Abstract
The quality of financial reporting by various companies affects the economy of the country in more ways than one. Apart from the economy of the country, the quality of audit and financial reporting affects the operation of the company as well. Effective disclosure and transparent finical reporting provide a necessary condition to maintain and assure the confidence of the stakeholders. This study seeks to investigate the relationship that exists between the type of corporate governance and the quality of audit among listed companies in Australia's Petroleum and Mining industry. It presents a review of previous and existing literature concerning the relationship between corporate governance and the quality of audit or financial reporting. Several factors such as the advancements in information technology, the existence of challenging benefit and the ever-growing development of economic bodies have resulted in the creation of controlling needs in these big companies.
Introduction
Australia is home to some of the largest companies in the Petroleum and Mining industry across the globe. These companies play a significant role in shaping the economy of Australia at large. Some of the largest companies generating large revenues for Australia in the Petroleum and Mining industry include Rio Tinto, BHP Billiton, and Coal India Limited (Ahmed, Hossain & Adams, 2006).
It is imperative to note that the need for independent auditing services across the nation has been prompted by contradicting benefits and the insufficiency of the user’s direct access to information. These companies exhibit different audit quality and financial reporting given that the exhibit different types of governance (Ahmed, Hossain & Adams, 2006). While the quality of financial reporting is affected by various factors, the type of governance employed in an organization has a major effect on the different aspects of audit quality. It is, therefore, imperative to establish the relationship that exists between corporate governance and the quality of financial reporting. Determination of the role played by corporate governance on the quality of financial reporting is the key to understanding and improving the quality of audit across the country.
Corporate governance and audit quality
The spread of crises in the past few decades has prompted the need to question the governance policies employed by most companies in Australia and the globe at large. As a consequence, various regulators have proposed novel laws and regulations of good conduct and financial security. The proposed recommendations are aimed at helping companies to mitigate the effects of mismanagement, the abuse of power and to solve the deficiencies in governance. It is apparent that there exists a relationship between corporate governance and the quality of financial reporting. The quality of financial reporting and corporate governance are imperative conditions to guarantee and maintain the confidence of the stakeholders, thus the success of the company. It is believed that good governance quality directly affects the way in which the organization conducts its financial reporting. It is significant to note that good financial information quality is attracted by good governance.
The relationship between corporate governance and the quality of financial information reporting has attracted the attention of many researchers. Carey & Simnett (2006) suggest that is imperative to identify the control mechanisms which are specific to audit quality before investigating the relationship between corporate governance and the quality of financial information reporting. Studies by Ahmed, Hossain & Adams (2006) asserts that identity of directors and stakeholders play a significant role in determining the control mechanism. Several research by Carey & Simnett (2006) agree that the quality of audit can be assessed by combining a market and an accounting based measures into a single factor so as to have a pertinent measure of financial reporting quality.
According to Lin & Hwang (2010), there are various governance mechanisms that can affect the quality of financial information reporting. Carey & Simnett (2006) identify the ownership structure and the characteristics of the board of directors as some of the governance mechanisms that influence the quality of financial information reporting. Additionally, the reputation of the external auditor is considered as a factor that affects the quality of financial information reporting. Before one can understand the relationship between corporate governance and the quality of audit, it is imperative to comprehend and outline the meaning of audit quality as well as corporate governance.
Audit quality
According to Marginson & Considine (2000), the measure of audit quality still needs a lot of information since there is no agreed or accepted definition or framework. However, a variety of studies has employed the use of dichotomy as a substitute for assessing the excellence of auditing. The application of this variable has demonstrated to be inopportune in appropriately assessing the quality of auditing. Krishnan (2003) holds that the major reason as to the difficulty of dichotomy is because it relies on plentiful factors such as auditor's experience, the extent of the audit firm, auditor's reputation, and the extent to which computer and information technology are utilized in the audit progression. Ahmed, Hossain & Adams, (2006) and Krishnan (2003) agree on the application of PCA to scrutinize the quality of audit with improved accuracy.
The superiority of audit exceedingly relies on the combined likelihood of an auditor establishing and exposing a predicament in an accounting system (Deis Jr & Giroux, 1992). Audit quality is the enthusiasm to report any substance exploitation or misstatement that will supplement the material doubts and solve trepidation problems (Mitton, 2002). An additional description of audit quality expresses that it is the likelihood that an assessor will not present an incompetent testimony for statements containing material errors. It is imperative to note that, while there are plentiful definitions of audit quality, there is no solitary accepted explanation of audit quality nor has any particular extensively accepted measure be devised (Deis Jr & Giroux, 1992).
Mechanism of corporate governance
Composition of the board of directors
Several studies on corporate governance, and audit quality has emphasized on the composition of the board of directors as one of the mechanisms of corporate governance that affect the quality of financial information reporting. Studies conducted by Krishnan (2003) assert that the likelihood of detecting fraud related to financial statement fraud in the different firms across the globe declines with the percentage of external directors. Alali, Anandarajan & Jiang (2012) outlined that the independent board alleviates earning management. In the similar context, Lin & Hwang (2010) asserts that the financial information quality increases with the percentage of external directors. Correspondingly, Carey & Simnett (2006) made a note that the independence of the board enables firms to disclose information that is of good quality. Contrary, other studies such as Lin & Hwang (2010) asserts that the external directors lack the competence to control the managers. Thus, their presence does not affect the quality of financial information reporting.
Size of the board
Several researchers pointed out that the size of the board has a positive effect on the quality of financial reporting in various firms across the globe. According to Alali, Anandarajan & Jiang (2012), a reduced number of directors suggests a high degree of communication and coordination between them and the managers. As a matter of fact, Ashbaugh-Skaife, Collins & LaFond, (2006) established that a big board size lessens the information content of the incomes, thus escalating the earnings of management across different firms. On the other hand, other authors disagreed to the positive effect associated with a small number of directors and audit quality. Ball & Brown (1968) and Beasley (1996) argued that a larger the number of directors guarantees the values reliance of financial statements and reporting. Some authors and studies did not establish a link between the size of the board of directors and the quality of financial information reporting.
The literature on corporate governance has laid much emphasis on the need to disconnect the position of the board chairman and the chief executive offices to ensure the sovereignty of the board and advance the transparency of the firm. According to Cohen, Krishnamoorthy & Wright (2004), the duality of chief executive officer increases the probability of violating the accounting principle, thus leading to poor quality reporting of financial information. Hoitash, Hoitash & Bedard (2009) and Carey & Simnett (2006) note the relationship between the division of the chief executive officer position and the board chairman with the quality of audit performed by a firm. Te existence of chief executive officer tasked with serving an additional role of board chairman is linked to poor quality of financial information reporting.
Similarly, Ahmed, Hossain & Adams, (2006) agree that financial information reporting is more pertinent in cases where the position of chief executive officer is separated from the position of board chairman. While most authors notice the relationship between separated position of chief executive officer and the board chairman and the quality of financial information reporting, other authors and studies Krishnan (2003) and Collett & Hrasky (2005) on corporate governance do not establish a link between the two factors.
Ownership structure
Additionally, empirical and theoretical studies done by Lin & Hwang (2010) and Larcker, Richardson & Tuna, (2007) on corporate governance have implied that the ownership structure of the organization or the firm can impact the quality of financial information reporting. On the contrary, the existence of block-holders may restrain the unrestricted characteristic of the manager. Additionally, it can provoke them to assume profitable strategies and unveil pertinent and dependable information. Indeed, Mitton (2002) and Bradbury, Mak & Tan (2006) reported the ownership concentration lessens the earnings management in various firms which improve the quality of financial reporting. A similar link between the ownership concentration and the quality of financial information reporting has been noted by several other authors. Bushman & Smith (2001) agree that the concentration of ownership lessens the level of discretionary accumulations and improves the intentional reporting made by managers. The findings on the positive relationship between ownership concentration have also been reported by others authors on corporate governance like DeAngelo (1981) and Lennox (1999). .
On the contrary, the existence of controlling shareholders may aggravate the agency predicaments according to Becker et al. (1998). They argue that holding a big fraction of capital motivates shareholders to be established in the firm and to confiscate the other shareholders. In the same context, numerous studies have implied that concentrated ownership lessens the pertinence of the financial information. The firms that are characterized by ownership concentration have been noted to have weak earning quality. Other research and studies on corporate governance performed by Lin & Hwang (2010) indicate that the presence of block-holders interferes with the credibility of the financial information reporting.
Conclusion
A literature review of the relationship between corporate governance and the quality of audit reveals several control mechanisms that affect the quality of financial information reporting in most firms; the composition of the board, the size of the board and the ownership structure. Several studies on corporate governance, and audit quality has emphasized on the composition of the board of directors as one of the mechanisms of corporate governance that affect the quality of financial information reporting. It is rational to conclude that a big board size lessens the information content of the incomes, thus improving the quality of financial information report. Additionally, the size of the board has a positive effect on the quality of financial reporting.
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