The impact of audit quality on earnings management and cost of equity capital: evidence from a developing market

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Ben Le ◽  
Paula Hearn Moore
Keyword(s):  
Financial Reporting ◽  
Audit Quality ◽  
Discretionary Accruals ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
Big 4 ◽  
The Government ◽  
The Impact

Purpose This study aims to examine the effects of audit quality on earnings management and cost of equity capital (COE) considering the impact of two owner types: government ownership and foreign ownership. Design/methodology/approach The study uses a panel data set of 236 Vietnamese firms covering the period 2007 to 2017. Because the two main dependent variables of the COE capital and the absolute value of discretionary accruals receive fractional values between zero and one, the paper uses the generalised linear model (GLM) with a logit link and the binomial family in regression analyses. The paper uses numerous audit quality measures, including hiring Big 4 auditors or the industry-leading Big 4 auditor, changing from non-Big 4 auditors to Big 4 auditors or the industry-leading Big 4 auditor, and the length of Big 4 auditor tenure. Big 4 companies include KPMG, Deloitte, EY and PwC, whereas the non-big 4 are the other audit companies. Findings The study finds a negative relationship between audit quality and both the COE capital and income-increasing discretionary accruals. The effects of audit quality on discretionary accruals and the COE capital depend on the ownership levels of two important shareholders: the government and foreign investors. Foreign ownership is negatively associated with discretionary accruals; however, the effect is more pronounced in the sub-sample of state-owned enterprises (SOEs), the firms where the government owns 50% or more equity, than in the sub-sample of Non-SOEs. Originality/value To the best of the knowledge, no prior similar study exists that used the GLM with a logit link and the binomial family regression. Global investors may be interested in understanding how unique institutional settings and capital markets of each country impact the financial reporting quality and cost of capital. Further, policymakers of developing markets may have incentives to improve the quality of financial reporting and reduce the cost of capital which should result in attracting more foreign investments.

The impact of mandatory IFRS adoption on capital markets: evidence from Korea

2018 ◽  
Vol 26 (1) ◽  
pp. 38-58 ◽  
Author(s):  
Saerona Kim ◽  
Haeyoung Ryu
Keyword(s):  
Financial Reporting ◽  
Financial Statements ◽  
Joint Effect ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
Ifrs Adoption ◽  
The Cost ◽  
The Impact

Purpose The purpose of this paper is to examine the effects of adoption of the mandatory International Financial Reporting Standards (IFRS) on the cost of equity capital in a unique Korean setting. In Korea, individual financial statements were taken as primary financial statements. Before the adoption of IFRS, consolidated financial statements were taken as supplementary financial statements. Design/methodology/approach The authors measure the cost of equity using the average estimates from the implied cost of capital models proposed by Claus and Thomas (2001), Gebhardt et al. (2001), Easton (2004) and Ohlson and Juettner-Nauroth (2005), using it as the primary dependent variable. Mandatory IFRS adoption, the independent variable in this study, is assigned a value of 1 for the post-adoption period and 0 otherwise. Findings Using a sample of listed Korean companies during the period from 2000 to 2013, the authors find evidence of a significant reduction in the cost of equity capital in Korean listed companies after mandatory adoption of the IFRS in 2011, after controlling for a set of market variables. Originality/value This study is one of a growing body of literature on the relations between mandatory IFRS adoption and the cost of equity capital (Easley and O’Hara 2004; Covrig et al. 2007; Lambert et al. 2007; Daske et al. 2008). According to the results of this study, increased financial disclosure and enhanced information comparability, along with changes in legal and institutional enforcement, seem to have had a joint effect on the cost of equity capital, leading to a large decrease in expected equity returns.

Litigation Risk and the Financial Reporting Credibility of Big 4 versus Non-Big 4 Audits: Evidence from Anglo-American Countries

2004 ◽  
Vol 79 (2) ◽  
pp. 473-495 ◽  
Author(s):  
Inder K. Khurana ◽  
K. K. Raman
Keyword(s):  
Financial Reporting ◽  
Audit Quality ◽  
Equity Capital ◽  
Brand Name ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Big 4 ◽  
Ex Ante ◽  
Anglo American ◽  
The U.S

Prior research suggests that Big 4 auditors provide higher quality audits in the U.S. in order to protect the firm's brand name reputation and to avoid costly litigation. In this study, we examine whether the perceived higher quality of a Big 4 audit is related to auditor litigation exposure or to reputation concerns. Specifically, we utilize an estimable proxy for financial reporting credibility—the ex ante cost of equity capital—to examine whether Big 4 auditors are perceived as providing higher quality audits (relative to non-Big 4 auditors) in the U.S., and in the less litigious (but economically similar) environments in other Anglo-American countries during the 1990–99 period. We find that a Big 4 audit is associated with a lower ex ante cost of equity capital for auditees in the U.S. but not in Australia, Canada, or the U.K. Our findings suggest that it is litigation exposure rather than brand name reputation protection that drives perceived audit quality.

scholarly journals Earnings quality and the cost of equity capital: evidence on the impact of legal background

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Ahmed Hassan Ahmed ◽  
Yasean Tahat ◽  
Yasser Eliwa ◽  
Bruce Burton
Keyword(s):  
Earnings Quality ◽  
Institutional Ownership ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
The Usa ◽  
The Uk ◽  
The Cost ◽  
The Impact

Purpose Earnings quality is of great concern to corporate stakeholders, including capital providers in international markets with widely varying regulatory pedigrees and ownership patterns. This paper aims to examine the association between the cost of equity capital and earnings quality, contextualised via tests that incorporate the potential for moderating effects around institutional settings. The analysis focuses on and compares evidence relating to (common law) UK/US firms and (civil law) German firms over the period 2005–2018 and seeks to identify whether, given institutional dissimilarities, significant differences exist between the two settings. Design/methodology/approach First, the authors undertake a review of the extant literature on the link between earnings quality and the cost of capital. Second, using a sample of 948 listed companies from the USA, the UK and Germany over the period 2005 to 2018, the authors estimate four implied cost of equity capital proxies. The relationship between companies’ cost of equity capital and their earnings quality is then investigated. Findings Consistent with theoretical reasoning and prior empirical analyses, the authors find a statistically negative association between earnings quality, evidenced by information relating to accruals and the cost of equity capital. However, when they extend the analysis by investigating the combined effect of institutional ownership and earnings quality on financing cost, the impact – while negative overall – is found to vary across legal backdrops. Research limitations/implications This paper uses institutional ownership as a mediating variable in the association between earnings quality and the cost of equity capital, but this is not intended to suggest that other measures may be of relevance here and additional research might usefully expand the analysis to incorporate other forms of ownership including state and foreign bases. Second, and suggestive of another avenue for developing the work presented in the study, the authors have used accrual measures of earnings quality. Practical implications The results are shown to provide potentially important insights for policymakers, creditors and investors about the consequences of earnings quality variability. The results should be of interest to firms seeking to reduce their financing costs and retain financial viability in the wake of the impact of the Covid-19 pandemic. Originality/value The reported findings extends the single-country results of Eliwa et al. (2016) for the UK firms and Francis et al. (2005) for the USA, whereby both reported that the cost of equity capital is negatively associated with earnings quality attributes. Second, in a further increment to the extant literature (particularly Francis et al., 2005 and Eliwa et al., 2016), the authors find the effect of institutional ownership to be influential, with a significantly positive impact on the association between earnings quality and the cost of equity capital, suggesting in turn that institutional ownership can improve firms’ ability to secure cheaper funding by virtue of robust monitoring. While this result holds for the whole sample (the USA, the UK and Germany), country-level analysis shows that the result holds only for the common law countries (the UK and the USA) and not for Germany, consistent with the notion that extant legal systems are a determining factor in this context. This novel finding points to a role for institutional investors in watching and improving the quality of financial reports that are valued by the market in its price formation activity.

Does intellectual capital disclosure affect the cost of equity capital? An empirical analysis in the integrated reporting context

2020 ◽  
Vol 21 (6) ◽  
pp. 985-1007 ◽  
Author(s):  
Antonio Salvi ◽  
Filippo Vitolla ◽  
Nicola Raimo ◽  
Michele Rubino ◽  
Felice Petruzzella
Keyword(s):  
Intellectual Capital ◽  
Equity Capital ◽  
Corporate Disclosure ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Integrated Reporting ◽  
Empirical Examination ◽  
Content Type ◽  
The Cost ◽  
The Impact

PurposeThe purpose of this study is to examine the impact of intellectual capital disclosure on the cost of equity capital in the context of integrated reporting, which represents the ultimate frontier in the field of corporate disclosure.Design/methodology/approachThe authors employ content analysis to measure intellectual capital disclosure levels along with a panel analysis on a sample of 164 integrated reports.FindingsEmpirical outcomes indicate that intellectual capital disclosure levels have a significantly negative association with the cost of equity capital.Originality/valueThis study's major contribution lies in its originality in terms of empirical examination of the relationship between intellectual capital disclosure in integrated reports and the cost of equity capital.

Can Big 4 versus Non-Big 4 Differences in Audit-Quality Proxies Be Attributed to Client Characteristics?

2011 ◽  
Vol 86 (1) ◽  
pp. 259-286 ◽  
Author(s):  
Alastair Lawrence ◽  
Miguel Minutti-Meza ◽  
Ping Zhang
Keyword(s):  
Audit Quality ◽  
Forecast Accuracy ◽  
Equity Capital ◽  
Analyst Forecast ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Client Characteristics ◽  
Big 4 ◽  
Audit Firms ◽  
Matching Models

ABSTRACT: This study examines whether differences in proxies for audit quality between Big 4 and non-Big 4 audit firms could be a reflection of their respective clients’ characteristics. In our analyses, we use three audit-quality proxies—discretionary accruals, the ex ante cost-of-equity capital, and analyst forecast accuracy—and employ propensity-score and attribute-based matching models in attempt to control for differences in client characteristics between the two auditor groups while estimating the audit-quality effects. Using these matching models, we find that the effects of Big 4 auditors are insignificantly different from those of non-Big 4 auditors with respect to the three audit-quality proxies. Our results suggest that differences in these proxies between Big 4 and non-Big 4 auditors largely reflect client characteristics and, more specifically, client size. We caution the reader that this study has not resolved the question, although we hope that it encourages other researchers to explore alternative methodologies that separate client characteristics from audit-quality effects.

Effect of intellectual capital disclosure on cost of equity capital: a study on Indian companies

2020 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Amitava Mondal ◽  
Chiranjit Ghosh
Keyword(s):  
Human Capital ◽  
Intellectual Capital ◽  
Research Work ◽  
Equity Capital ◽  
Negative Association ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
Structural Capital ◽  
The Impact

PurposeThe impact of the intellectual capital disclosure (ICD) on the cost of equity capital (COEC) is not well established in the aspect of the Indian scenario. So the objective of this paper is to examine not only the overall effect of ICD but also the individual effect of human capital disclosure (HCD), relational capital disclosure (RCD) and structural capital disclosure (SCD) on COEC.Design/methodology/approachThis research work is conducted by regressing COEC, firm size, leverage, industry type and disclosure index. The disclosure index is prepared based on content analysis of disclosure made in the annual reports of a sample of 50 companies listed in the Nifty 50 index for the year 2018–2019. But in this paper 20 companies are eliminated due to their negative COEC and rest 30 companies are used as the sample companies for this study.FindingsThe outcome of this study indicates a negative association between the disclosure of intellectual capital (IC) as a whole and the COEC. But a negative association only for two components (human capital and structural capital) with the COEC is found only when the association of COEC with the categories of ICD is considered.Originality/valueThis is the first study that examines the nexus between the level of ICD and its impact on the COEC in India context.

Audit committee ownership and the cost of equity capital

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Ahsan Habib ◽  
Md. Borhan Uddin Bhuiyan ◽  
Julia Y.H. Wu
Keyword(s):  
Firm Performance ◽  
Financial Reporting ◽  
Audit Committee ◽  
Reporting Quality ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Data Set ◽  
Content Type ◽  
The Cost

Purpose This paper aims to investigate whether audit committee ownership (consisting of both equity holdings and option holdings) is associated with the cost of equity capital. Design/methodology/approach This paper uses regression analysis to examine the association between audit committee ownership and the cost of equity capital. The data set consists of 2,825 firm-year observations for companies listed on the ASX between 2001 and 2015. This paper also conducts tests to explore the mediating effects of financial reporting quality, firm performance and the risk of reporting problems, on the relation between audit committee ownership and cost of equity capital. Findings The analyses reveal that audit committee ownership reduces the firm’s cost of equity and, thereby, support the incentive alignment view. However, the association is driven primarily by audit committee equity ownership, with option holdings having an insignificant effect. This paper also finds that firm performance mediates the association between audit committee ownership and the cost of equity capital. Practical implications Findings of the existing corporate governance research relating to the cost of equity capital and audit committee ownership remain sparse in the context of “comply-or-explain” types of regulatory environment, like that of Australia. The findings indicate that principle-based discretionary governance arrangements, e.g. compensating audit committee members with company equity, may bring benefits to firms in terms of cheaper financing. Regulators, scholars and practitioners are invited to consider further the comprehensive implications of the structure and transparency of audit committee incentives on the effective functioning of security markets. Originality/value The effects of audit committee ownership on the cost of equity capital are an issue of direct economic consequence for equity investors. The main finding of this study, namely, that a firm with higher audit committee share ownership is likely to benefit from a lower cost of equity capital, therefore adds value to the limited extant literature.

scholarly journals The impact of corporate social and environmental practices on the cost of equity capital: UK evidence

2019 ◽  
Vol 27 (3) ◽  
pp. 425-441 ◽  
Author(s):  
Ahmed H. Ahmed ◽  
Yasser Eliwa ◽  
David M. Power
Keyword(s):  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Environmental Practices ◽  
Content Type ◽  
Environmentally Responsible ◽  
Corporate Social ◽  
The Cost ◽  
The Impact ◽  
The Relationship

Purpose There has been an ongoing call from various groups of stakeholders for social and environmental practices to be integrated into companies’ operations. A number of companies have responded by engaging in socially and environmentally responsible activities, while others choose not to participate in these activities, which incur additional costs. The absence of consensus regarding the economic implications of social and environmental practices provides the impetus for this paper. This study aims to examine the association between corporate social and environmental practices (CSEP) and the cost of equity capital measured by four ex ante measures using a sample of UK listed companies. Design/methodology/approach First, we undertake a review of the extant literature on CSEP. Second, using a sample of 236 companies surveyed in “Britain’s most admired companies” in terms of “community and environmental responsibility” during the period 2010-2014, we estimate four implied a cost of equity capital proxies. The relationship between a companies’ cost of equity capital and its CSEP is then calculated. Findings The authors find evidence that companies with higher levels of CSEP have a lower cost of equity capital. This finding determines the significant role played by CSEP in helping users to make useful decisions. Also, it supports arguments that firms with socially responsible practices have lower risk and higher valuation. Practical implications The finding encourages companies to be more socially and environmentally responsible. Furthermore, it provides up-to-date evidence of the economic consequences of CSEP. The results should, therefore, be of interest to managers, regulators and standard-setters charged with developing regulations to control CSEP, as these practices are still undertaken on a voluntary basis by companies. Originality/value To the best of the authors’ knowledge, this is the first study to investigate the association between CSEP of British companies and their cost of equity capital. The study complements Ghoul et al. (2011), who examine the relationship between CSR and the cost of equity capital of the US sample. The authors extend Ghoul et al. (2011) by using a sample of the UK market after applying International Financial Reporting Standards.

scholarly journals How Investors Perceive Mandatory Audit Firm Rotation in Korea

2019 ◽  
Vol 11 (4) ◽  
pp. 1089 ◽  
Author(s):  
Sook Kim ◽  
Seon Kim ◽  
Dong Lee ◽  
Seung Yoo
Keyword(s):  
Audit Quality ◽  
Indirect Evidence ◽  
Auditor Independence ◽  
Equity Capital ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Audit Firm ◽  
The Cost ◽  
Mandatory Audit Firm Rotation ◽  
The Impact

Credible audit quality is a precondition for a firm’s sustainability. External auditors offer assurance with regard to the uncertain factors that can jeopardize a firm’s sustainability and provide audit opinions that help investors assess risk. After the global crisis and accounting scandals, mandatory audit firm rotation has been implemented globally. However, few studies have investigated either the cost or the benefit of mandatory audit firm rotation. Prior studies provide only indirect evidence on the effects of audit firm tenure on audit quality/perceived audit quality. By discussing prior arguments, we examine how investors perceive the implementation of mandatory audit firm rotation in Korea. Using a unique and direct setting to examine our research question, we analyze the relationship between firms with mandatorily switched audit firms and the cost of equity capital from 2006 to 2008. We find that the mandatory change in the auditors has a negative association with the cost of equity capital. The results are robust to using the arithmetic mean of the cost of equity capital, lagged control variables, and the manufacturing industry effect. The results indicate that investors perceive that mandatory audit firm rotation provides an environment for qualified audits by enhancing auditor independence and skepticism, and thus decreases the cost of equity capital. This study helps to improve our understanding of the impact of mandatory audit firm rotation the information risk evaluations and provides political implications for policy makers by showing the benefit of mandatory audit firm rotation.

Does compliance with the German Corporate Governance Code pay off?

2015 ◽  
Vol 16 (3) ◽  
pp. 344-376 ◽  
Author(s):  
Thomas Kaspereit ◽  
Kerstin Lopatta ◽  
Jochen Zimmermann
Keyword(s):  
Corporate Governance ◽  
Empirical Analysis ◽  
Equity Capital ◽  
Outcome Variable ◽  
Cost Of Equity Capital ◽  
Cost Of Equity ◽  
Content Type ◽  
Good Corporate Governance ◽  
The Government ◽  
Open Question

Purpose – This paper aims to empirically investigate the relationship between the level of compliance with the German Corporate Governance Code’s (GCGC) recommendations and the implied cost of equity capital (ICC). German listed companies are required by law to annually disclose their compliance with the recommendations of the GCGC. Whether the GCGC achieves its aim to promote the trust of stakeholders in the management and supervision is still an open question. Design/methodology/approach – ICC is regressed on a score that captures compliance with the GCGC and several control variables. The dataset covers the period of 2003-2012 with declarations of compliance from 447 companies. ICC is chosen as an outcome variable, as it captures general investment risk as well as risk arising from asymmetric information and mistrust of investors in management. Findings – The results of the empirical analysis demonstrate that a higher level of GCGC compliance is associated with lower ICC. Research limitations/implications – It is expected that the results of this study will strengthen acceptance of the GCGC and empirically support the work of the government commission that is responsible for it. It has not been analyzed yet whether the firms cite good reasons why they do not adhere to certain items. Originality/value – This empirical analysis is the first to provide statistically reliable evidence on how compliance with the GCGC affects ICC and whether the work of the government commission reflects good corporate governance as perceived by capital markets.

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