THE RELATIONSHIP BETWEEN AUDITOR INDEPENDENCE, FIRM CHARACTERISTICS AND AUDIT QUALITY

  • Chapters:5
  • Pages:79
  • Methodology:Ordinary Least Square
  • Reference:YES
  • Format:Microsoft Word
(Business Administration and Management)
THE RELATIONSHIP BETWEEN AUDITOR INDEPENDENCE, FIRM CHARACTERISTICS AND AUDIT QUALITY
CHAPTER ONE: INTRODUCTION

1.1    Background to the Study
It has been advocated by auditing scholars that the main aim of an audit assignment is to produce a quality report. The emphasis here is on ‘quality report’, hence, it is presumed that the major role of the auditor is the production of a quality report; achieved through strict adherence to the principles of high audit quality. DeAngelo (1981) defines audit quality as the market-assessed joint probability that a given auditor will both detect material misstatements in the client’s financial statements and report the material misstatements. This probability depends upon the broad concept of an auditor’s professional conduct, which includes factors as objectivity, due professionalism and conflict of interest (Mgbame, Eragbhe&Osazuwa, 2012).
Chang, Dasgupta and Hilary (2009) noted that a good-quality auditor will always detect any misreporting, so its clients announced earnings are the same as its true earnings. Similarly, Gul, Lynn and Tsui (2002) define audit quality as the auditor’s ability to detect and eliminate errors and manipulations in reported earnings.Chan and Wong (2002) noted that audit quality, though unobservable, impacts the probability of successful detection of discrepancies between the firms’ favorable report and the true quality of the project. The implicit common link in all these statements is the auditor’s ability to satisfy their professional obligation to find material misstatements through the execution of the audit process. Due to the fact that these characteristics are largely unobservable,different proxies have been used by researchers to measure audit quality like: audit size, audit hours, auditfees, corporate reputation, board independence and discretionary accruals.
Corporate scandals like Enron debacle and Andersen collapse confirmed a requirement for high qualityaudit and considerable attention to different factors that may have effect on audit quality. High quality auditrefers to the production of financial information without misstatements, omissions or biases. From an agencytheory perspective, Dang (2004) argues that audited financial statements are a monitoring mechanism toprovide assurance for users of financial information.In essence, auditing is used to provide the needed assurance for investors when relying on audited financial statements. More precisely, the role of auditing is to reduce information asymmetry on accounting numbers, and to minimize the residual loss resulting from managers’ opportunism in financial reporting (Adeyemi&Fagbemi, 2010). Effective and perceived qualities (usually designated as apparent quality) are necessary for auditing to produce beneficial effects as a monitoring device. Although so many different proxies have beenutilized, Lennox (1999) believed that most researchers generally agree that auditor independence and sizeare appropriate indicators of audit quality.
It is therefore, based on these tenets, that this study aims to analyze the relationship between auditor independence, firm characteristics and audit quality. Having established that the contribution of the auditor is basically through the production of a quality report, the study investigates the factors that could influence the achievement of high audit quality and determine the existence of relationships and correlation among these factors.
1.2    Statement of the Research Problem
The production of a quality audit report is perceived to foster engendered confidence in financial reports by the users of those reports. Investors in particular tend to place better trust in financial statements that are audited; as the expected independence of the auditor boosts the assurance that important investment decisions can be made on the thrust of those statements (Hsieh, 2011). The increased confidence of these set of financial users tends to attract the inflow of capital which has the long-run effect of creating growth and development in the business environment.
However, inefficiencies on the part of management could lead to ‘structured financial statements’. These financial statements ordinarily do not show the true state of affairs and financial position of the organization and hence, could jeopardize the decisions of prospective investors. Adverse results on investment would reduce the credibility of the financial statements; which would in turn reduce the level of capital flow, thereby deteriorating the state of the business environment (Cook & Omer, 2012). The onus therefore rests on the auditors to address these issues through efficient and effective execution of the audit assignment, and the resultant production of a quality report. The study therefore investigates the factors that could affect the quality of the audit assignment, and analyzes the existence and degree of relationships between these factors and the achievement of high audit quality.
The value relevance of auditing depends upon the quality of audits. However, Moizer (1997) noted that the appraisal of the indices of measuring the quality of the audit service is not without its challenges since audit quality is typically unobservable (as cited in Francis, 2004). Thus, according to Heflin and Shaw (2000), auditing could be categorized as a type of credence good and hence auditors add credibility to corporate financial reports by expressing an opinion about the true and fair representation but only in so far as the users of financial statements perceive that opinion as valuable. That is, the audit service acquires value because of the trust clients place upon the auditor. In this regards, Hardies, Breesh and Branson (2010) argued that audit quality is not simply a linear function of auditor competence and auditor independence, but also on the market’s perception about the value of the auditor’s report which is the result of the perceived competence and the perceived independence of the auditor. From this perspective, audit quality refers to the credibility of the audit opinion which is a measurement of the degree of confidence users place upon the information provided by the auditor. However, the non quantitative nature of audit quality as a variable has necessitated the existence of a plethora of proxies and indicators for its measurement (Cohen & Hanno, 2000). Some studies (Francis, 2004; Geiger &Raghunandan, 2002) measure audit quality in terms of audit or reporting failure, based on the idea that audit quality is inversely related to audit or reporting failures. Other studies (Nagy, 2005; Myers, Myers & Omer, 2003) use earnings as a surrogate for audit quality. The implicit assumption is that high audit quality implies high earnings quality (Johnson, Khurana& Reynolds, 2002). Researchers have also used estimated discretionary accruals as a surrogate for audit quality (DeChow, Sloan, & Sweeney, 1996) assuming that higher estimated discretionary accruals reflect lower earnings quality and thus lower audit quality. Krishnan and Schauer (2000) noted that audit quality is measured by the propensity of the auditor to issue a going concern opinion after controlling for other factors that might affect this decision. All of the divergences with regards to the appropriate measure of audit quality may be seen to reflect the need by researches to monitor and provide indices amenable to control so as to make inferences on the audit quality, as the need to monitor necessarily should be preceded by the ability to appropriately define the concept. Consequently, studies have attempted to identify possible control variables for the state of audit quality. In light of these studies, there are conflicting findings which this research attempts to provide empirical evidence from Nigeria using the engagement of the Big-4 audit firms as a proxy for audit quality, and investigating the variance of the results as compared to those of prior studies. The following research questions are therefore proposed.
What is the relationship between auditor independence and audit quality?
What is the relationship between board independence and audit quality?
What is the relationship between ownership structure and audit quality?  
Is there a relationship between firm size and audit quality?
Is there a relationship between audit committee independence and audit quality?
1.3    Objectives of the Study
The main objective of the study is to ascertain the relationship between auditor independence, firm characteristics and audit quality. The specific objectives of the study are to:
Investigate the relationship between auditor independence and audit quality.
Determine the relationship between board independence and audit quality.
Analyze the relationship between ownership structure and audit quality.
Ascertain the relationship between firm size and audit quality.
Analyze the relationship between audit committee independence and audit quality.
1.4    Research Hypotheses
The following null hypotheses are postulated for the study:
Ho1: There is no significant relationship between auditor independence and audit quality.
Ho2: There is no significant relationship between board independence and audit quality.
Ho3: There is no significant relationship between ownership structure and audit quality.
Ho4: There is no significant relationship between firm size and audit quality.
Ho5: There is no significant relationship between audit committee independence and audit quality.
1.5    Scope of the Study
The study investigates the relationship between auditor independence, firm characteristics (which for the purpose of this study includes board independence, ownership structure, firm size and audit committee independence) and audit quality. The study focused on 50 firms listed on the Nigeria Stock Exchange, and cuts across various industries. Thus, the study is a panel study and covers a period of 5 years (2006 – 2011).
1.6    Significance of the Study
The study aims to provide additional insights into the relationship between auditor independence, firm characteristics and audit quality in the Nigerian context.  It is hoped that the evidence would serve as important quantitative information for policy formulation, as well as add to the existing body of empirical literature from a developing stock exchange such as that of Nigeria.
Investors perceive audited financial statement to be more useful in making economic decisions. The audited nature of financial statements has however, failed to correct the syndrome of failing organizations. An understanding of the factors that impinge on audit quality is therefore essential for investors and stakeholders alike. It is also hoped that the research will contribute to existing knowledge and act as a guide for future researchers.
1.7    Limitations of the Study
A study of this nature cannot be carried out, without some form of constraints militating against it. These constraints do not only make the execution of the research work difficult, but also limit the scope of study. The problem to be encountered in the use of secondary data in this research is the assurance of reliability. The selection of the sample (to be achieved through the use of random sampling); despite its representativeness of the population, cannot be expected to produce exactly the same results as the entire population. Also due to availability of data, the scope of the research is limited to public companies listed on the Nigerian Stock Exchange.
REFERENCES
Adeyemi, S. B., &Fagbemi, T. O. (2010).Audit quality, corporate governance and firm characteristics in Nigeria.International Journal of Business and Management, 5(5), 169-179.
Chan, D., &Wong, K. (2002).Scope of auditors’ liability, audit quality, and capital investment.Review of Accounting Studies,7(2), 97-122.
Chang, X., Dasgupta, S., Hilary, G. (2009).The effect of auditor quality on financing decisions.The Accounting Review,84(4), 1085-1117.
Cohen, J. R., & Hanno, D. M. (2000). Auditors' consideration of corporate governance mid management control philosophy in preplanning and planning judgments. Auditing: A Journal of Practice & Theory, 19(2), 133-146.
Dang, L. (2004).Assessing actual audit quality(Unpublished PhD thesis).Drexel University, Philadelphia, USA.
DeAngelo, L. E. (1981). Auditor size and audit quality.Journal of Accounting and Economics, 3(3), 183-199.
DeChow, P.M., Sloan, R.G., & Sweeney, A.P. (1996). Causes and consequences of earnings manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research, 13(1), 1-36.
Francis, J. (2004). Are auditors compromised by non-audit services? Assessing the evidence.Contemporary Accounting Research,23(3), 747-760.
Geiger, M., &Raghunandan, K. (2002).Auditor tenure and audit reporting failures.Auditing: A Journal of Practice and Theory 21(1), 67-78.
Gul, F., Lynn, S. G., &Tsui, J. (2002).Audit quality, management ownership, and the informativeness of accounting earnings.Journal of Accounting, Auditing and Finance,17(1), 25-49.
Heflin, F., & Shaw, K. (2000).Blockholder ownership and market liquidity.Journal of Financial and Quantitative Analysis, 35(4), 621-633.
Johnson, V., Khurana, I., & Reynolds, J. (2002). Audit-firm tenure and the quality of financial reports. Contemporary Accounting Research, 19(4), 637-660.
Krishnan, J., &Schauer, P. C.(2000). The differentiation of quality among auditors: Evidence from the not-for-profit sector. Auditing: A Journal of Practice and Theory, 19(2), 9-26.
Lennox, G. S. (1999). Audit quality and auditor size: An evaluation of reputation and deep pockets hypotheses.Journal of Business Finance and Accounting, 26(7), 779-805.
Mgbame, C. O., Eragbhe, E., &Osazuwa, N. P. (2012). Audit partner tenure and audit quality: An empirical analysis. European Journal of Business and Management, 4(7), 154-162.
Myers, J., Myers, L., & Omer, T. (2003). Exploring the term of the auditor-client relationship and the quality of earnings: A case for mandatory auditor rotation? The Accounting Review, 78(3), 779-799.
Nagy, A. (2005). Mandatory audit firm turnover, financial reporting quality, and client bargaining power: The case of Arthur Andersen. Accounting Horizons, 19(2), 51-68.

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Project Details

Department Business Administration and Management
Project ID BAM0741
Price ₦3,000 ($9)
Chapters 5 Chapters
No of Pages 79 Pages
Methodology Ordinary Least Square
Reference YES
Format Microsoft Word

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    Project Details

    Department Business Administration and Management
    Project ID BAM0741
    Price ₦3,000 ($9)
    Chapters 5 Chapters
    No of Pages 79 Pages
    Methodology Ordinary Least Square
    Reference YES
    Format Microsoft Word

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