1.0 Abstract
Stakeholders are of central importance to every business organization. The success of any business hinges on the relationship that it has with its stakeholders. Disclosure of quality financial reports is significant for the capacity of business organizations to build confidence with their key stakeholders. Corporate governance and the audit quality have attracted the interest of researchers to determine how they impact stakeholders. Additionally, the implementation of IFRS (International Financial Reporting Standards) has impacted the direction of business organizations especially with regards to corporate governance. The question of whether the quality and extent of disclosure of financial information is related to the quality of an auditor and whether companies that hire higher quality auditors have quality disclosure have also become an interesting area of further studies.
The research tries to consider the existence of correlation between the audit size and the extent of information disclosure. It looks at the implications that corporate governance has for business stakeholders as well as how it affects the quality of an audit. The data for the research was collected from a list of companies on the Australian Stock Exchange. In addition, more information was obtained from various sources such as newspaper articles, journals, and the reports of financial audits of the companies. The research found that positive correlation exists between the quality of an auditor and financial reporting of the companies. Additionally, the quality of information the companies disclose is positively related to the quality of an auditor. The research concluded that the quality and extent of information disclosure and the quality of the audit are positively correlated. In addition, the research found that companies that hire high-quality international auditors tend to have quality disclosure of their financial information. Thus, the research findings supported the literature and the hypothesis that companies that utilize high- quality auditors tend to have quality disclosure and audits.
2.0 Introduction
Stakeholders are instrumental to the success of business organizations. The failure of companies to establish strong relationships with their stakeholders constitutes a significant risk (Bepari & Mollik, 2015). The major business stakeholders include various players such as customers, suppliers, government, management, and the community (Bepari & Mollik, 2015). Shareholders and financiers of an organization also constitute the main stakeholders. The financial capacity of an organization depends on how it relates with its stakeholders. If investors lose confidence in the management of a business organization, they tend to withdraw their invested funds which may result in the failure of the business.
The transparency of the management in disclosing the relevant financial information of their organizations is fundamental to building investors confidence. Corporate governance entails the adoption of management strategies to ensure that the interests of all business stakeholders are brought into consideration (Abor & Adjasi, 2007). Essentially, corporate governance focuses on the balancing of the stakeholders’ interests as well as the direction of the business. It focuses on the management boards that are ultimately responsible for the business (Abor & Adjasi, 2007). Business entities tend to compete for the capital required to maintain business operations. As such, they implement different methods to attract investors such as offering high dividends and maintaining reputable corporate governance (Gaa, 2009). The capacity of business organizations to obtain the required capital depends on the level of confidence that investors have with their management (Gaa, 2009). Thus, efficient corporate governance is crucial to give a reassurance of investors’ confidence in an organization.
The accuracy of the management reporting, as well as the efficiency of business internal control, depends on the way corporate governance is executed (Grant, 2005).The main pillars of corporate governance include various stakeholders’ representatives such as audit committees, auditors, and the executive management (Carnegie & O’Connell, 2014). Corporate governance impacts significantly the way business is directed. According to the recent research, corporate governance influences the quality of information disclosed to the stakeholders through manipulation or influencing the auditor’s reports (Wong, 2009). Various measures such as the implementation of IFRS (International Financial Reporting Standards) have been embraced to enhance auditing quality and financial reporting, although the problem of management inefficiencies still exist (Wong, 2009). The quality of an audit is crucial to the strengthening of the relationship between a business organization and its stakeholder. In essence, audit quality entails the capacity that an auditor has in detection and elimination of material misstatement as well as manipulation of information concerning the reported net income by a company (Martin, 2013). The next part of this report will look at the background information on the study.
3.0 Literature review/ background information
3.1 An overview of the concept of corporate governance
The financial that occurred in 2008 was the greatest crisis since the Great Depression of the 1930s (Allen & Carletti, 2009). Between 2007 and 2008, many business organizations closed down, resulting in worldwide loss of investors’ funds and jobs (Carnegie & O’Connell, 2014). The major causes of these losses were inefficiencies in corporate governance and the fact that organizations lacked transparency in their management (Bushman, Piotroski, and Smith, 2004). Since then, corporate governance has been emphasized, and various reforms have been realized by several emerging markets. These reforms have contributed to notable changes in various countries (Gaa, 2009).
The idea of corporate governance mainly entails mechanisms that are involved in balancing the varying interests of business stakeholders. Primarily, this concept applies to the direction and internal control of business organizations, and it focuses on how organizations are managed and who is ultimately responsible for the business (Abor & Adjasi, 2007). Due to the advancements in technology, as well as the international trade that promote products diffusion, it has become increasingly essential for business organizations to maintain efficient corporate governance (Waymire & Baker, 1978). The limitations of the national legal reforms, coupled with the dawn of globalization and existence of internationally integrated financial markets are the key contributors to the literature review that surround the idea of corporate governance (Waymire & Baker, 1978).
Corporate governance has significant impacts on the business stakeholders and the quality of audit and financial reports of business organizations (Bebchuk, 2005). The research focused on the impacts the corporate governance has on the quality of audit as well as its implication for the business stakeholders. Corporate governance usually influences the financial reporting of companies by influencing the audit process and the audit reports concerning the reported net income of the companies (Jyh-shyan, Hsueh-chang, & Yung, 2014). Additionally, the manipulation of financial records by the managements tends to affect the outcomes of the audits.
The information disclosed to the auditors significantly affects the audit as well as the financial reporting process in most companies (Jyh-shyan, Hsueh-chang, & Yung, 2014). According to Mallin (2002, effective execution of corporate governance ensures that quality and sufficient information is disclosed to facilitate the audit process. In addition, it helps to heighten the confidence that investors have in the business, which is one of the major causes of the success of the companies such as BBN and BOQ in obtaining business capital (Grant, 2005). Companies use various strategies to attract investors (Pilcher, 2014). However, efficient corporate governance has been the major contributor to the success of companies in obtaining capital.
3.2 The relationship between corporate governance and quality of audit in companies of different sizes
The financial capacity of a company influences its financial decisions in various ways. Companies with greater financial capability tend to hire international high- quality auditors (Turley & Zaman, 2004). Additionally, the efficiency of corporate governance in large companies tends to be high due to their sensitivity to the large number of stakeholders (Pilcher, 2014). However, according to Abor & Adjasi (2007), corporate governance may be inefficient in a large company than in a small one depending on the manner in which it is executed and the desired objectives of the management.
International regulatory organizations have adopted various strategies to enhance the efficiency of auditing process and corporate governance in business organizations (Sundgren and Svanström, n.d). Some of the strategies adopted include the implementation of IFRS (International Financial Reporting Standards). However, the impacts of these regulations on the financial reporting have been disruptive to the process of financial reporting process than the use of taxes according to financial analysts (Gaa, 2009). The prices of share are sensitive to the use of IFRS regulations. Thus, its adoption has adverse effects on the shareholders. Besides, a change in the reported profit tends to affect dividend payments to the shareholders (Gaa, 2009). Therefore, the implementation of the IFRS is not efficient in impacting the financial reporting of companies in the desired direction. Moreover, companies spend a lot of resources in its implementation (PricewaterhouseCoopers, 2004).
In Australia, various firms have been affected by the adoption of IFRS with regards to financial reporting (Waymire & Baker, 1978). This has prompted stakeholders to push for more expanded roles of audit committees, although the process has been slow. However, it has become necessary to consider AASB (Australian Accounting Standard Board 1047) disclosures (Martin, 2013). Financial disclosures under this board are quality considering how they affect companies and the interests of various business stakeholders (Martin, 2013). Firms are concerned about the quality of audit that can attract a large number of investors. As such, the impacts of implementation of various reporting standards must draw the attention of business managements.
Auditors from large international audit firms like KPMG, Ernst, Deloitte and Young tend to have great reputation due to the quality of their work (Martin, 2013). As such, they hire experienced auditors who ask for comprehensive details of financial information of companies that utilize them to protect their reputations. Large companies such CONSOLIDATED GOLD LIMITED, ALS LIMITED, ALTERRA LIMITED, AMBITION GROUP LIMITED, ANAECO LIMITED, ABSOLUTE EQUITY PERFORMANCE LIMTED, AROWANA INTERNATIONAL LIMITED, ASHLEYS SERVICE GROUP LIMITED, AUSTRALIAN LEADERS FUND LIMITED, and AUSTRALIAN MASTERS CORPORATE BOND FUNDNO. 5 LIMITED (Australian Stock, 2005). These companies were selected from the financial sector and their level of information disclosure studied to establish the relationship between audit quality and the extent of information disclosure. They tend to hire auditors from reputable audit firms to ensure the accuracy of their financial and audit reports (Hemraj, 2004). Therefore, the quality of audit tends to be high in large companies than in small ones that hire lower quality auditors. The failure of an auditor represents the failure of the audit firm that has employed him. Therefore, auditors from reputable audit firms must as ask for full disclosure of information to avoid putting their companies at risk.
The risk involved in internal audits in the modern business organizations, as well as the need to ensure compliance with the regulations, call for quality corporate governance (Bae, & Lee, n.d). A quality audit ensures that any material misstatements, as well as manipulations of the financial information, are eliminated from the financial records to ensure accurate reports. Therefore, companies that hire experienced auditors must disclose all their financial information. Hence, they have quality audits (Hemraj, 2004). However, there has been limited study on quality of audit in Australia since very few cases of audit failure have been reported both in financial and other markets (Martin, 2013).
AASB1047 (Australian Accounting Standards Board 1047) stresses the quality of disclosure to the users of information (Palmer, 2008). The information disclosed should be quality and sufficient to assist the auditors in making quality audit reports. The extent of disclosure furthermore helps the determination of the effects of changes in regulations such as the adoption of IFRS (Wong, 2009). Quality auditing helps to minimize irregularities in the disclosure of information since it involves the verification and validation of financial statements by an independent person. Furthermore, auditing promotes transparency of organizations in the financial reporting process. Hence, it contributes significantly to the efficiency of corporate governance. Research indicates that most firms incorporate auditors in their disclosure strategy to portray the decision of the firms to give high- quality disclosure (The international, 2004). However, Singh, Woodliff, Sultana, & Newby (2013), found that auditors are usually manipulated to give inaccurate audit reports in favour of companies.
Corporate governance significantly influences the financial reporting process in many companies. The manipulation of financial information, as well as the provision of inadequate disclosure, has serious implications for the stakeholders. The adoption of IFRS does not produce the desired effects in terms of improving the extent of information disclosed by companies as well as the corporate governance. Therefore, is important to consider AASB 1047 which has a significant influence on both the quality of disclosure and the balancing of stakeholders’ interests. The quality of an audit is positively related to the experience of the auditor. Large companies with great financial capabilities tend to have quality audit since they hire experienced auditors from reputable audit firms. Furthermore, large companies usually have quality disclosure since auditors from reputable firms tend to ask for comprehensive information to ensure the accuracy of audit reports to protect their reputation. The next section will look at the methodology of the research.
4.0 Methodology
The data used in the research was collected from ten companies in the list of ASX (Australian Stock Exchange). Additional information was obtained from financial reports of the companies for the financial year 2013-2014, newspaper articles, and some relevant scholarly journals. Various methods of data analysis such as ratio and analysis, regression, and descriptive statistics were utilized. The ratio analysis entails the quantities approach to the analysis of financial information of companies. Essentially, ratio analysis involves calculating financial ratios of various financial items to evaluate the performance of the business (Cohen, 1988). The efficiency of business and the impact of the introduction of a new policy can be measured using changes in financial ratios. In this research, ratio analysis helped to evaluate the efficiency of companies in terms of profitability and returns on investments as a result of the adoption of new policy such as IFRS.
The primary objective of the research was to accept or reject the hypothesis that the quality of the audit is related to the disclosure and that large companies have quality disclosure because they hire experienced auditors than small companies. To determine the correlation between the audit quality and the extent of disclosure, regression analysis was applied. Regression analysis entails the determination of the relationship between two or more variables. Fundamentally, this analysis is used to determine how one variable known as the independent variable affect another variable usually referred to as the dependent variable (Cohen, 1988). The dummy variables were used to classify the companies as large or small where a company could be assigned the value 1 if it is large or 0 otherwise, to make the regression model more relevant (Cohen, 1988). Dummy variables include those variables that do not consume resources and time, but they help in the presentation of a model (Cohen, 1988). Regression analysis helped to evaluate how the extent of disclosure correlated with the audit quality where the audit quality was the dependent variable since it is affected by the disclosure. Descriptive statistics were used to compare some financial ratios like return on investment as well as their interpretations.
Return on investment entails the measurement of profitability of investments by dividing the net profit by the total value of assets. Essentially, it refers to the relative benefit of an investment compared to its cost (Goodwin-Stewart & Kent, 2006). Information disclosure entails the amount of information available to the users of the financial information of the company. There is no specific parameter for measuring the disclosure, but the establishment of the relationship is based on both the quantity and quality of the information disclosed. If more sentences were disclosed, the quality of audit increased.
5.0 Results
The research involved the comparison of the quality of audits and information disclosure. Its objective was to establish whether large companies have quality disclosure because they hire experienced auditors than small companies. The analysis of the data collected shows that positive correlation exists between the quality of audit and the extent of disclosure. In addition, findings from data analysis confirm the hypothesis that large companies provide quality information disclosure. Hence, their audits are quality. The quality of audit increases as the number of sentences disclosed increased. Suppose we quantify the quality using numbers, the expected relationship would appear as follows
Suppose the quality can be measured in numbers, the relationship between audit quality and the number of sentences disclosed is linear. As the company disclose more information, the audit quality improves. This confirms that large companies which hire experienced auditors will tend to have quality audit since the auditor will ask for qualitative information. Calculation of the coefficient of determination will show that a large percentage of audit quality is explained by the number of disclosed sentences. If we formulate a linear model, the data could be presented as follows
Q= a+bS where Q represents the audit quality, a represents the audit quality that is not explained by information disclosure, b represents the rate of change of audit quality with sentences disclosed, and s represents the number of sentences disclosed. Considering this model, the value of b is positive. This shows that the coefficient of correlation is positive, proving that the relationship between the between the audit quality and the extent of information disclosure is positive. This support the hypothesis and theories that argue for the positive relationship.
6.0 Discussions
Based on the sample used in the research, the hypothesis that large companies have quality audit due to disclosure of qualitative information has been confirmed. The literature suggests that large companies hire experienced auditors to portray their decision to disclose quality financial information (Doxey, 2013). The audit committees in large organizations are concerned with the level of confidence that investors have in the management of their business (Deng et al., 2014). Thus, they ensure high efficiency of corporate governance to build and maintain stakeholder confidence by ensuring quality financial reporting. Auditors from reputable international audit firms understand the risk involved in audit, assessment and reporting of financial information of large companies (Council, 2010). They fear that their reputation may be damaged if they are associated with low-quality work (Deng et al., 2014). Therefore, they tend to ask for comprehensive information from the companies that hire them. As a result, large companies usually have quality audits.
The results of the data analysis support the arguments made in the literature review. The findings from ratio analysis support the argument that the experience of an auditor affects the amount of information disclosed by companies. With quality corporate governance, companies are able to acquire more capital due to high investor confidence. The availability of a large amount of capital promotes business expansion, resulting in high returns. High profits enable companies to pay high dividends to the shareholders, thereby attracting more investors. However, information disclosure is not the only factor that affects the quality of an audit. Some auditors are influenced by the management to provide audit reports that are falsified for the sake of protecting some interests of the management. In addition, financial information may be manipulated to provide the desired results by the management. Therefore, the quality of an audit does not entirely reflect the actual financial performance of the business and users should not be fully complacent with it. For example, in Australia, cases of audit failure are rare because intensive research has not been conducted to establish all the factors that affect the quality of an audit (Wong, 2009).
The implementation of international regulations such as IFRS has significantly influenced the process of financial reporting in many companies (Council, 2010). According to financial analysts, the adoption of this policy has produced disruptive effects on companies (Gaa, 2009). Findings from the data analysis reveal that the profitability and improvement in corporate governance did not improve upon the adoption of this policy. Additionally, the implementation of IFRS has adverse effects on the price of shares. Various companies reported that they spend a lot of resources in the implementation of IFRS. Therefore, a more efficient financial reporting standard board that will improve the quality of disclosure is suggested. Disclosures under AASB 1047 (Australian Accounting Standards Board) are significant since the board emphasizes the quality of disclosure (Australian Accounting, 2004). Furthermore, disclosures under this board promote the effectiveness of corporate governance because they integrate the interests of stakeholders.
The results from this study constitute significant implications for the future of financial reporting standards of business organizations. The adoption of policies to improve information disclosure must consider all the possible outcomes and the reactions of business organizations. A policy may be implemented with the aim of improving the quality of disclosure and consequently the corporate governance, but fail due to lack of consideration of other factors in play. For example, taxes introduced in 2000 had less impact than the adoption of IFRS, which was thought to be more effective in improving the quality of corporate governance (Moullakis, 2004). Although the results supported the literature, it is apparent that disclosure of qualitative information is not the only factor that affects the quality of an audit. Therefore, further research is required to determine other significant factors that influence the process of auditing and the quality of audit report as this will help in improving the corporate governance and performance of business organizations.
7.0 Conclusion
Corporate governance represents the heart in business organizations. A strong relationship with business stakeholders is instrumental to business success. The research findings reveal that good corporate governance promotes the success of business organizations by fostering the investor confidence in their investments in various companies. The study has furthermore confirmed that disclosure of quality information to the users is crucial to facilitate the process of financial and audit reporting. The research was significant since it brought more understanding of the concept of disclosure of financial reports. However, the research has various limitations. The measurement of the quality of the audit is complicated. Furthermore, getting an exact definition of the quality of audit is a challenge. The study used the perceived usefulness of the information disclosed to draw the conclusion and confirmation of the stated hypothesis. Another limitation is that companies may disclose information concerning the impacts of adoption of policies such as IFRS by other means such as websites and not through their financial statements. This will affect the outcomes of research and lead to wrong conclusions. The results of the empirical research supported theories and the literature about the quality of information disclosed and how it affects the quality of an audit. However, more research is needed on other factors that are significant determinants of the quality of audit reports. The role that audit committees play in the quality of audits furthermore constitutes an interesting area of research, although it is only possible to companies with such committees.
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