THE DETERMINANTS OF AUDITORS REPUTATION IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1      BACKGROUND OF THE STUDY

Audit quality according to Fairchild (2008) is an essential ingredient in enriching the credibility of financial statements to users of accounting information as it helps in verifying management claims about the company activities and affairs thereby reducing the information risk exposure of users. Woodland and Reynolds (2003) claim that no two audits may be equal in terms of quality because the technical expertise and independence levels of the engaged auditors are likely to differ. That is, the ability of the auditor is brought to bear in determining audit quality.

Furthermore, he asserts that the auditor’s manner of approach and strategy is fundamental to the nature of the audit.

DeAngelo (1981) offers a definition of audit quality regularly used in literatures as primarily a combination of two characteristics associated with the auditor viz the technical ability to identify misstatements, and independence required for the correction of misstatements. That is, the auditor based on his qualification and displayed acumen shoulders the responsibility of audit quality. He further argues that the reputation of the engaged audit firm is germane to its producing quality report. The principal-audit relationship between shareholders and management is one of the many adduced reasons for engaging the services of external auditors. According to the agency theory as expounded in literature, an agency relationship will normally exist where there is a contract in which one party called the agent acts and perform delegated duties on behalf of another party called the principal. Whenever conflict of interest arises between the principal and the agent, the agent may not act in the best interest of the principal therefore, in order to avoid such, a third party is usually called upon to mediate. This third party is the external auditor (Barzegar and Salehi, 2008). In order to properly serve as a watchdog, the auditor is expected to possess and show requisite skill, diligence, and care in executing his duties, which amongst many things is to express an opinion on the state of affairs of their clients as claimed by management. The opinion as expressed in his report affects the decisions of users of the financial statement. The way and manner the auditor employs in gathering evidence for his opinion may also go a long way in affecting the quality of his report popularly referred to as audit quality.

According to Generally Accepted Auditing Standards, the standards any auditor would be required to adhere while performing his work are divided into three sections viz general standards addressing the characteristics and nature of auditors, standards on fieldwork addressing the conduct of the audit, and standard of reporting addressing the manner of communicating audit findings and opinion (AICPA 1996). According to Woodland and Reynolds (2003), these three combined describe the minimum necessary requirements for audit quality. Therefore, it follows that the ability of the auditor to bring to bear these standards in the course of performing his duties will affect the quality of the audit opinion he puts forward. Hence, a “good” audit firm should produce quality reports. Furthermore, Salehi and Abedini (2008) asserts that audit quality is associated with the quality of information contained in the financial statements and because these financial statements are audited by high quality auditors (reputable audit firms), they should be less likely to contain material misstatements.

Auditors express their audit opinions on a financial statement presented to them based on audit evidence. The objective of an audit, therefore, is to plan and perform the audit to obtain appropriate audit evidence that is sufficient to support the opinion expressed in the auditor’s report.

Insufficient or inappropriate audit evidence may lead to wrong conclusions and this may affect the quality of the report. Hence, the issue of audit quality has received increased attention due to highly publicized audit failures culminating in corporate scandals, corporate fraud, corporate failure.

The choice of a firm’s auditor is considered one of the most important decisions taken by any firm. This is due to the vital benefits resulting from having the financial statements audited by a reputable auditor. First, it reduces information risk; as argued by the agency theory; firms with higher agency costs are motivated to choose a high-quality auditor to strengthen their corporate governance and thus lessen potential agency conflicts (Francis & Wilson, 1988; Mansi et al., 2004; knechel et al., 2008; Matonti et al., 2016) specially in complex organizations where management interests could differ from shareholder interests (Ekumankama & Uche, 2009). It has been documented by Farooq and Kacemi (2011) that stock price performance improved in the MENA region because of choosing one of the big-four auditors. Second, an audit might result in improving internal processes operational efficiency and effectiveness since the auditor must assess the client’s internal control reliability, moreover, it helps firms better comply with legal and regulatory constraints (Wallace, 1981).

Olowooker (2016) mentioned that there is a market share gap between the Big Four and smaller firms in Nigeria, as 90 percent of listed companies are audited by the Big Four; while the 15 national firms audit the remaining 10 percent. In Saudi Arabia, as reported by the Saudi Ministry of Commerce and Investment (2018) there is 176 auditing firm. A large number that shows a severe competition in Saudi audit market that triggered the need to investigate the market share of the Big Four as compared to the Non-Big Four auditors in Saudi market and the factors behind the firm selection of its auditor to help auditors rely on their competitive advantages. Therefore, this study focuses on the determinants of auditors’ reputation In Nigeria.

1.2      STATEMENT OF THE PROBLEM

The Nigerian business environment has been perceived in some quarters as not too conducive to investors; both local and foreign. Adjudged reasons for this assertion include the inability of financial reports to meet the needs of this group of users. The prevalence of fraud, excessive earnings management and other financial crimes in the country has reduced the level of confidence reposed in these financial statements; and in the ability of these statements to perform their requisite functions. In light of the cost of frauds to the business and the offender, it is important to develop strategies to prevent or detect business fraud, taking a cursory look at the risk factors associated with business, giving due attention to the motives attached with it, and establishing how to effectively manage it on a daily basis (Akinjobi and Omowumi, 2010). Hence, the auditors are looked upon as ‘messiahs’ in correcting this anomaly, and thereby directly, or indirectly creating a balance in the functioning of the business environment.

The spate of audit failure in the world, especially in Nigeria, has brought great disappointment the user of financial report. The bane of the problem has been linked to long term of audit firm tenure which has also been linked with creative accounting. In Nigeria audit setting, the challenge of audit tenure and audit quality reporting has not attracted much empirical study beyond mere anecdotal opinions Mgbame, et al., (2012). In view of these studies, auditor tenure has become the focus of much debate. Should a firm replace its auditors on a regular basis, or should the auditor be allowed to build a long term relation with the client?

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. The increased confidence of these set of financial users tend to attract the inflow of capital which has the long-run effect of creating growth and development in the business environment.

Several researchers have proxy audit quality using reputation of auditors on the premises that the loss of reputation, economic rent and increase in litigation cost amongst other things will make auditors ensure that the report they produce is of quality however, the experienced scandals across the globe points otherwise as even some companies audited by the reputable firms have been involved (Weber, Willenborg and Zhang, 2008). Furthermore, Simunic (2003) asserts the notion that audit quality varies across different classes of audit firms has been a heated debate over centuries with divergent opinions surfacing as time elapse. Prior to 2000, the argument was in favor of reputable firms providing quality audit because the audit fees of reputable firms (former) were higher than that of non-reputable firms (latter), litigation rates are lower for the former, the stock market reacts mildly to positive unexpected company earnings that are audited by the latter, companies making IPOs and POs experience less underpricing if audited by a reputable firm... just to mention a few, however, the direction of the argument is changing because of the series of corporate scandals, the mergers of reputable firms from Big Eight to Big Four, rejection of the audit quality ranking of reputable firms versus non-reputable by practitioners and a host of other revelations (Simunic, 2003).  These problems make it glaring that there is a need to carry out a study on the determinants of auditors’ reputation In Nigeria.

1.3      OBJECTIVES OF THE STUDY       

The general objective of the study is to examine the determinants of auditors’ reputation In Nigeria. The specific objectives include the following:

1.  To ascertain the state of auditors’ reputation In Nigeria.

2.  To find out if audit quality is a determinant of auditors’ reputation In Nigeria.

3.  To examine the influence audit firm size on auditors’ reputation In Nigeria.

4.  To know if audit fee is a determinant of auditors’ reputation In Nigeria.

5.  To investigate the relationship between auditors’ reputation and the profitability of audit firms in Nigeria.

1.4      RESEARCH QUESTIONS

1.     What is the state of auditors’ reputation In Nigeria?

2.     Is audit quality a determinant of auditors’ reputation In Nigeria?

3.     What is the influence audit firm size on auditors’ reputation In Nigeria?

4.     Is audit fee a determinant of auditors’ reputation In Nigeria?

5.     What is the relationship between auditors’ reputation and the profitability of audit firms in Nigeria?

1.5      SIGNIFICANCE OF THE STUDY

This study is indeed relevant as it seeks to help diffuse the tension as to whether or not the reputation of audit firms is important in determining which auditor to employ and also whether the bid to reduce auditors’ liability because of the reputation issue is valid.

High quality external auditing is a central component of sound corporate governance. Yet relatively little is known about the determinants of audit quality. We study the audit market, where recent events provide a powerful setting for investigating the effect of auditor reputation on audit quality. An important but largely unresolved issue in both the academic and policy arenas is what determines audit quality. This research work will create significance in the minds of the general public as to the determinant of audit in their investment decisions.

This study will enhance the existing body of literature by contemplating the areas of the literature that have not yet been examined or considered and incorporating these factors into the current study. The study will thus form the basis for further studies in the field.

1.6      SCOPE OF THE STUDY

The scope of this study is restricted to examine the determinants of auditors’ reputation In Nigeria using a sample of listed companies trading on the floor of the Nigerian Stock Exchange.   Data was gathered from annual reports of selected companies quoted on the floor of the Nigerian Stock Exchange. The cross sectional data comprise audited financial statements as at 2010. A sample size of thirty-five (35) companies was selected from the list of quoted companies. The Ordinary Least Square technique (OLS) was used to analyze the relationship between our dependent variable and independent variables.

1.7      LIMITATION OF THE STUDY

Some of the major constraints the researchers encountered in putting up this research include lack of time and full access to information  resources.

1.8      DEFINITION OF TERMS

An auditor: is a person authorized to review and verify the accuracy of business records and ensure compliance with tax laws.

Reputation: the opinion that people in general have about someone or something, or how much respect or admiration someone or something receives, based on past behaviour or character.