Using a large cross-sectional data set of Finnish firms based on fiscal years 2006-2010, the fourth study examines the effect of the audit partner industry specialization on the earnings quality of private firms. The test sample is obtained from the AMADEUS database of the Bureau Van Dijk and it includes 26,775 observations. The data are analyzed using OLS regression analysis. Applying an industry market share in the audit market of private and public Finnish firms as a proxy for audit partner industry specialization, the results suggest that the audit partner industry specialization has a
23 positive effect on the earnings quality of private firms. Specifically, the results show that the audit partner’s market share in the client’s industry is inversely related to absolute abnormal accruals reported by the client firm. This association is strongest for audit partners representing the Big 4 audit firms and for client firms reporting earnings increasing abnormal accruals. The result holds after controlling for audit firm level factors (e.g., audit firm size). The results imply that the audit partner indus-try specialization is a source for variation in audit quality in the relatively low auditor litigation setting of private firms.
24
References
Anderson, Ronald C., Mansi, Sattar A. & Reeb, David M. (2003): Founding Family Ownership and the Agency Cost of Debt. Journal of Financial Economics, Vol. 68, No. 2, 263−285.
Ang, James S., Cole, Rebel A. & Lin, James Wuh (2000): Agency Costs and Ownership Structure.
The Journal of Finance, Vol. 55, No. 1, 81−106.
Antle, Rick & Nalebuff, Barry (1991): Conservatism and Auditor-Client Negotiations. Journal of Accounting Research, Vol. 29, No. 3, 31−54.
Ball, Ray, Kothari, S. P. & Robin, Ashok (2000): The Effect of International Institutional Factors on Properties of Accounting Earnings. Journal of Accounting and Economics, Vol. 29, No. 1, 1−51.
Ball, Ray & Shivakumar, Lakshmanan (2005): Earnings Quality in UK Private Firms:
Comparative Loss Recognition Timeliness. Journal of Accounting and Economics, Vol.
39, No. 1, 83−128.
Balsam, Steven, Krishnan, Jagan & Yang, Joon S. (2003): Auditor Industry Specialization and Earnings Quality. Auditing: A Journal of Practice and Theory, Vol. 22, No. 2, 71−97.
Basioudis, Ilias G. & Francis, Jere R. (2007): Big 4 Audit Fee Premiums for National and Office-Level Industry Leadership in the United Kingdom. Auditing: A Journal of Practice and Theory, Vol. 26, No. 2, 143−166.
Becker, Connie L., DeFond, Mark L., Jiambalvo, James & Subramanyam, K. R. (1998): The Effect of Audit Quality on Earnings Management. Contemporary Accounting Research, Vol.
15, No. 1, 1−24.
Bharath, Sreedhar T., Sunder, Jayanthi & Sunder, Shyam V. (2008): Accounting Quality and Debt Contracting. The Accounting Review, Vol. 83, No. 1, 1−28.
Blackwell, David W., Noland, Thomas R. & Winters, Drew B. (1998): The Value of Auditor Assurance: Evidence from Loan Pricing. Journal of Accounting Research, Vol. 36, No.
1, 57−70.
Bond, David, Hamilton, Jane M. & Stokes, Donald J. (2004): Big 5 Audit Partner Industry Expertise – Audit Pricing Evidence. Working Paper, University of Technology Sydney.
Broye, Géraldine & Weill, Laurent (2008): Does Leverage Influence Auditor Choice? A Cross-Country Analysis. Applied Financial Economics, Vol. 18, No. 9, 715−731.
Cano-Rodríguez, Manuel (2010): Big Auditors, Private Firms and Accounting Conservatism:
Spanish Evidence. European Accounting Review, Vol. 19, No. 1, 131−159.
Cano-Rodríguez, Manuel, Sánchez-Alegría, Santiago & Arenas Torres, Pablo (2008): Do Banks Value Audit Reports or Auditor Reputation? Evidence from Private Spanish Firms.
Working paper, University of Jaén and Public University of Navarra.
Carey, Peter, Simnett, Roger & Tanewski, George (2000): Voluntary Demand for Internal and External Auditing by Family Businesses. Auditing: A Journal of Practice and Theory, Vol. 19, No. 1, 37−51.
Carney, Michael (2005): Corporate Governance and Competitive Advantage in Family-Controlled Firms. Entrepreneurship Theory and Practice, Vol. 29, No. 3, 249−265.
25 Chaney, Paul K., Jeter, Debra C. & Shivakumar, Lakshmanan (2004): Self-Selection of Auditors
and Audit Pricing in Private Firms. The Accounting Review, Vol. 79, No. 1, 51−72.
Chrisman, James J., Chua, Jess H. & Litz, Reginald A. (2004): Comparing the Agency Costs of Family and Non-Family Firms: Conceptual Issues and Exploratory Evidence.
Entrepreneurship Theory and Practice, Vol. 28, No. 4, 335−354.
Chu, Ling, Mathieu, Robert & Mbagwu, Chima (2009): The Impact of Corporate Governance and Audit Quality on the Cost of Private Loans. Accounting Perspectives, Vol. 8, No. 4, 277−304.
Chung, Hyeesoo & Kallapur, Sanjay (2003): Client Importance, Nonaudit Services, and Abnormal Accruals. The Accounting Review, Vol. 78, No. 4, 931−955.
Craswell, Allen T., Francis, Jere R. & Taylor, Stephen L. (1995): Auditor Brand Name Reputations and Industry Specializations. Journal of Accounting and Economics, Vol. 20, No. 3, 297−322.
DeAngelo, Linda Elizabeth (1981): Auditor Size and Audit Quality. Journal of Accounting and Economics, Vol. 3, No. 3, 183−199.
DeFond, Mark L. (1992): The Association Between Changes in Client Firm Agency Costs and Auditor Switching. Auditing: A Journal of Practice and Theory, Vol. 11, No. 1, 16−31.
DeFond, Mark L., Francis, Jere R. & Wong, Tak Jun (2000): Auditor Industry Specialization and Market Segmentation: Evidence from Hong Kong. Auditing: A Journal of Practice and Theory, Vol. 19, No. 1, 49−66.
Duh, Rong-Ruey, Hou, Chi-Ping & Huang, Der-Fen (2009): Audit Partner’s General Experience, Industry Specialization, and Audit Quality. Working paper, National Taiwan University, China University of Technology, and National Dong Hwa University.
Dutillieux, Wouter & Willekens, Marleen (2009): The Effect of Auditor Industry Specialization on Audit Pricing in Belgium. Review of Business and Economics, Vol. LIV, No. 2, 129−146.
Dye, Ronald A. (1991): Informationally Motivated Auditor Replacement. Journal of Accounting and Economics, Vol. 14, No. 4, 348−374.
Fama, Eugene F. & Jensen, Michael C. (1983): Separation of Ownership and Control. Journal of Law & Economics, Vol. 26, No. 2, 301−325.
Ferguson, Andrew, Francis, Jere R. & Stokes, Donald J. (2003): The Effects of Firm-Wide and Office-Level Industry Expertise on Audit Pricing. The Accounting Review, Vol. 78, No.
2, 429−448.
Fortin, Steve & Pittman, Jeffrey A. (2007): The Role of Auditor Choice in Debt Pricing in Private Firms. Contemporary Accounting Research, Vol. 24, No. 3, 859−896.
Francis, Jennifer, LaFond, Ryan, Olsson, Per & Schipper, Katherine (2005): The Market Pricing of Accruals Quality. Journal of Accounting and Economics, Vol. 39, No. 2, 295−327.
Francis, Jere R. (2004): What Do We Know About Audit Quality? The British Accounting Review, Vol. 36, No. 4, 345−368.
Francis, Jere R. & Lennox, Clive S. (2008): Selection Models in Accounting Research. Working paper, University of Missouri-Columbia and Hong Kong University of Science and Technology.
Francis, Jere R., Maydew, Edward L. & Sparks, H. Charles (1999): The Role of Big 6 Auditors in the Credible Reporting of Accruals. Auditing: A Journal of Practice and Theory, Vol. 18, No. 2, 17−34.
26
Francis, Jere R., Reichelt, Kenneth & Wang, Dechun (2005): The Pricing of National and City-Specific Reputations for Industry Expertise in the U.S. Audit Market. The Accounting Review, Vol. 80, No. 1, 113−136.
Francis, Jere R. & Wilson, Earl R. (1988): Auditor Changes: A Joint Test of Theories Relating to Agency Costs and Auditor Differentiation. The Accounting Review, Vol. 63, No. 4, 663−682.
Gill-de-Albornoz, Bélen & Illueca Muñoz, Manuel (2006): The Effect of Auditor Reputation on the Pricing of Accruals: Evidence from Privately Held Companies. Working paper, Universitat Jaume I and Instituto Valenciano de Investigaciones Económicas (IVIE).
Guedhami, Omrane & Pittman, Jeffrey A. (2006): Ownership Concentration in Privatized Firms:
The Role of Disclosure Standards, Auditor Choice, and Auditing Infrastructure. Journal of Accounting Research, Vol. 44, No. 5, 889−929.
Hope, Ole-Kristian & Langli, John Christian (2010): Auditor Independence in a Private Firm and Low Litigation Risk Setting. The Accounting Review, Vol. 85, No. 2, 573−605.
Hyytinen, Ari & Pajarinen, Mika (2007): Is the Cost of Debt Capital Higher for Younger Firms?
Scottish Journal of Political Economy, Vol. 54, No. 1, 55−71.
Hyytinen, Ari & Väänänen, Lotta (2004): Mandatory Auditor Choice and Small Firm Finance:
Evidence from Finland. Helsinki: The Research Institute of the Finnish Economy (Discussion Papers; No. 950).
Ittonen, Kim, Johnstone, Karla & Myllymäki, Emma Riikka (2010): Characteristics of Individual Audit Partners and their Client Portfolios: Effects on Discretionary Accruals and Audit Fees. Working paper, University of Vaasa and University of Wisconsin School of Business.
Jensen, Michael C. & Meckling, William H. (1976): Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, Vol. 3, No. 4, 305−360.
Jeong, Seok Woo & Rho, Joonhwa (2004): Big Six Auditors and Audit Quality: The Korean Evidence. The International Journal of Accounting, Vol. 39, No. 2, 175−196.
Kallunki, Juha-Pekka, Nilsson, Henrik, Sahlström, Petri & Zerni, Mikko (2009): Do the Leading Audit Partner Characteristics Affect Audit Quality? Working paper, University of Oulu and Umeå School of Business.
Kend, Michael (2006): Client Industry Expertise: An Investigation of the Different Units of Analysis. Working paper, Australian National University (ANU).
Kim, Jeong-Bon, Simunic, Dan A., Stein, Michael T. & Yi, Cheong H. (2007): Voluntary Audits and the Cost of Debt Capital for Privately Held Firms: Korean Evidence. Working paper, Concordia University, the Hong Kong Polytechnic University, the University of British Columbia, and Old Dominion University.
Knechel, Robert W., Niemi, Lasse & Sundgren, Stefan (2008): Determinants of Auditor Choice:
Evidence from a Small Client Market. International Journal of Auditing, Vol. 12, No. 1, 65−88.
Krishnan, Gopal V. (2005): The Association Between Big 6 Auditor Industry Expertise and the Asymmetric Timeliness of Earnings. Journal of Accounting, Auditing and Finance, Vol.
20, No. 3, 209−228.
Lennox, Clive S. (2005): Management Ownership and Audit Firm Size. Contemporary Accounting Research, Vol. 22, No. 1, 205−227.
27 Morck, Randall, Shleifer, Andrei & Vishny, Robert W. (1988): Management Ownership and
Market Valuation: An Empirical Analysis. Journal of Financial Economics, Vol. 20, 293−315.
Morck, Randall & Yeung, Bernard (2003): Agency Problems in Large Family Business Groups.
Entrepreneurship Theory and Practice, Vol. 27, No. 4, 367−382.
Niemi, Lasse (2004): Auditor Size and Audit Pricing: Evidence from Small Audit Firms. European Accounting Review, Vol. 13, No. 3, 541−560.
Palmrose, Zoe-Vonna (1988): An Analysis of Auditor Litigation and Audit Service Quality. The Accounting Review, Vol. 63, No. 1, 55−73.
Power, Michael (1997): The Audit Society: Rituals of Verification. New York: Oxford University Press Inc.
Schulze, William S., Lubatkin, Michael H. & Dino, Richard N. (2003): Exploring the Agency Consequences of Ownership Dispersion Among the Directors of Private Family Firms.
Academy of Management Journal, Vol. 46, No. 2, 179−194.
Simunic, Dan A. (1984): Auditing, Consulting, and Auditor Independence. Journal of Accounting Research, Vol. 22, No. 2, 679−702.
Simunic, Dan A. & Stein, Michael T. (1987): Product Differentiation in Auditing: Auditor Choice in the Market for Unseasoned New Issues. Vancouver, B.C.: Canadian Certified General Accontants’ Research Foundation.
Solomon, Ira, Shields, Michael D. & Whittington, O. Ray (1999): What Do Industry-Specialist Auditors Know? Journal of Accounting Research, Vol. 37, No. 1, 191−208.
Steijvers, Tensie, Voordeckers, Wim & Vanhoof, Koen (2010): Collateral, Relationship Lending and Family Firms. Small Business Economics, Vol. 34, No. 3, 243−259.
Sundgren, Stefan (1998): Auditor Choices and Auditor Reporting Practices: Evidence from Finnish Small Firms. European Accounting Review, Vol. 7, No. 3, 441−465.
Taylor, Stuart (2004): Audit Fee Premia and Discounts for Auditor Industry Specialisation by Individual Audit Partners. 2nd Annual ANCAAR Audit Research Forum (May).
Van Tendeloo, Brenda & Vanstraelen, Ann (2008): Earnings Management and Audit Quality in Europe: Evidence from the Private Client Segment Market. European Accounting Review, Vol. 17, No. 3, 447−469.
Vander Bauwhede, Heidi & Willekens, Marleen (2004): Evidence on (the Lack of ) Audit-quality Differentiation in the Private Client Segment of the Belgian Audit Market. European Accounting Review, Vol. 13, No. 3, 501−522.
Watts, Ross L. & Zimmerman, Jerold L. (1983): Agency Problems, Auditing, and the Theory of the Firm: Some Evidence. Journal of Law and Economics, Vol. 26, No. 3, 613−633.
Watts, Ross L. & Zimmerman, Jerold L. (1986): Positive Accounting Theory. Englewood Cliffs, NJ: Prentice Hall.
Zerni, Mikko (2009): Audit Partner Specialization, Audit Fees, and Auditor-Client Alignments.
Working paper, University of Oulu.
Publications of the University of Eastern Finland Dissertations in Social Sciences and Business Studies No 29
Publications of the University of Eastern Finland Dissertations in Social Sciences and Business Studies
ISBN 978-952-61-0551-2 ISSN 1798-5749
Jukka Karjalainen
Audit Quality and
Private Finnish Firms
Using the research setting of private Finnish firms, the purpose of this dissertation is to enhance our understanding of the relevance of audit quality in private firms. The dissertation provides evidence of the demand for differential audit quality by lenders and different types of private firm owners, as well as evidence of audit partner industry specialization as a source for audit quality differentiation in the audit market of private firms.