated earnings today and overstated earnings in the future, which creates a higher investor demand for auditing services in future periods. The incumbent auditor can satisfy this future demand better than any competitor, because the first-period learning cost is sunk. Thus, conservatism enhances the competitive advantage of the incumbent and increases the future quasi-rent, which is used for a higher initial low-balling discount. I further show implications of the auditor-firm interaction for fee-cutting, a common proxy for low-balling, and the frequency of modified audit opinions, a common proxy for audit quality. Thus, my model provides a theoretical foundation for the connection between high low-balling discounts, accounting accruals, and audit quality.

Organizational complexity and audit report lag in GCC economies: the moderating role of audit quality

Purpose This study aims to investigate whether organizational complexity (hereafter firm complexity) increases audit report lag (ARL) in a unique environment of GCC countries. Design/methodology/approach The research study uses a panel data set of 6,084 firm-year observations of nonfinancial firms from GCC economies from 2009 to 2022. First, the study uses an ordinary least square estimator to examine the association of firm complexity with ARL. Second, for robustness purposes, the study applies the propensity score matching technique. Findings This research study finds that the firms’ complexity increases ARL. Supporting the argument that auditors respond to firm complexity with increased effort, the authors find a positive relation of firm complexity with ARL. This relationship is augmented by auditor change, auditors’ tenure, auditor-qualified opinion and adoption of IFRS. In addition, the authors also find that Big-4 and audit firm industry specialization curtail the positive impact of firm complexity on ARL. Research limitations/implications Firms in the GCC have less time to complete their audit and complex firms are likelier to have bigger ARLs. This study provided evidence regarding the curtailing effect of audit quality in GCC. Our findings suggest policymakers and reformers choose improved audit quality to reduce the possibility of larger ARL. Originality/value This study enriches the scholarship by presenting a mechanism for reducing the ARL of complex firms through higher audit quality. This study contributes to agency theory by emphasizing audit quality’s important role in emerging markets.

Family succession and cost of bank loans: Evidence from China

This study examines the effect of family succession on the cost of bank loans and non-price contractual terms. We use a unique dataset from China and find that lending banks are likely to charge higher interest rates and offer tighter contractual terms, such as loan maturity and collateral requirements, for family succession firms. These findings indicate that information asymmetry and default risks may arise after subsequent family successions. We also find that family succession firms can lower the cost of bank loans by hiring top-tier auditors, who can enhance financial reporting credibility. This finding suggests that professional, high-quality auditors can provide extremely valuable services to family succession firms.

Pengaruh Risiko Audit Dan Stres Kerja Terhadap Motivasi Auditor Pada Kantor Akuntan Publik Kota Padang

This research aims to find out how much influence audit risk and work stress have on the motivation of auditors at the Padang City Public Accounting Firm. In this research, the population is all auditors in public accounting offices in Padang City. The population in this study was 92 people consisting of several employees who had different positions/groups in KAP Padang City. The sampling method used was the accidental sampling method. The regression analysis carried out was multiple linear regression analysis. The research results obtained based on the partial test (t test) showed: (a) The audit risk variable has a positive and significant effect on auditor motivation. (b) The work stress variable has a positive and significant effect on auditor motivation. Meanwhile, the simultaneous test of audit risk and work stress has a positive and significant influence on auditor motivation. Auditors may be motivated by the challenge of performing high-quality audits in the face of increased audit risk. These challenges can provide a sense of accomplishment and satisfaction for auditors who successfully navigate risks and complete high-quality audits. The stress faced in challenging work situations can motivate individuals to try harder and challenge themselves. When someone feels that they can overcome or cope with a difficult task, this can increase their motivation to succeed.

The Informative Value of CG Code Voluntary Disclosure on Firm Performance When Moderated by External Auditors

The study aims to empirically examine the voluntary disclosure of the corporate governance code (CG Code) of Thai-listed companies. It also examines the effects of the information value of the CG Code on firm performance and the moderating role of external audit quality in this effect. A disclosure specification comprising 137 voluntary items recommended by the OECD is employed to judgmentally evaluate the CG Code disclosed by the 95 fully implementing firms listed on the Stock Exchange of Thailand. The analysis is performed using multivariate regression techniques along with Hayes’s regression-based analysis and shows that CG Code and audit quality have a statistically significant positive effect on firm performance. In addition, audit quality was found to moderate the positive effect of the CG Code on firm performance, such that the effect of the CG Code on firm performance is strengthened as the quality of audits increases. Specifically, the positive effect of CG Code on firm performance is stronger when the audit quality is at the average value and above, whereas CG Code shows no statistically significant effect on firm performance when audit quality is below average. The paper has contributed to the academic literature that managers should be motivated to voluntarily disclose the CG Code and also engage with high-quality auditors in general and Thailand in particular.

Auditor Choices in Family Companies

This study aims to empirically examine the comparison of auditor choice and audit fees in family firms, as well as to test more comprehensively how the characteristics of family firms will influence the choice of auditors and audit fees in family firms. The purposive sampling results of this study show that the number of sample companies in this study is 133 non-financial companies listed on the Indonesia Stock Exchange in 2015-2021, with a total of 931 observations. The results of the logistic regression analysis of the auditor's choice model in this study indicate that family firms tend to be less choosing a high-quality auditor (auditor of KAP BIG4) and the presence of a CEO who is descended from the founder's family company is negatively related to the appointment of an auditor for KAP BIG4. In addition, the percentage of family ownership, the presence of the founder CEO of the family company and the presence of a professional CEO of the family company are not related to the appointment of KAP BIG4 auditors. The results of ordinary least square regression analysis using the robust standard error estimation method on the audit fee model show that family firms and the percentage of family members in top management are negatively related to audit fees, while the percentage of family ownership and the percentage of family members on the board of commissioners is not related to audit fees.

Ownership Concentration and Audit Actions

This study presents current evidence on the impact of different corporate ownership types on audit quality in Oman and potentially in other developing countries with similar institutional environments, such as GCC countries. While previous research has primarily focused on overall ownership concentration, this study aims to examine the role of specific shareholder identities and their influence on the demand for audit quality. This research sheds light on the relationship between ownership identities and audit quality of Omani financial companies listed on the Muscat Stock Exchange from 2014 to 2020. This study employs additional analysis to mitigate potential confounding factors and ensure robust results. Additionally, a GMM test establishes the robustness of our findings, alleviating potential endogeneity concerns. The findings highlight the positive impact and significance of bank, government, and foreign ownership in promoting high audit quality. In contrast, ownership by financial institutions (non-banks) and block holder concentrations negatively and significantly impact audit quality. In addition, this study found that family members on boards play positive moderating roles in the relationship between ownership concentration and audit quality. In addition to contributing to the existing literature, this study provides valuable insights for regulatory bodies to consider the role of ownership types in their decision-making processes. Our findings also assist investors in making informed choices and offer a better understanding of how ownership structures influence audit quality for other stakeholders. The implications of this research extend beyond Oman and can be relevant to countries with similar ownership structures and regulatory frameworks.

THE INFLUENCE OF COMPANY SIZE, AUDITOR QUALITY AND AUDIT OPINION ON THE TIMELINESS OF FINANCIAL REPORTING WITH PROFITABILITY AS A MODERATION VARIABLE

This research delves into the determinants of financial reporting timeliness, with a specific focus on the moderating effect of profitability. It examines factors such as company size, auditor quality, and audit opinion in the context of 46 banking companies listed on the Indonesian Stock Exchange, utilizing secondary data from the exchange itself. Employing the Partial Least Modeling (PLS-SEM) Structural Equation Modeling approach, the study reveals noteworthy insights. It finds that company size and auditor quality significantly impact reporting timeliness, indicating that larger companies and those with higher-quality auditors tend to report financial information more promptly. Surprisingly, neither audit opinion nor profitability demonstrates a direct influence on financial reporting timeliness, although profitability does act as a moderator, significantly affecting the relationship between company size and reporting timeliness. However, profitability does not play a similar moderating role in relationships involving auditor quality and audit opinion. In summary, this research elucidates the multifaceted nature of factors influencing financial reporting timeliness in the banking sector of the Indonesian Stock Exchange, highlighting the direct impacts of company size and auditor quality alongside the nuanced role of profitability as a moderator in specific relationships.

Do media coverage and audit quality of US companies affect their Environmental, Social and Governance transparency?

Purpose The purpose of this paper was to study the direct impact of audit quality on environmental, social and governance (ESG) transparency. It aimed also to investigate the moderating effect of media coverage on the relationship between audit quality and ESG transparency in the USA. Design/methodology/approach The sample consisted of US companies listed in the Standard and Poor’s 500 Stock Index between 2010 and 2019. The Thomson Reuters database was used to collect ESG disclosure scores and governance information. The authors applied multiple panel data regressions. Findings The results showed that audit quality has a direct positive effect on ESG transparency. The findings also showed that the high exposure to public media by firms, the more they commit to high audit quality leading to disclose more transparent ESG information. Research limitations/implications The results illustrated the significance of an external audit on an organization’s ESG report. Second, improving data quality has significant consequences not only for rating agencies but also for investors, businesses and researchers. These steps are required to increase the information content of ESG ratings. Originality/value The findings demonstrated that third-party external verification improves the dependability of nonfinancial reporting, hence bridging the confidence gap between corporations and the market regarding sustainability reporting.

The Influence of Cultural, Legal and Institutional Factors on Auditors' Roles, Responsibilities and Perceptions of Audit Quality

This study provides an international perspective on auditing practices by comparing and contrasting the qualitative aspects of auditing across different countries and regulatory environments. It examines how cultural, legal, and institutional factors shape auditors' roles, responsibilities, and perceptions of audit quality. The research explores the influence of these factors on auditors' professional ethics, independence, and accountability. By analyzing the similarities and differences in auditing practices, the study sheds light on the variations in regulatory frameworks and cultural contexts that impact the profession. It highlights the importance of understanding these factors to ensure effective and high-quality audits. The findings contribute to a better understanding of the global auditing landscape and provide insights for regulators, standard-setting bodies, and auditors to enhance auditing practices and standards. The study also emphasizes the need for further research in this area to deepen our understanding of the complex interplay between cultural, legal, and institutional factors in auditing.

Auditor Materiality Threshold and Audit Quality—Evidence from the Revised ISA 700 in the United Kingdom

SYNOPSIS Using a broad sample of U.K. firms that are required to disclose auditor materiality thresholds under the International Standards on Auditing (United Kingdom and Ireland) 700, we examine whether the auditor materiality threshold is associated with audit quality. We document that a lower materiality threshold is associated with higher audit quality, as measured by lower absolute discretionary accruals, higher accruals quality, and a lower propensity to just meet or beat analysts’ earnings expectations. We also find some evidence that the negative association between the materiality threshold and audit quality is attenuated when the audit committee is more effective and when the auditor is more economically dependent on the client, and the negative association is more pronounced when management has a stronger incentive to manage earnings. Overall, our study extends the limited studies on large-sample archival evidence on the implications of audit materiality thresholds on audit outcomes. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M40; M41; M42.

Auditors’ response to earnings management after split-share structure reform in China

PurposeThis study aims to investigate whether and how auditors responded to the documented increases in earnings management after split-share structure reform (SSSR) in China, as manifested in auditors’ propensity to issue modified audit opinions (MAOs) after the SSSR. This study further investigates how client importance and auditor size influence auditors’ response to earnings management after the SSSR.Design/methodology/approachThis study adopts logit regression models to investigate auditors’ propensity to issue MAOs to their clients that appear to manage earnings after the SSSR. Initially, including all Chinese publicly listed firms from the CSMAR database, the sample for final analyses consists of 21,904 firm-year observations for 1,290 unique listed firms during the period 2001–2020. The sample period surrounds the implementation of the SSSR, which started in 2005, allowing the examination of auditors’ propensity to issue MAOs after vis-à-vis before the SSSR.FindingsThe authors find that non-Big10 auditors in China were less likely to issue MAOs to their economically important clients who appear to manage earnings after SSSR. However, in the years of non-tradeable shares being released to the markets, both Big10 and non-Big10 auditors were less likely to issue MAOs to their economically important clients who appear to manage earnings. The findings suggest that auditors may have compromised auditor independence in response to earnings management after the SSSR, likely due to the pressure from their economically important clients.Originality/valueThis paper contributes to the literature, specifically the practice and theory in auditing, by shedding light on ever-changing auditors’ reporting behaviour, especially with regard to auditor independence. It also adds to the growing body of literature on the impact of institutional changes on auditing practices worldwide. The findings of this study further suggest that the recently documented declining demand for high-quality audits after the SSSR may be motivated by the clients’ intention to manage earnings after the SSSR.

Evaluation of ownership structure and audit-quality in the wake of the Covid-19 crisis: empirical evidence from Jordan

PurposeThis study aims to collect new empirical evidence to determine how different forms of ownership structure responded to the recent COVID-19 crisis. In light of this tragedy, it explores the relationship between ownership structure forms (i.e. block-holders, foreign, institutional and family ownerships) and audit quality (proxied by audit fees).Design/methodology/approachIn total, 3,200 firm-year observations for Jordanian enterprises covering the years 2005 through 2020 are used in an ordinary least squares regression with firm-clustered standard error to assess the hypotheses.FindingsThe regression results showed that COVID-19 strengthens the association between each type of ownership (i.e. block-holders, foreign, institutional ownership forms) and audit quality. This result reflects the need for high-quality audit services during the pandemic by such owners to improve their business decisions and limit agency-conflict issues. However, the analysis failed to find any effect of COVID-19 when it comes to family ownership. Family-controlled firms may react faster in crisis situations, and correspondingly, they do not bear high audit costs. The extended analysis covering the years 2005–2022 came to the same results.Practical implicationsThe results aid authorities in their control and management of the auditing business. The findings have important consequences for policymakers, lawmakers, regulators and the audit profession as they assess the growing issues in an uncertain economic environment. Evidence is provided that may be used to reassure investors and aid authorities as they devise appropriate remedies to the pandemic-triggered economic crisis. The findings may aid in the improvement of legislation that governs Jordan’s auditing industry. Furthermore, the results can be generalized to other Middle Eastern countries.Originality/valueTo the best of the authors’ knowledge, this is the first study to empirically evaluate how different types of ownership affect audit quality in response to a dramatic shift in auditors’ working conditions brought on by the global health calamity. In emerging economies like Jordan, this type of analysis allows for preliminary assumptions to be established about ownership status during the COVID-19 outbreak. It adds to the body of auditing knowledge by shedding light on how various kinds of ownership affect responses to adverse events. This assessment is intended to serve as the definitive testimony in the field of accounting regarding the effects of the coronavirus across various corporations’ portfolios.

How Audit Quality Affects Bank Performance and Stability with Moderating Role of Ownership Structure

This study examines the impact of audit quality on bank performance and stability, considering ownership structure. Analyzing BR/CS economies and Pakistan from 2010 to 2020, it finds that audit quality positively affects bank performance and stability. Foreign ownership moderates this relationship, while public ownership does not. These findings inform policymakers and regulators in promoting high-quality auditing practices and improving bank stability and performance. Audit quality is a crucial factor in maintaining the financial success and stability of banks, contributing to improved performance and transparency. Foreign ownership has a significant and positive moderating effect on the relationship between audit quality and bank performance and stability. The findings have implications for policymakers and regulators in implementing policies that promote high-quality auditing practices and enhance the stability and performance of banks in BR/CS economies and Pakistan. The current research focuses on the moderating role of ownership structure in the relationship between bank profitability, audit quality, and performance in BR/CS countries and Pakistan, which is a novel approach. The global financial crisis of 2007-2008 highlighted the importance of audit committees in overseeing financial institutions and enforcing regulations and standards. Emerging economies like BR/CS face unique challenges due to weaker regulatory structures, less mature financial systems, and higher levels of debt. Long-term stability of banks is crucial for the overall economic system and the incidence of financial fraud and bankruptcies affects investor confidence and economic growth.

Knowledge Creation and Transfer in the Context of National Office Consultations: Experiences of Audit Firm Partners

SUMMARY Knowledge creation and transfer within audit firms is critical to achieving high audit quality. We conduct semistructured interviews with 22 engagement partners and national office partners, and we draw on Nonaka and Takeuchi’s socialization, externalization, combination, and internalization (SECI) model to understand how knowledge creation and transfer processes unfold in audit firms in the context of national office consultations. Overall, we observe that the national office and engagement partners engage in all four processes of knowledge creation and transfer outlined in the SECI model: tacit to tacit, explicit to explicit, tacit to explicit, and explicit to tacit. Our study offers implications for auditors and regulators and brings to light opportunities for future auditing research. JEL Classifications: M41.

Board Members’ Outside Directorships and the Demand for Audit Quality: Large Sample Evidence From Private Firms

Board members with multiple directorships develop reputational capital as decision experts. Prior studies based on public firms suggest that such directors would use higher quality auditors to improve the quality of financial reporting and, thereby, protect their reputational capital. This study is the first large-scale study that investigates whether multiple directorships influence auditor choice in the setting of private firms. The result indicates a significant positive association between the proportion of board members with outside directorships and audit quality. Furthermore, it shows that the propensity to hire a higher quality auditor is significantly influenced by directors’ network. Finally, the results indicate that the incentives to invest in higher quality auditors are largely influenced by the size of the companies in which board members have their outside directorships.