The Effect of Corporate Governance and Audit Market Privatization on the Auditor Independence

Transcription

1 European Online Journal of Naural and Social Sciences 2014; Vol.3, No.3 pp ISSN The Effec of Corporae Governance and Audi Marke Privaizaion on he Audior Independence Afsaneh Soroushyar, Bahman Banimahd*, Hadi Amiri Deparmen of Accouning, Tehran Science and Research Branch Islamic Azad Universiy, Tehran, Iran * Received for publicaion: 21 April Acceped for publicaion: 05 Augus Absrac Esablishmen of he Iranian Associaion of Cerified Public Accounans and audi marke privaizaion as he new phenomenon in Iranian audi marke is aken ino consideraion by many researchers. The purpose of his paper is o invesigae he effec of audi marke privaizaion on audior independence and accruals qualiy, and o sudy wheher corporae governance mechanisms (dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO) can affec above relaions. We es research hypohesis in lised firms on Tehran Sock Exchange (TSE) for he period of 2001 o Using muliple regression analysis, we have found ha audi marke privaizaion is negaively associaed wih audior independence and accruals qualiy. Also, corporae governance mechanisms don decrease he negaive relaion beween audi marke privaizaion, audior independence and accruals qualiy. This paper exends he audi marke lieraure by examining how increased compeiion in he audi marke affecs audior independence and accruals qualiy in emerging markes. Keywords: Audi Privaizaion, Audior Independence, Corporae Governance, Accruals Qualiy Inroducion Financial saemens are he easy and cheap way o access he informaion of companies. Since managers ineress depend o performance of company and also managers prepare he financial saemens, i provides incenives and opporuniies for hem o manipulae financial resuls (Klimenchenko, 2009). Audi services are demanded as monioring devices o deec he vas majoriy of disorions and verify he undisored informaion (Ellio and Jacobson, 1999). Audi increase he reliabiliy of financial informaion by decreasing he noise conained in financial saemens. Audior monioring srengh is deermined by he audiors abiliy o provide objecive repors. Compeence and independence of audior are he measures of audior s monioring effeciveness (Li, 2007). Independen audiors can idenify missaemens in financial saemens and exer pressure on he clien o correc hose missaemens (DeAngelo 1981). As a resul of reducing accouning missaemens, he audied financial saemens show higher qualiy (Chambers and Payne, 2011). Audior independence improves he reliabiliy of he audior s repor in wo ways. Firs, audior independence increases he credibiliy of published financial repors and adds value o sakeholders. The second, audior independence by decreasing informaion asymmery and increasing he informaion ransparency, improve he informaion qualiy (Li, 2007). The issue of audior independence is imporan because much of relaions in he capial markes depend on he credibiliy of he audied financial saemens (Anandarajan e al, 2010). Brown e al (2009) addresses he quesion wheher audior independence affec he earnings qualiy. They find he 651

2 Afsaneh Soroushyar, Bahman Banimahd, Hadi Amiri posiive relaion beween he audior independence and earnings qualiy. Also, Meuwissen e al (2003) examine he relaion of audior independence regulaion and earnings qualiy in he US. Their resuls indicae ha wih increasing he srengh of audior independence regulaion, informaion conen of accruals increase and earnings managemen decrease. Concenraion or compeiion in markes always akes ino consideraion of economiss. Based on he mos of economic heory compeiion in markes improve he qualiy and decease he price of goods and services. Bu according o economic heory of cusomer swiching cos compeiion, in some service indusries such as audi (ha relaionships of cusomer and service providers are long-erm, swiching cusomer requires high ransacions coss and clien specific knowledge is necessary) probably increasing he compeiion in marke decrease he qualiy of services. Because compeiion in audi marke increase he number of audi firms and audiors inclined o reain heir cliens; so, hey may accep quesionable accouning reamens of cliens (Harris and Duellman, 2008). Privaizaion of Iran audi marke lead o esablishmen of privae audi firms, increase he number of audi firms and compeiion in his marke. Accordingly, i seems ha audi marke privaizaion may declines he audior independence and qualiy of financial saemens. The main purpose of his paper is sudying he effeciveness of audi privaizaion plan in Iran and he role of he corporae governance srengh on improvemen he effeciveness of audi privaizaion. The resul of his sudy in several aspecs imporan: firs, his paper is o examine he effecs of he privaizaion of Iranian audi marke on audior independence and financial saemens qualiy by using informaion of firms lised in Tehran Sock Exchange (TSE). Second, he role of corporae governance as a mechanism of moderaing he performance managers on he audi marke privaizaion consequences is examined. Third, his paper adds new evidences abou audi marke privaizaion in capial markes of developing counries. Finally, hese resuls can direc legislaors and sandards seer and provide he paern for oher capial marke in Middle-Eas. This sudy seeks o provide answer hese quesions: Firs, did he audi privaizaion reduce he accruals qualiy? Second, did he audi privaizaion disor he audior independence? Third, did corporae governance mechanisms affec he relaion beween audi marke privaizaion and he accruals qualiy? Fourh, did corporae governance mechanisms affec he relaion beween audi marke privaizaion and he audior independence? The remainder of he paper is organized as follows: The nex secion explains heoreical framework and lieraure review. Secion 3 presens hypohesis developmen. Secion 4 conains sample selecion. Secion 5 explains research design. Secion 6 presens and discusses he empirical resuls of research. Secion 7 concludes he paper. Lieraure Review Audi Marke Privaizaion, Audior Independence and Qualiy of Financial Saemens Before Islamic revoluion in 1979, KPMG, Winney Merry, Arhur Andersen, Arhur Young and Deloie had paricipaed in Iranian audi marke as major audi firms. Afer Iranian revoluion, he ownership of all banks and insurance firms and many indusrial companies were ransferred o governmen conrol. During , he governmen esablished audi firms and he Budge, Planning and Naional Indusries Organizaion. In 1987, following he merger of he public-secor audi firms, he Audi Organizaion was esablished as he sole audior of eniies wih public ownership and as he only regulaory body for naional accouning and audiing sandards. The Audi Organizaion is responsible for compiling and deermining principles and rules of audiing and accouning in Iran (Banimahd and Vafaei, 2012). Openly accessible a hp:// 652

3 Social science secion In 2001, Iranian Associaion of Cerified Public Accounans (IACPA) was esablished. Since ha ime, IACPA members are permied o esablish privae audi firms and provide audi services. Audi marke privaizaion causes o presence of privae audi firms in his marke. As a resul, raio of audior change and compeiion in audi marke increase. The exen of economic consequences of his phenomenon causes he new concerns and quesions for capial marke praciioners. For example, based on economic heory of cusomer swiching cos, compeiion in audi marke leads o desroying he audior independence and subsequenly disoring he financial saemens. Consisen wih he expecaions Harris and Duellman (2008) find compeiion in audi marke decline he qualiy of financial saemens. Also, Kallapur e al (2008) achieve o similar resuls. Francis e al (2013), by sudying audi markes in 42 counries, address he quesion wheher concenraion of audi marke decrease earnings qualiy of cliens. The research resuls indicae dominance of Big 4 doesn harm audi qualiy and earnings qualiy. Jensen and Payne (2003) sudy he effecs of price compeiion on he audi marke. They conclude compeiion in audi marke decrease audi fees, delee he experise premia, inclined o unskilled audi firms and exi Big 6 audi firms. Newon e al (2013) invesigae he relaion of audi marke compeiion and financial resaemens due o defeas in he applicaion of GAAP. Their resuls indicae high audior compeiion increase he probable of financial resaemens. Unlike our expecaions, Yang e al (2001) invesigae he consequences of disaffiliaion of CPA firms from governmen bodies in China. They show ha disaffiliaion program improve he audior independence. Also, Gul e al (2009) find afer performing his program he likelihood of receiving a qualified repor as a measure of audior independence significanly increased. On he oher hand, some researchers believe large audi firms presen more qualiy services. Two argumens o his issue are presened. Firs, DeAngelo (1981) argues larger audi firms have more incenive o issue accurae repors because hey have more o lose from failure o deec and repor he imporan missaemens of cliens. Moreover, Dye (1993) argues larger audi firms have more wealh a risk from liigaion because hey have deeper pocke (Li e al, 2008). DeFond e al (2000) examine he impacs of implemening rigorous new audiing sandards in China. Their resuls show since larger audiors have more loss if hey are found o be in violaion of audiing sandards, i expecs ha larger audiors o be relaively more independen han smaller audiors. Li e al (2008) indicae he posiive relaions beween audi firm size and audi qualiy. Corporae Governance and Qualiy of Financial Saemens The corporae governance mechanism includes he sysem by which organizaions are direced and conrolled and hence, i deermines o implemen he inernal and exernal process and policy. Corporae governance mechanisms improve financial reporing qualiy and decrease he risk of financial reporing problems (Hashim and Devi, 2008). Therefore, he qualiy of financial saemens can be affeced by corporae governance mechanisms. Jiang e al (2008) argue ha weak corporae governance increase he probable of earnings managemen. Abdullah (2004) suggess srong governance pracices improve he reliabiliy of financial repors. Xie e al (2003) invesigae he effec of he board of direcors, he audi commiee, and he execuive commiee as he mechanisms of corporae governance on earnings managemen. They find he composiion of a board and audi commiee meeing frequency decrease earnings managemen. Lin and Liu (2009) show srong corporae governance (such as he ownership concenraion, he size of he supervisory board and he dualiy of CEO and chairman of board of direcors) lead o choose high qualiy audiors. Soliman and Elsalam (2012) examine he effeciveness of corporae governance pracices and heir relaions o audi qualiy and conclude board independence; CEO dualiy and audi commiees significanly associae wih audi qualiy, bu insiuional invesor and managerial ownership have no significan relaionship wih audi Openly accessible a hp:// 653

4 Afsaneh Soroushyar, Bahman Banimahd, Hadi Amiri qualiy. Hashim and Devi (2008) sudy he effec of inernal governance mechanisms on earnings qualiy. Their resuls show ha board enure and ouside board ownership have significan relaion wih earnings qualiy. Bu here isn any significan relaion beween board of direcors independence and earnings qualiy. Shiri e al (2012) examine he relaion of he composiion of he board of he non-bound direcors, absen from he CEO as chairman or vice chairman and insiuional invesors as he corporae governance mechanisms and accrual qualiy, persisence and predicabiliy as he measures of earning qualiy in Iran. They conclude he raio of non-bound members, separaion of he chairman or vice chairman and he percenages of insiuional invesors are associaed wih earnings persisen. Also, here is he significan relaionship beween he raio of non-bound members and predicabiliy of earnings. Moreover, he percenage of insiuional invesors is associaed wih accrual's qualiy. According o he negaive effec of audi marke privaizaion on earnings qualiy, i seems he srong corporae governance can reduce his negaive effec and improve he earnings qualiy. In his sudy dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO are used as he corporae governance mechanisms. Hypohesis Developmen Privaizaion as he new phenomenon in he audi marke in Iran may have imporan economic consequences. Wih performing he audi marke privaizaion plan and esablishmen of privae audi firms, monopoly of Audi Organizaion as he only audi firm ended and small audior ener o audi marke. According o sudies, small audi firms probably presen lower qualiy audi. Also, presence of privae audi firms increases he compeiion in his marke. Audior compeiion may desroy audior independence and audior ignores he missaemen of cliens. So, he qualiy of financial saemens is diminished. Before privaizaion, Audi Organizaion was only audi insiuion, so wihou concern abou missing he clien, issued is acual opinion. Bu afer esablishmen of he Iranian Associaion of Cerified Public Accounans and enforce he privaizaion plan, privae audi firms in order o reain cliens may compromise heir independence and qualiy of cliens financial saemens is decreased. Hence, we hypohesize ha: H1: Audi marke privaizaion decreases he accruals qualiy. H2: Audi marke privaizaion decreases he audior independence. Wih agency conflic beween managemen and company s sakeholders, he exisence of monioring devices is necessary. Alhough independen audiors mosly play his role, he inernal corporae governance mechanisms can help o reduce informaion asymmery and improve he reliabiliy and ransparency of financial saemens. Considering our expecaions abou reducing he audior independence and accruals qualiy by audi marke privaizaion and he effec of monioring corporae governance mechanisms, we hypohesize ha: H3: srong corporae governance decreases he negaive effec of audi marke privaizaion on accruals qualiy. H4: srong corporae governance decreases he negaive effec of audi marke privaizaion on audior independence. Sample Selecion Our sample covers companies lised in Tehran Sock Exchange (TSE) across he period from 2001 o The sample selecion crieria are: 1. The end of fiscal year is March 2001; 2. The end of fiscal year aren change over he period of ; 3. Their basic operaions aren invesmen, insurance and banking ; Openly accessible a hp:// 654

5 Social science secion 4. Book value of asses aren negaive; 5. Daa is available in his period. Given o above crieria, final sample included 111 firms. Research Design In his paper we used four muliple regressions for he es of hypoheses presened. Because of heeroskedasic error, all regressions are esimaed in GLS mehod. Accruals qualiy is used as he qualiy of financial saemens. For calculaing accruals qualiy, he model described by McNichols (2002) is esimaed cross-secionally. Then, sandard deviaion of residuals esimaed from his regression is applied as a measure of earnings managemen. Since he high sandard deviaion of residuals represens low accruals qualiy, i is muliplied by (-1). WC CFO CFO CFO REV PPE i i i 5 i ε i (1) Where, WC i, is he change in non-cash working capial, CFOi, is he operaing cash flow, REV is he change in firm sales and PPEi, is he gross propery, plan and equipmen. In order o examine he effec of audi marke privaizaion on he accruals qualiy, model (2) is esimaed. EQ 0 1Privae 2Tenure 3Size 4CFO 5 LEV 6 growh 7 BTM 8 ROA 9 Loss ε (2) Where, EQ is accruals qualiy explained above, Privaeis he dummy variable ha se 1 if firm changes is audior from Audi Organizaion o privae audi firms, bu 0 oherwise, Tenurei, is he enure of audi in firm s clien, Sizeis he naural logarihm of book value of oal asses, CFO is he operaing cash flow scaled by beginning oal asses, LEV is he leverage of company is calculaed by sum of long-erm deb and deb in curren liabiliies divided by beginning oal asses, growh is he change in revenues scaled by beginning oal asses, BTM is he Book-o-Marke raio (Company marke value is calculaed by liabiliy book value plus equiy marke value), ROAis reurn on asses, Loss is he dummy variable equal o 1 if earnings is negaive, equal o 0 oherwise. In order o examine he relaion beween audi marke privaizaion and audior independence, model (3) is esimaed. Influei, 0 1 Privae 2Tenure 3Size 4Lev 5ROA 6 Loss (3) Influe :clien influence on audior as a measure of audior independence ha is deermined as follow: Like o Chambers and Payne (2011) clien influence is calculaed by raio of he clien s audi fees o he oal audi fees earned by his audi firm. Because audi fees aren available for all companies and here is high correlaion beween audi fees and oal asses, for calculaions of clien influence measure, oal asses are used insead of audi fees. In order o invesigae he role of corporae governance mechanisms on he relaion beween audi marke privaizaion and accruals qualiy, model (4) is used. EQ α Privae Governance Privae * Governance Tenure i, 3 i, 5 Size 6 CFO 7 LEV 8 growh 9 BTM 10 ROA 11 Loss ε (4) G overnance is he measure of corporae governance. Dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO are used as hree Openly accessible a hp://

6 Afsaneh Soroushyar, Bahman Banimahd, Hadi Amiri index of corporae governance. So, model (4) is esimaed hree imes separaely for each corporae governance variable. Finally, for examine he fourh hypohesis, model(5)is esimaed. According o he laes hypohesis, he ineracion effec of dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO (as he measures of corporae governance) and privaizaion on audior independence are esed. Influe 0 1 Privae 2 Governance 3 Privae * Governance 4Tenure 5 Size 6 Lev 7 ROA 8 Loss ε (5) Resuls Table 1 presens he sample means, median and sandard deviaions. The mean of privaizaion is shows ha 65.7% of he sample companies are audied by privae audi firms. On he oher word only 34.3% of he sample companies are audied by Audi Organizaion. These resuls indicae he share of Audi Organizaion in audi marke has been decreased gradually. Table 1. Descripive Saisics of Variables Variables Mean Median Sd. Deviaion EQ Privae Tenure Size CFO LEV growh BTM ROA Loss Influe IND Model (1) examines he effec of audi marke privaizaion on accruals qualiy. The resuls of he esimaion of his model are shown in Table 2. The coefficien of privaizaion is and significan. So, i was found ha audi marke privaizaion decrease he accruals qualiy. Z-saisics of his variable is Table 2. Regression of Accruals Qualiy on Privaizaion EQ 0 1Privae 2Tenure 3Size 4CFO 5 LEV growh BMT ROA Loss ε Variables Coefficiens z-saisics p-value Privae Tenure Size CFO LEV growh BTM ROA Loss Openly accessible a hp:// 656 Wald-saisics (p-value) 84.60

7 Social science secion Model (2) ess wheher audi marke privaizaion decrease audior independence. The obained resuls are refleced in Table 3. The coefficien of privaizaion is and z-saisics is 0.000; ha is, audi marke privaizaion increase he clien influence on audior and decrease audior independence. Table 3. Regression of Audior Independence on Privaizaion Influe 0 1 Privae 2 Tenure 3 Size 4 Lev 5 ROA 6 Loss Variables Coefficiens z-saisics p-value Wald-saisics (p-value) Privae Tenure Size Lev ROA Loss Table 4. Regression of corporae governance effec on he relaion beween Privaizaion and Accruals Qualiy EQ 0 1Privae 2Governance i, 3 Privae * Governance i, 4Tenure Size CFO LEV growh BTM ROA Loss ε 5 Variables Privae Governance Privae* Governance Tenure Size CFO LEV growh BTM ROA Loss Wald chi2 -saisics (p-value) * Significan a 5% 6 7 dualiy of CEO and chairman of board of direcors Coefficiens (z-saisics) * (-5.17) (0.67) (0.29) * (-2.88) * (-2.48) * (-2.45) * (3.89) (-0.99) (-1.13) * (-3.21) (-1.21) The number of changes in board of direcors Coefficiens (z-saisics) * (-4.55) (-0.60) (0.44) * (-3.09) * (-2.33) * (-2.33) * (4.16) (-0.63) (-1.12) * (-3.22) (-0.74) The change of CEO Coefficiens (z-saisics) * (-3.93) (-0.82) (0.26) * (-3.53) * (-4.03) (-1.86) * (2.99) (-1.27) (-1.27) * (-4.61) * (-2.12) Openly accessible a hp:// 657

8 Afsaneh Soroushyar, Bahman Banimahd, Hadi Amiri Third hypohesis provide empirical evidence on effec of corporae governance mechanisms on he relaion beween audi marke privaizaion and accruals qualiy. Model (3) ess his hypohesis and is resuls are presened in Table 4. We used hree variables as he measures of corporae governance: dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO. Then, model (3) is esimaed hree imes. Table 4 indicaes he coefficiens of privaizaion like o model (1) negaive and significan (-0.378, and ). The coefficiens of dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO respecively are 0.313, and The ineracion coefficiens of privaizaion and dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEOrespecively are 0.144, 0.02 and Bu hen one of corporae governance variables and he ineracion coefficiens of corporae governance variables and privaizaion are significan. Table 5 shows he resuls obained from esimaion of model (4), which invesigaes he effec of each corporae governance variable on relaion beween audi privaizaion and he audior independence. Similar o model (3), his model is esimaed separaely for each corporae governance variable. Consisen wih he noion, he coefficiens of privaizaion are 0.125, and and significan. The coefficiens of dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO respecively in his regression are , and The ineracion coefficiens of privaizaion and dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO respecively are , and Like o model (3) corporae governance variables and he ineracion coefficiens of corporae governance variables and privaizaion aren significan. Table 5. Regression of corporae governance effec on he relaion beween Privaizaion and Audior Independence Influe 0 1 Privae 2 Governance 3 Privae * Governance 4Tenure Size Lev ROA Loss ε dualiy of CEO and chairman of The number of changes in board of direcors board of direcors The change of CEO Variables Coefficiens (z-saisics) Coefficiens (z-saisics) Coefficiens (z-saisics) Privae * * * (18.31) (14.01) (15.17) Governance (-0.62) (-0.25) (0.14) Privae* Governance (0.03) (-0.78) (-1.61) Tenure * * * (-4.80) (-4.85) (-6.47) Size * * * (6.66) (7.04) (8.92) LEV (-0.00) (-0.21) (0.50) ROA (-0.45) (-0.39) (0.25) Loss (-0.90) (-0.74) (-0.37) Wald chi2 -saisics (p-value) * Significan a 5% Openly accessible a hp:// 658

9 Social science secion Conclusion and remarks Audi Organizaion as only insiue o provide audi services in Iran was esablished in Bu in 2001 wih esablishmen of Iranian Associaion of Cerified Public Accounans (IACPA), privae audi firms were allowed o provide audi services. This even is named audi privaizaion and i is expeced affecs audi marke and capial marke considerably. This paper seeks o provide evidence on he effecs of audi marke privaizaion on accruals qualiy. The resuls of his sudy indicae audi marke privaizaion reduce he accruals qualiy; ha is, accruals qualiy of companies audied by Audi Organizaion is more han he companies audied by privae audi firms. Also, audi marke privaizaion desroys he audior independence. Therefore, we can argue audi marke privaizaion wih increasing he number of audi firms (ha some of hem are small and have lower experience han Audi Organizaion managers) in order o reain heir clien, don enforce clien o adjus he missaemens in heir financial repors. Therefore, qualiy of financial repors decrease. These resuls is consisen wih he resul of Newon e al (2013), Harris and Duellman (2008), Kallapur e al (2008) and Jensen and Payne (2003) bu agains o Gul e al (2009) and Yang e al (2001). The oher resuls of his research is ha dualiy of CEO and chairman of board of direcors, he number of changes in board of direcors and he change of CEO as he measures of corporae governance don improve he accruals qualiy and audior independence. Furhermore, hese corporae governance variables can decline he negaive consequence of audi marke privaizaion on audior independence and accruals qualiy. These resuls conribue he exising lieraure abou he consequences of audi marke privaizaion in he emerging marke. This research reveals he audi marke privaizaion has no been successful o achieve he underlying inen of his plan in Iran. Regarding o inefficiency of inernal corporae governance mechanisms in Iran, legislaors should concenrae on improvemen of independen audi qualiy. Accordingly, legislaors and sandards seer should issue some acs and sandards o resric fraud and missaemens of managers and proec he ouside users. References Abdullah, S.N. (2004). Board Composiion, CEO Dualiy and Performance Among Malaysian Lised Companies. Corporae Governance. 4(4). pp Anandarajan, A., G. Kleinman. And D. Palmon. (2010). Audior Independence Research: Where Do We Sand? Banimahd. B. and E. Vafaei. (2012). The Effecs of Clien Size, Audi Repor, Sae Ownership, Financial Leverage and Profiabiliy on Audior Selecion: Evidence From Iran. African Journal of Business Managemen, 6(11), Brown,J.R., D. Falaschei, and M.J. Orlando. (2009). Audior Independence and The Qualiy of Informaion in Financial Disclosures: Evidence for Marke Discipline vs. Sarbanes-Oxley Prescripions. American Law and Economics Review, 12(1), Chambers, D. and J. Payne. (2011). Audi Qualiy and Accrual Persisence: Evidence from he Preand Pos-Sarbanes-Oxley Periods. Managerial Audiing Journal. 26(5). pp DeAngelo, L. E. (1981). Audior Size and Audi Qualiy. Journal of Accouning & Economics, 3(3) DeFond, M.L., T.J Wong, and S. Li. (2000). The Impac of Improved Audior Independence on Audi Marke Concenraion in Chin. Journal of Accouning and Economics, 28, Dye, R. A. (1993), Audiing Sandards, Legal Liabiliy, and Audior Wealh. Journal of Poliical Economy, 101, Openly accessible a hp:// 659

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