What are the benefits of audit assurance to private companies? Better financial reporting quality, and superior credit scores, suggests ‘ The impact of voluntary audit on credit ratings: Evidence from UK private firms ,' a recent research paper by Elisabeth Dedman and Asad Kausar ( www.ssrn.com ). The paper sets the context by informing that, by allowing progressive size-based audit exemptions for private firms, the UK has been steadily moving towards a largely audit-exempt private sector. “Both audit professionals and credit rating agencies have expressed concern about the effect of this policy on standards of financial reporting and on credit ratings for unaudited firms. Prior evidence suggests that firms do not share these reservations, however, believing that audit and credit score are not related (Collis 2010).”
To explore the issue deeper, the authors look at the effect on credit scores of firms choosing to opt out of, or retain, a voluntary audit in the first year of exemption due to a substantial threshold change. After analysing a sample of 4,873 newly exempt firms, the authors report that firms which retain the audit enjoy significantly higher credit scores than those which opt out of audit, even after controlling for known determinants of credit score such as profitability, size, liquidity, age and the tangible nature of assets. “Our results therefore suggest that firms are mistaken in their view that opting out of audit will not affect their credit score.”
Instructive research for policy-makers in the domain of mandated disclosures and assurance.
Expectations from external auditors
Marianne Ojo's paper titled ‘ A global perspective on the changing perceptions of the role of the external auditor and the significance of audit developments ' ( www.ssrn.com ) discusses the situation in Malaysia, Nigeria and Brazil.
In Malaysia, the activity of external auditing is characterised by little publicity and little public clamour for needed changes, the author notes, citing studies in this regard. “There may be a few lone voices from both the public and private sectors asking auditors and their representative bodies, the Malaysian Institute of Accountants (MIA) and the Malaysian Association of Certified Public Accountants (MACPA) to do a better job, but that appears to be where the ‘story' ends.”
In the case of Brazil, even though the audit practice has undergone recent improvements which include ‘mandatory continuing professional education, quality assurance system based on peer reviews, an examination of minimum professional qualification,' these mechanisms still fall short of international good practice, particularly as a result of the self regulation arrangements under which they are implemented, Ojo observes, drawing from the Report on the Observance of Standards and Codes.
The section on Nigeria can be distressing for accounting professionals because it talks about the Companies and Allied Matters Decree of 1990, which provides the opportunity for the government to register its dissatisfaction with the performance of auditors in Nigeria, a case of ‘pot calling kettle black,' as the paper describes. One also reads about the ‘Audit Report of 2001,' which implies that ‘heads should roll for the wickedness and inefficiency made potent in high places' (Uwem Inyang et al, 2003).
Important study that merits elaboration by other researchers for other geographies.
‘Foreign' demand for audit quality
The presence of foreign shareholders and foreign directors increases audit quality, say Sang Cheol Lee, Mooweon Rhee, and Jongchul Yoon in ‘ The effects of foreign monitoring on audit quality: Evidence from Korea' ( www.ssrn.com ), after studying 1,574 non-financial companies listed on the Korea Stock Exchange from 2000 to 2003. The authors find that if the foreign block shareholders with monitoring incentives and expert knowledge become a part of corporate governance structure in the less-developed Korean capital market, they may demand improved external audit quality in order to monitor managers and to protect their investment, which may lead to higher audit fees. The paper notes that foreign investors hold about 30 per cent of the total market value of Korean listed companies, which is higher in comparison to foreign investors' holdings in Taiwan (8.8 per cent), Japan (13.2 per cent), and the US (7.2 per cent).
While focusing on foreign investors as influential participants in the corporate governance structure with the essential incentive and expertise to improve monitoring, the authors also study if the impact the foreign investors' participation on audit quality is greater in professional management-controlled companies than in owner-controlled ones when foreign monitors exist in both types of firms.
Hoping that the study will contribute to the construction of more desirable corporate governance structure, the authors underline the relationship between corporate governance structure and audit quality due to the multiple stakeholders influencing decisions about control and auditing in firms.
Useful work in the field of corporate governance.
IFRS impact on executive pay
The paper by Neslihan Ozkan, Zvi Singer, and Haifeng You, titled ‘ Mandatory IFRS adoption and the contractual usefulness of accounting information in executive compensation ' ( www.ssrn.com ), opens by stating that the mandatory adoption of International Financial Reporting Standards (IFRS) by the European Union (EU) and several other countries (e.g., Australia; South Africa) marks major progress toward a single set of high-quality, globally accepted accounting standards.
The focus of the authors is on how the mandatory adoption of IFRS affects the contractual usefulness of accounting information in executive compensation, as reflected in pay-for-performance sensitivity (PPS) and relative performance evaluation (RPE). “These tests allow us to infer whether compensation committees of European companies view IFRS as leading to increased earnings quality and comparability,” they note.
For starters, PPS is a measure to find out if a chief executive is compensated appropriately according to how well s/he runs the company ( http://lexicon.ft.com ). “In its simplest incarnation, the pay-performance sensitivity is the correlation between a chief executive pay and stock return across a large number of chief executives and their companies.” And RPE is an evaluation of an individual's performance that is based on the difference between an individual's measurable output and an aggregated amount of the same measurable output observed in a group of the individual's peers, as the FT lexicon defines. “The main idea behind relative performance evaluation is that an individual should not be held responsible for risks and factors beyond the control of the individual.”
Of relevance to accountants closer home, readying themselves for IFRS adoption.