ERASMUS UNIVERSITY ROTTERDAM
ERASMUS SCHOOL OF ECONOMICS
ACCOUNTING, AUDITING AND CONTROL MASTER’S PROGRAM 2009-2010
Master Thesis:
“The effects of the current financial crisis on auditors’ conservatism and
audit fees, concerning stock exchange quoted firms in The Netherlands”
Conductor: Maria Moirasgenti (student nr.: 331425)
Supervisor: E.A. de Knecht RA
Co-reader: A.H. van der Boom
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ABSTRACT
This study was conducted in order to investigate the impacts of the current financial crisis
on the auditors’ use of professional conservatism and on the audit fees, regarding Dutch
stock exchange quoted companies. Audit conservatism was tested between two periods:
first in the prior to the crisis period of 2005-2006, and second during the financial crisis
period of 2008-2009. Audit fees were tested between the years 2008 and 2009 due to
data limitations. 51 stock exchange quoted firms were selected and investigated through
multivariate pooled and linear regression analyses. Contrary to the hypothesized increased
levels of conservatism and audit fees, the Dutch auditors were found to use lower levels of
audit conservatism in their financial audit tasks and charge lower amounts of audit fees.
Acknowledgements
This study would have not been performed without the continuous guidance and help of
my supervisor, with the Erasmus School of Economics E.A. de Knecht. Additional thanks
are provided to the co-reader of this research, Dr. sc. ind. A.H. van der Boom. Special
thanks are given to my sister Rallou, my parents Kostas and Vicky Moirasgenti, my friends
across Greece and The Netherlands, and Phd. candidate Stylianos Sakkas for their
tremendous psychological support and precious willingness to share with me the pressure
and stress of the last months.
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CONTENTS
Abstract………………………………………………………………………………………………………………………….p.2
Acknowledgements…………………………………………………………………………………………………………p.2
Contents…………………………………………………………………………………………………………………………p.3
CHAPTER 1-Introduction…………………………………………………………………………….…………………..p.6
1.1 Background……………………………………………………………………………………….………………………p.6
1.1.1 The current financial crisis……………………………………………………………………………………p.6
1.1.2 The external auditing profession……………………………………………………………………………p.7
1.1.3 Auditors’ conservatism and audit fees…………………………………………………………….…..…p.8
1.2 Objectives………………………………………………………………………………………………………….........p.8
1.3 Problem definition………………………………………………………………………………………..………….p.9
1.4 Methodology………………………………………………………………………………………………………….…p.9
1.5 Demarcation and limitations………………………………………………………………………………….p.10
1.6 Structure…………………………………………………………………………………………………………………p.10
CHAPTER 2-Financial information………………………………………………………...………………………p.12
2.1 Introduction…………………………………………………………………………………………………….........p.12
2.2 Theories concerning financial and accounting information……………………………………..p.13
2.1.1 Agency Theory…………………………………………………………………………………………………….p.13
2.2.2 The efficient Market Hypothesis………………………………………………………………………….p.14
2.2.3 The Positive Accounting Theory…………………………………………………………………………..p.16
2.3 Summary…………………………………………………………………………………………………………………p.18
CHAPTER 3 – The Financial Crisis…………………………………………………………………………………..p.19
3.1 Insight in the causes of the crisis……………………………………………………………………………..p.19
3.2 Fair-value and off-balance sheet accounting: the features of controversy………………p.24
3.3 Summary…………………………………………………………………………………………………………..…….p.27
CHAPTER 4 – The external auditing profession, the impacts of the financial crisis on
external auditors, audit conservatism and audit fees…………………………………………………...p.28
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4.1 External Auditing………………………………………………………………………………………………….…p.28
4.2 Implications of the current financial crisis on the audit profession……………………….…p.32
4.3 Conservatism in audits…………………………………………………………………………………………….p.34
4.4 Audit fee……………………………………………………………………………………………………………..….p.39
4.5 The Association between Audit Fees and Audit Conservatism…………………………….…..p.40
4.6 Summary…………………………………………………………………………………………………………………p.41
CHAPTER 5 – Prior Research………………………………………………………………………………….……p.42
5.1 Prior Research investigation and Hypotheses development………………………………..….p.42
5.2 Summary……………………………………………………………………………………………………………….p.53
CHAPTER 6 – Research Design…………………………………………………………………………..............p.54
6.1 Research approach……………………………………………………………………………………………….p.54
6.2 Research methodology…………………………………………………………………………………………p.55
6.3 Measuring auditors’ conservatism and audit fees……………………………………………….…p.56
6.4 Control variables……………………………………………………………………………………………………..p.59
6.5 Sample selection …………………………………………………………………………………………………….p.61
6.6 Summary………………………………………………………………………………………………………………..p.63
CHAPTER 7 – Research results and analysis…………………………………………………………………..p.64
7.1 Analysis of the investigation concerning the impact of the current financial crisis on
auditors’ use of conservatism……………………………………………………………………….…………..….p.64
7.1.1 Descriptive statistics for Model 1…………………………………………………………………………p.64
7.1.2 Pearson’s correlation testing………………………………………………………………………………p.65
7.1.3 Coefficients’ analysis - Results investigation…………………………………………………………p.68
7.1.4. Complementary evidence concerning data from 2005, 2006, 2008 and 2009……..p.71
7.2 The impact of the current financial crisis, concerning the auditors’ fees…………………p.74
7.2.1 Descriptive statistics for Model 3………………………………………………………….……………p.75
7.2.2 Pearson’s correlation testing………………………………………………………………………………..p.76
7.2.3 Coefficients’ analysis - Results investigation………………………………………………………..p.79
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7.3 Summary………………………………………………………………………………………………………………...p.84
CHAPTER 8 – Conclusion and Limitations……………………....................................................p.85
8.1 Conclusion………………………………………………………………………………………………………………p.85
8.2 Limitations………………………………………………………………………………………………………………p.85
8.3 Further research suggestions…………………………………………………………………………….……p.85
REFERENCES………………………………………………………………………………………………………………….p.87
APENDIX…………………………………………………………………………………………………………...………….p.9
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CHAPTER 1 – Introduction
1.1 Background
“We have an important role to play to ensure the survival of the financial system. Its
survival depends on the vigilance of regulators, the adequacy of reporting processes and
the openness of communication among all the key players. Now it is the time for external
auditors to reassess their roles and responsibilities.” (CA Magazine, “The external auditors’
pivotal role” by Bradshaw & Brown, 1988; p. 46)
This extract was taken from an article written and published in 1988. The time could not
be more right to argue that today, during the days of a financial recession, auditors and
their profession is in a high degree influenced.
This paper concerns a research that will try to shed light on the effects of the recent
financial crisis to the tasks of external financial auditing. This interest concerning the
influence of the financial crisis on the external auditing profession is originated based on
three parties: First the whole business world, second the public and third the academic
world. All previous studies have proved that auditing is severely affected by changes in the
business world, therefore the assumption exists that in this case a great influence exists.
More precisely, the focus of this research will concern the levels of the use of
conservatism in auditors’ evaluations. The levels of conservatism determine the audit fees,
consequently the impact of the current financial crisis on audit fees will be investigated as
well.
1.1.1
The current financial crisis
The financial crisis that started in 2007 indeed is a global financial crisis. It is considered
the outcome of the liquidity shortfall in the United States. Its results in the general
financial sector can be summarized in the dissolution of large financial institutions, the
huge declines in consumer growth rates, the supporting efforts of banks by the national
governments and severe downturns in the stock markets globally.
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The results and the implications from the current situation are so expanding and severe,
that all aspects of the business world are now going through a changing and developing
phase. The auditing profession is inevitably affected in a major scale. Criticism and blame
has focused on a wide range of complex and global factors in general. However, it is more
than disappointing to note that the financial audits assuring the fairness of statements by
banks declaring financial difficulties and filing for bankruptcy soon after receiving an
unqualified audit report were conducted exclusively by one of the Big Four Auditing firms,
committed to provide the highest assurance level.
The interest of this study focuses on a few economic theories that provide insights in the
function of the capital markets and on the causes and the consequences of the crisis in the
global economy. In addition, detailed references concerning the external auditing
profession are provided.
1.1.2
The external auditing profession
Audits are one form of the attestation services provided by external auditors. This
research focuses on audits of historical financial statements, in which an opinion is
expressed about the fairness of a company’s financial statements by CPA firms.
The magnitude of the financial crisis is huge enough to have influenced all the areas of
the business-financial world, including of course the auditing profession. External audit is
promoted as an assurance tool concerning all interested parties in the financial statements
of a company. This is highly to be questioned though considering the latest news. A very
well known example concerning this is the case of Lehman Brothers, one of the biggest
banks that operated in the United States of America (USA) and received an unqualified
opinion shortly before filing for bankruptcy. Because the roots of the problematic situation
expand beyond the auditors’ profession scope, but cannot be characterized as not
plausible, the question “where were the auditors?” is not as prevalent as in the past where
the big auditing scandals had taken place (Enron, A hold, Adelphia). However, since the
level of “duty” towards the public keeps on increasing, the skills concerning the financial
audits of firms in the current years need to be enriched.
The implications concerning the auditing profession, especially the independent one,
are inevitable and certainly severe. In any case, it is not to be forgotten that traditionally
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financial auditors were and still are the ones to trust the savings of a lifetime. The key
features of the profession will be analyzed in this study, along with the impacts of the
crisis on its functions.
1.1.3
Auditors’ conservatism and audit fees
Auditors’ conservatism relates to the general accounting principle of conservatism that
can be summarized in the next rule: anticipation of all losses but no anticipation of profits
(Basu, 1997).
Conservatism is a highly respected concept on audits and at the same time highly
associated with audit fees. The higher the conservatism the more the efforts and the
working hours the auditors dedicate for the conduction of their assurance tasks, resulting
in increased audit fees. It will be very interesting from a scientific point of view to
investigate how auditors’ conservatism has actually been affected during the recent
financial crisis. Comparisons with the prior-to-crisis levels of conservatism will provide us
with a clear view of these effects.
1.2 Objectives
The purpose of this research is to investigate the effects of the recent financial crisis
concerning the external auditing tasks. More specifically, the impact of the current
financial crisis on the auditors’ use of conservatism and the audit fees will be investigated.
All previous studies have proved that auditing is severely affected by changes in the
business world; consequently, a great influence in this case is expected as well.
The public -including also all related parties- is relying on auditors’ assurance about the
discovery of frauds and advice for safer and profitable money investing. A proof of high
professional standards based on the findings of this research will boost the trust and the
lost confidence on auditors, especially today that the business world is still in the midst of
a recession phase.
The motivation of this research results from the timeliness and the importance of this
issue, considering the worldwide financial circumstances and the key role of the auditing
profession. What is more, the great interest in actual practical and ethical considerations
was the motivation to investigate issues from an academic point of view.
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1.3 Problem Definition
The problem of this research can be summarized in the following question:
“What are the effects of the current financial crisis on auditors’ conservatism and audit
fees concerning Dutch stock exchange quoted companies?”
In order to answer this main question the next sub-questions need to be answered:
a. What is the theoretical background concerning financial information?
b. What are the causes and the impacts of the present financial crisis for the business
world?
c. What is the content of the external auditors’ profession and what is the content of the
term auditors’ conservatism?
d. What is the relation between the audit conservatism and the audit fees?
e. Based on prior research, in which way did the financial crisis influence the audit
profession?
1.4 Methodology
The sample of this study will consist of Dutch listed firms audited by both the Big Four
and non-Big Four audit firms. These firms were chosen because in general firms in The
Netherlands are considered fast responding in changes and new developments. In
addition, Dutch Big Four audit firms have proved to be very innovative and competent to
consider their work effective, valid, and precise. This is highly significant since the starting
point of this crisis (severe negative facts did actually happen) is considered 2008, only two
years ago. Data prior to crisis will be gathered from years 2005-2006 and will be compared
with the data during the crisis concerning the period 2008-2009. This comparison will take
place in order to investigate the changes in auditors’ conservatism. Because three years
are considered an adequate period concerning full adjustments in Sarbanes-Oxley act of
2002 requirements, while at the same time predictions of the upcoming crisis had not still
taken place, the years of 2005-2006 have been selected. The years 2008 and 2009 are
years of proved recession. Due to absence of data, 2010 cannot be investigated. Since they
are published in the companies’ financial statements every year after June 2008, data on
audit fees and auditors will be easily collected concerning 2008 and 2009. Consequently,
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the changes in audit fees will be found through the comparison of the audit fees between
2008 and 2009 due to the lack of disclosed data concerning 2005 and 2006. Access to this
data, along with all the other financial data needed, can be provided by the Library
Databases of the Erasmus University (Erasmus School of Economics). Other online sources
of financial data are also the http://www.annualreports.com website and the
http://www.ecb.int/pub/annual/html/index.en.html, which is the official internet site of
the European Central Bank.
The variables that will be tested are auditors’ conservatism and audit fees in response to
the recent financial crisis. The current financial crisis is the independent variable and the
dependent variables consist of auditors’ conservatism and audit fees. The control variables
are presented and explained in the relative part. With the ordinary least squares (OLS) a
linear regression model will be used and estimated. More precisely, the adjusted version
of the regression model Basu created in this research will be used.
1.5 Demarcation and limitations
The findings of this research will help to understand the causes of the changes in
auditors’ conservatism, the implications concerning the auditing profession and the
business world on a second level.
As in every scientific research, limitations exist that need to be considered. First, the
period that will be investigated during the crisis is limited to the years 2008 and 2009 and
because the presence of changes could be in a premature phase this may have
implications concerning the findings. Inflation effects on audit fees, if any, should be
captured too. Lack of data in audit fees for the years 2005-2006 limits the generalization of
the findings concerning fees and makes the comparison between the periods prior and
during the crisis not possible. However, the expectation exists that these results are
representative concerning the audit firm industry.
1.6 Structure
The remainder of this study will continue according to the next structure: Chapter 2 is
focused on the economic theories and the background on financial information. Chapter 3
deals with the present global financial crisis. Insights will be provided that refer to the
causes and implications of the crisis on the business world. Chapter 4 analyzes the external
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auditing profession, the impacts of the financial crisis on it and the concept of audit
conservatism, while Chapter 5 comments on the relation between the audit conservatism
and audit fees. Chapter 6 demonstrates the methodology and findings of prior research
conducted, concerning the subject of auditors’ use of conservatism and audit fees.
Chapter 7 presents the research design that is used for the empirical part of this study and
Chapter 8 provides the presentation of the results of the empirical testing. Finally, Chapter
9 analyzes the main conclusions and the limitations of this study and makes
recommendations concerning the areas that the future research should focus on.
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CHAPTER 2 – Financial information
2.1 Introduction
From an economic perspective, information can be recognized as a business resource
and as such, it is extremely important for the survival of the businesses. The most
important characteristic is that information is produced by facts that cause the user of the
information to take an action that otherwise he/she would or could have not taken (Hall,
2008, p. 11).
Financial information’s supreme goal is to help the users of the financial statements of
the companies in their decision making process and that is the reason why the users of
financial statements are also characterized as decision makers. Auditors’ tasks are part of
the assurance services that are designed to improve the quality of information, both
financial and non-financial used by the decision makers. Conflict resolution and
uncertainty reduction are outcomes emerging also from the problematic use of financial
information.
The users of financial information and financial reporting consist of two broad
categories: external and internal. Creditors, suppliers, customers, stockholders, potential
investors, regulatory and tax authorities are namely the external users. More specifically,
this category is distinguished in institutional users such as the Securities and Exchange
Commission (SEC), banks and the Internal Revenue Service (IRS) and trading partners such
as clients and suppliers. Internal users are managers of every level and operational
personnel of the organization.
The financial statements of the companies communicate all relevant information
concerning the financial position of the company to the users. These statements though,
can be prepared according to a number of accounting and reporting methods that are able
to manipulate the content of the financial information. Managers have incentives to and
do actually misstate the accounting information concerning the firm that employs them.
At this point, the professional duty of the auditors is highlighted. Auditors are committed
to assure the public for the fairness of the reported financial statements of the firms that
are considered the sum of all the associated with the firm financial information. These
statements are considered by many as one of the triggering forces of the investing
activities.
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The importance of valid and adequate financial information is undisputed concerning
the survival and the plain functioning of the economic world. The next part of the chapter
will give insight in the financial theories that explain the nature, the scope, the treatment
and the incentives of the financial information presented in the financial statements.
2.2 Theories concerning financial and accounting information
2.2.1
Agency Theory
A very famous theory concerning managers’ decisions related to the choice and
disclosure of accounting methods is agency theory or otherwise referred to as the
“principal-agent” problem. Focusing on the relationship between the trading parties of
principals and agents, this theory recognizes the existence and importance of transaction
and information costs incurring from this relationship. The theory explained in a valid way
the incentives behind managers’ accounting methods selection.
Jensen and Meckling’s study (1976) was the primary paper that contributed to the
development of the agency theory. They used the principals and agents’ definition of the
two parties forming the agency relationship, in which a contract is used concerning the
engagement of one (or more) person –the agent- to perform a service that requires
delegated decision-making activities on behalf of another –the principal-. They relied upon
traditional economic literature that highlights the maximization of own wealth as the main
cause of people engaging in financial transactions. The relationships and conflicts between
these two parties and the efficiency of markets and other contractual mechanisms were
investigated in order to discover their effects on the minimization of the inherent costs of
the agency relationship. The agency theory considers the firm as a nexus of contracts. The
purpose of these contracts is to ensure that all related parties act for their own profit and
simultaneously for the achievement of the organization’s goals as well. The nominal
assumption of the agency theory is that the individuals will always act motivated by selfinterests, thus the key tool for a successful organization is the setting of mechanisms
adequate to ensure the benefit of both the individuals and the organization.
The incentives issue is another core element of the agency theory. Referring to that
Lambert (2001) pointed out the importance of the incentive problem in the financial world
and distinguished four common reasons resulting in the conflicts between agents and
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principals. These are signaled as effort aversion, differential risk aversion, differential timehorizons, and effort for personal profit of every form from the side of the agent. Thus, it is
claimed in the agency theory that principals will be motivated by self-interest and that
they will demonstrate self-opportunistic behavior in their professional tasks, resulting
finally in agents receiving lower salaries from the principals. Consequently, it is argued that
in the end the agents are the ones to pay for the mistaken principals’ assumptions. Hence,
“the agents are therefore assumed to have an incentive to enter into contractual
arrangements that appear to be able to reduce their ability to undertake actions
detrimental to the interests of the principals” (Deegan and Unerman, 2006, pp. 214). The
bottom-line assumption is that the information problem that arises when agents are not
aware of when principals’ goals are met is solved with the provision of appropriate
incentives to the agents.
Agency theory is one of the fundamental theories of the economic and political science
world and contributed to the development of many more. The Efficient Market Hypothesis
is another theoretical approach that is highly associated with the role financial information
and will be analyzed in the subsequent part of this chapter.
2.2.2
The Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis is a theoretical approach that became famous in the
1960’s and has been developed by Eugene Farma. It is based in the random walk theory,
developed by Bachelier (1964) and supporting that all current information is reflected in
current security prices, consequently future price movements are random because they
are triggered by unexpected news. It supports in general that capital markets are
informationally efficient, interpreted in capital markets reacting to publicly available
information in an efficient and impartial way. The basic concept is that security prices
reflect the informative “package” of all publicly available information, while this publicly
available information emerges from more sources than just accounting disclosures. Since
the capital market is extremely competitive, the release of new information is expected to
be quickly and in a high degree adjusted in the prices of the shares.
The EMH is based in three primary arguments. First, it argues that share prices reflect
information from all kinds of sources and that accounting information is only one kind of
these sources. Thus, capital market reactions are not expected if changes in the
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accounting method occur, assuming of course that the changes do not cause differences in
the cash flows of a firm. In addition, the efficiency of the markets in the evaluation of
accounting information is considered granted. The third and last perspective is that other
potentially unverified evidence can always emerge. These three arguments were pointed
out from Watts and Zimmerman (1968) to note that increased accounting regulation has
little to do in restricting opportunistic behaviors.
The three versions of the hypothesis are namely weak, semi-strong, and strong. In its
weak form, the EMH claims that the prices of traded assets already reflect all public
available information of the past. The semi-strong version adds to the claims of the weak
version the immediate response in the prices of the traded assets of new public available
information. The strong form of the hypothesis additionally predicts the price adjustments
of the traded assets in response to hidden or inside information. From a forecasting
perspective, Timmermann and Granger (2004) argue that the EMH “crudely” notes that
calculating beforehand the returns from speculative assets is simply not possible.
The significant limitation of the EFH is that it fails to give explanations concerning the
preferences of managers in accounting methods. Opponents of the EMH argue that the
EFH is simply inefficient. In more detail, it is argued that investors’ behavior is also driven
by cognitive biases (i.e. overconfidence or overreaction) that are attributed to simple
human errors in the reasoning and information analyses. Warren Buffet, an American
billionaire and one of the most successful investors of the world, characteristically quoted
“I’d be a burglar in the street if markets were efficient.”1
Despite the severe restrictions of the EMH, it has contributed in the development of
other economic theories and approaches. The conceptual combination of the Efficient
Market Hypothesis and the Agency Theory provided the theoretical base of the Positive
accounting theory, which is the last economic approach analyzed subsequently in this
study.
1
http://www.brainyquote.com/quotes/authors/w/warren_buffett_3.html, accessed on 11th of October 2010
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2.2.3
The Positive Accounting Theory (PAT)
In general, a positive theory concentrates on the explanation and prediction of
particular phenomena. The perspective of the firm as an aggregate of contractual
arrangements along with other theoretical views of the company as an efficient
mechanism of reducing transaction costs led to the development of the Positive
Accounting Theory. The title of this theory itself reveals the dispensed importance on the
role of accounting in reducing the transaction costs of the firm emerging from information
and motivational asymmetries between the associated parties. Additionally, it is
highlighted that firms with efficient corporate governance structures focus on efficiently
written contracts for every part of the firm, including of course the accounting system. The
paper of Watts and Zimmerman (1978) is recognized as the official documented study that
resulted in the development and the recognition of the Positive Accounting theory by the
scientific world.
Positive Accounting theory focuses on the explanation and prediction of managers’
choices concerning accounting methods. The relationships between the individuals within
and outside a firm are a central point of the PAT. Insights in financial accounting’s role as a
measure to overcome the “principal-agent” problem are provided and more specifically,
how financial accounting mitigates the contradicting and costly implications of each
party’s self-interest operating behavior. Primary to the Positive Accounting theory is the
self-interest approach, which argues that contractual arrangements are inevitable in order
to achieve alignment of all the associated parties’ self-interests. The important implication
here referring to the accounting information provided by the agents is that these contracts
must take into consideration the outputs of the accounting system in order to be valid and
correctly detained. It is certainly undisputed that agents eventually select the use of
accounting methods that reflect their achievements in the most efficient way. Thus,
severe importance is given in the reduction of regulation concerning financial reporting
since it is encountered to result in unnecessary costs and complications concerning the
contractual arrangements.
Positive Accounting Theory relies in two different perspectives: the opportunistic and
the efficiency perspective. The opportunistic perspective is focused on the explanation of
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the role of the contractual arrangements in minimizing the agency costs emerging from
the delegated authority for decision making by the principals to the agents. It can be also
referred to as “ex ante” perspective since it is applied in the proactive approach of these
contractual arrangements. Differences in the choices of accounting methods from
different organizations are explained by this approach. The opportunistic perspective on
the other hand, is not interested in the contractual arrangements themselves that can be
costly if written in too much detail concerning the accounting choices, but is more focused
on the explanation and prediction of opportunistic behaviors from the side of the agents
that occur inevitably. It is also entitled as the “ex post” perspective because it concerns
management’s behavior after the signing of the defining responsibility contracts.
Utilizing these two different perspectives, the PAT highlights the next three principal
hypotheses as signaled in the book of Deegan and Unerman (2006). The bonus hypothesis
is based on the opportunistic perspective in that it predicts that companies will make use
of the accounting numbers reflecting the performance of the firm to determine managers’
bonuses. Consequently, managers’ self-interest will dominate their effort to show the
highest possible profits, no matter the magnitude of the manipulated financial reports.
The debt hypothesis argues that in the effort of obtaining lower cost funds, firms will hold
contractual arrangements with lenders that commit to correct value-reflecting safeguards
in management’s choice of accounting treatments. However, the opportunistic incentive
predicts that leveraged firms will select accounting methods that reduce the effects of
debt obligations. The last one is the political cost hypothesis, concerning the direct and
indirect relationships and connections between the firms and the many other external
parties. A characteristic assumption is that managers of high profit firms will make use of
accounting practices that reduce the amount of reported earnings, in order to avoid the
negative attention of politicians, which can lead to higher taxation or numerous other
measures, and the public outcry.
Despite the many useful implications emerging from the Positive Accounting Theory, a
lot of criticism has been put into its failure in the prescription issue. Its focus is the
explanation and the prediction of actual accounting practices used, but no investigating
effort is put on the study of optimal accounting standards. The contradicting theory of
normative accounting is the one trying to derive and implement in an efficient way these
optimal accounting standards-shortly signaling “what ought to be”. Another significant
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limitation of the PAT is that it restricts all aspects of the human mind and behavior by
assuming that all individuals act based solely on self-interest. While the before signaled
criticisms continue to gain defenders and accounting practice challenges its assumptions,
the Positive Accounting Theory still holds in numerous scientific studies and is still taught
in many accounting research schools.
2.3 Summary
All theories of accounting have limitations and flaws and this is the underlying
conclusion of this chapter. This chapter was dedicated in the economic theories
investigating the information gap between capital holders and managers, namely the
Agency Theory, the Efficient Market Hypothesis, and the Positive Accounting Theory.
Insight was given in the consequences of the inevitable existence of this gap, concerning
all regarding parties and the relationships between them. The current financial crisis is of
course considered as an outcome of this informational gap and will be investigated in the
subsequent chapter. Focus is concentrated on the causes and the implications of the crisis
on the business world.
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CHAPTER 3 – The Financial Crisis
3.1 Insight in the causes of the crisis
It is an undisputed fact, that the financial crisis that started in 2008 in the United States
is a global one. The collapse of major financial enterprises, the numerous dissolutions of
enterprises, the increased rates of unemployment, the extremely reduced stock prices,
and the freeze of investing and growth activity are evidence proving the pervasiveness of
the crisis. All economies, independently if they are developed or under development ones,
are suffering from increasing economic turbulence and that causes severe consequences
in every aspect of the human life. Despite the countless economic damage, the social cost
of the unfolding crisis is another impact that can be proved even more significant.
A large number of contributions exist, namely financial institutions, academic
researchers, and statistic analysts, consulting and financing enterprises that are primarily
concerned with the causes of the global financial crisis in both the short-run determinants
and the underlying structures approach. Briefly, commonly recognized core causes are the
financing of Western economies that created a huge credit debt and supported extremely
risky and complex financial instruments, corporate structures, and inadequate rules of
regulation.
Crotty (2009) locates the cause on the New Financial Architecture and the financial
deregulation and financing processes. He argues that the consequences of the crisis are
more severe, but still in the borders of a normal recession phase results due to
endogenous restrictions of the business cycle functions.
Morgan (2009) places focus on the sequential and cumulative financial failures of the
pre-crisis period, with a concentrated caution on the banking sector’s theoretical
framework and practical policies. Tregenna (2009) also focuses on the United States
banking sector and specifically on its structure and profitability, merely caused by the
rising levels of concentration.
Palma (2009) used the perspective of heterodox Keynesian-Minsky-Kindlebergian
financial economics to point out the primary mechanisms responsible for the crisis,
namely excess liquidity, income polarization, financial and productive capital conflicts, lax
regulation, rationalities and principal-agent dilemmas. He argues that the outcomes of the
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crisis are expected in a recession or crisis period, but were so severe in this case due to the
general political and resource distributional environment. Since they have transformed the
neo-liberalism theory into a constant and systematic tool for abnormal earnings, in the
first place the capital holders are the ones to be held responsible for the current situation.
Responsibility lies also in the hands of the state holders. The capitalists were able to place
their “cruel intentions” in action due to the “no compulsions on big business” approach
that the state bodies of the world adopted during the past few decades.
Diamond and Rajan (2009) offered a more detailed documentation on the causes of the
crisis. They argued that the United States financial sector flooded with new exotic financial
instruments firstly the real estate branch and then the bank balance sheets in both
commercial and investment banks. These exotic instruments, named generally Structured
Investment Vehicles (SIVs) or conduits were mainly financed with high-risk short-term
debt. SIVs are investment assets issued with some unusual, often option-like in the case of
notes or bonds, clause. Digging deeper in the search for the roots of these causes they
analyzed the problematic conditions and SIVs that led to the crisis.
The misallocation of investment was the first one to be investigated. Prior to the currentone crises that occurred in the late 1990’s in East Asia, Argentina, Brazil, Russia and Turkey
led to emerging markets becoming more “prone” to abroad borrowing. Inevitably,
investment and consumption was reduced. Noise from the collapse of the IT bubble of
2000 was still loud, but the world’s central banks led by the Federal Reserve provided the
public with comfort through extreme accommodative monetary policies. Low interest
rates in many countries called out the need for housing. Demand for housing, as well as
prices, rose severely all over the world. The crisis though was deeper in the US because of
the securitized sub-prime mortgage loans. “Sub-prime” or “Alt-A” are not official
regulatory designations that refer to borrowers perceived to be riskier than average
borrowers due to their credit history as noted by Gorton (2009). Mortgage-Backed
Securities (MBS) are asset-backed securities, secured by a mortgage or collection of
mortgages. Securitization reassured international investors to hold home mortgage loans
directly, despite the many “disadvantages” they carry like servicing, credit quality risk and
default likelihood. The diversification of the packaged mortgages mitigated the risk,
leaving “riskier” claims to be sold to those who had the appetite and the knowledge to
hold them. Through these securitizing procedures, AA-rated portions, that are bonds
20
receiving the highest rating by the bond rating agencies like Moody’s and Standard and
Poor’s (S&P), were squeezed out from the underlying package of mortgages. As Diamond
and Rajan (2009, pp. 606) signaled “the lower quality securities issued against the initial
package of mortgages were packaged together with similar securities from other
packages, and a new range of securities, including a large quantity rated AAA, was issued
by this collateralized debt obligation”.
Since rating agencies could only process information such as the homeowner’s credit score
and the loan-to-value ratio, but not more detailed information concerning the evaluation
of the borrower’s creditworthiness, originators relied on the “house/equity’s” price rise in
the case of a needed loan repayment. Simultaneously, the creation of very complicated
securities through repeated securitization caused significant problems in valuing these
financial instruments. As long as house prices kept rising the evaluation difficulties were
overlooked. Their severe consequences though became evident immediately after the first
reductions in prices came forward and defaults started taking place. The authors find
interesting that even though, theoretically, banks were in position to realize and assess
the risk of the numerous MBSs they were holding, they kept on holding them. Banks
trusted that they were worth the risk because they were quite profitable for a period and
the uncertainty concerning the true or apparent excess returns was not at that time a
significant problem to deal with. International savings and the Federal Reserve’s
reassurances for instant lowering interest rate measures enhanced banks’ risky short-term
profit policies if they were to be increased. In general, short-term debt is cheaper in
normal circumstances than long-term obligations. However, when times are unfavorable,
illiquidity is an unwanted and negative effect that runs the situation to extremes. Thus, the
financial crisis turned out to be inevitable after all.
Banks were holding numerous securities of high risk financed with short-term debt. When
the “housing bubble” started steaming, as soon as the first house prices declined and
mortgage defaults started expanding, all MBSs started falling in value and became harder
to price and even more unprofitable to borrow. The Federal Reserve tried to mitigate the
illiquidity problem of the banks with new terms of banking borrowing but the route to the
financial collapse was predestinated. The authors describe this clearly (pp.608): as more
banks tried to sell out of their positions, prices plummeted further and concerns about
illiquidity turned to potential insolvency -despite being able to borrow against the full
21
value of their illiquid assets- there was now not enough asset value to offset the liabilities.
Confusion and uncertainty from the side of the bank clients called forth many bank runs.
The chaos started in September 2008, when Lehman Brothers, the fifth biggest investment
bank of the US filed for bankruptcy. Soon after that, banks became very reluctant in
lending and interbank lending was minimized. The failures of financial institutions like
Freddie Mac (Federal Home Loan Mortgage Corporation), Fannie Mae (Federal National
Mortgage Association ), AIG (American Insurance Group ) and Lehman Brothers that
invested in the exotic financial instruments are signaled as the most characteristic.
The significance of the systemic risk present in the United States in 2007 and 2008 is
highlighted in the paper of Acharya, Philippon, Richardson, and Roubini (2009). Systemic
risk is interpreted as “widespread failures of financial institutions or freezing up of capital
markets that eventually reduce the levels of capital available in the markets” (pp. 1). In
general, the authors distinguish three phases of the financial collapse, which is shortly
recognized as the outcome of a simultaneous credit boom and a housing bubble, emerging
from the coexistence of extended leverage and preservation of the credit risk from the
financial entities. The first phase is located in 2007; when the system of sub-prime and AltA mortgages held by numerous non-bank lenders fell apart. The second phase involved the
destruction of the SIVs system and conduits that took place soon after the investors
realized the degree of risk of the financial assets they were holding. The third phase was
the burst of the primary US independent broker-dealers. This fact occurred when their
liabilities took the form of repurchase agreements (REPOs), financing that was the basis of
their leveraged operations (pp. 95). Driving forces of these risky betting behaviors were
poor corporate governance driven by executive compensation incentives, loose guarantee
government policies inducing moral hazard and managements’ haul to extreme risk/return
investments.
Providing a temporal sequence of the facts, the authors recognize the initial trigger for
the worst post-war financial crisis as the housing market’s downturn in the first quarter of
2006. The housing bubble did indeed “blew up”, however it was the collapse of the two
highly levered funds invested in ABSs held by Bear Stearns that is identified as proof of the
systemic failure occurring at the time. Bear Sterns was the fifth largest investment bank
involved in a major scale in the sub-prime mortgage market and went through a bank run
in March 2008. The high systemic risk of Bear Sterns is attributed to the major interference
22
of the bank with the rest counterparts of the financial industry. JP Morgan & Chase, a
major financial services provider internationally was prompted and provided US$30 billion
no recourse funding by the US government and did purchase Bear Sterns. ‘Lehman
brothers’, the fourth largest investment bank was signaled by the authors as an actual
case of materialized systemic risk. Lehman Brothers filed for bankruptcy on 12 September
2008 a fact that nobody could ever expect considering the financial place of the bank and
the prevalence of its activities. Doubts and insecurity flooded in the business industry even
though the government decided its full-blown bailout. The purchase of Merrill Lynch by
the Bank of America is signaled as a consequence of Lehman Brothers’ bankruptcy, along
with the huge increases in the cost of Morgan Stanley’s and Goldman Sachs’s five year
Credit Default Swaps protection points. A credit swap or credit derivative is an exchange of
a fixed or floating coupon against the payment of a loss caused by default on a specific
loan or bond. Lack of transparency became apparent in the whole business world, since
government bailouts continued and federal investments worth millions of dollars in the
collapsed enterprises came out public. Illiquidity and insolvency were the obvious
concerns for the investors and the Federal Reserve and the Treasury went on taking
assurance measures like bailouts and extreme favorable terms for the purchases of the
shocked entities. The authors characteristically mention that improvisation in these
measures, instead of thorough analysis and investigation, was overused. However, as it is
always the case, shallow curing was never a good healing method and the downturn
turned out to be an international fact. Moving on to suggestions for the salvation of the
wounded business world, they propose three broad recommendations to the government
sector: liquidity provision, burst prevention, and establishment of long-term solutions.
Taylor (2008) also tried to shed light on the causes of the crisis and the circumstances
that prolonged it, focusing on government policies and interventions. The main cause
presented here is a monetary excess and more specifically, the rapid change in the interest
rate policy that led to the inevitable boom and bust in the housing field.
In the paper of Reinhart and Rogoff (2008), while the government response is signaled
as one way to mitigate the results of the crisis, more emphasis is given on how dramatic
the shock of the financial markets will turn out to be. Additionally all common sources for
the crises of the last 60 years are described, defined in a broad scope as increases in asset
prices, debt, and deficits and decreases in growth patterns. A common characteristic is
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also a precedent financial liberalization, enhanced by the general technological progress
and the formation of new financial entities and instruments.
Carmassi, Gros, and Micossi (2009) named in short the cause of the global financial crisis
as the result of lax monetary policies. These policies concerned excessive leverage and
maturity transformation by the banking sector. Regulation contributed to the situation
simply by minimum and favorable to the banks’ risky financial instruments’ intervention,
allowing reckless bets on asset price increases. Innovation is the term used to name the
establishment of the new SIVs. They argue that innovation did indeed promote credit
expansion and instability, but was not the main cause of the crisis. Instead, the entire
short-term profit-seeking environment in which they were established is highlighted as the
primary factor generating them.
3.2 Fair-value and off-balance sheet accounting: the features of controversy
Lack of transparency in every aspect of the business world was also identified as one of
the two main issues that generated the crisis, from a core level perspective by Rouse
(2009). Mark-to-market valuations, in which market prices are used for the calculation of
values and losses or gains of positions, is the point of controversy that has created
numerous conflicts due to the need for accurate value-reflecting transactions. Lax
corporate governance was highlighted as the second one. Executive compensation and
lack of responsibility admittance acts are the symptoms highlighted to misuse the concept
of corporate governance.
Mark-to-market or Fair value accounting is an ambiguous subject that is discussed in
many papers. In the paper of Laux and Leuz (2009), it is argued that great pressure is put
on the accounting standard setters to loose the rules concerning “strict” fair-value
accounting. However, research has proven that no significant correlation between the fairvalue accounting practice and the expansive bank problems that led to the generalized
crisis. On the contrary, this method was used by the banks as a safeguard and provided
the necessary discretion to banks in their efforts to avoid market price traps. In addition,
they argue that even if the effect of fair-value accounting in downward routes of prices
and contagion turns out to be existent, the positive effect of timely recognition of losses is
still dominant.
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Goh, Ng, and Yong (2009) provided more insight in the fair-value accounting concept by
researching the reliance of investors for the estimates of assets reported by banks in
conformity with Statement of Financial Accounting Standards no. 157 (SFAS 157).
Significant variation in the pricing of different fair value assets was discovered, and more
specifically mark-to-model assets were priced lower than mark-to-market assets. Mark-tomodel accounting is the opposite of mark-to-market accounting that makes use of internal
assumptions and finance models for pricing purposes.
The paper of Coates (2009) expressed another weakness of the financial system that
contributed to the unpleasant crisis, which are the defective disclosure rules. Off-balance
sheet accounting was enforced inadequately, however, importance is also given to the fact
that many financial entities simply failed to estimate correctly their assets’ risks. Of course,
it was the combination of these with the no-limits subsidized home ownership policy and
the launch of mortgage-related assets with minimum government guarantee that created
the widespread damage. Caution is also given on the integration between the sectors of
the economic world, since a downturn in one sector is proved to lead to losses in others.
Political implications are also emphasized as weak proactive measures taking the form of
repeated regulation and deregulation, which was more confusing than calming for the
worrying public.
Within the same scope, the research of Whalen (2008) refers to the fair-value
accounting method that the Securities and Exchange Commission (SEC) and the Financial
Accounting Standards Board (FASB) require for the enterprises to adopt, as one of the
three fundamental reasons for the downswing of the sub-prime market. The other two are
of course the aggressive homeownership policy that took place with the support of new
exotic financial tools and the abnormally favorable attitude that the SEC and the national
bank regulators showed against the complex structured derivatives and securities leading
to severe illiquidity and distrust problems.
Murphy (2008) concentrates on the effects the severe mispricing in the Credit Default
Swaps (CDS) market that was the result of severe mispricing for these assets and
theoretical framework based on unrealistic assumptions. The housing mortgage default is
of course recognized as the initial trigger for the whole economic collapse, but the author
states that it was only a component and symptom of the deeper problem. More than $60
trillion worth credit default swaps were unregulated and contracted without even the
25
minimum guarantee of adequate documentation. The bailout policy as an effective
measure against the financial downward is also criticized and was computed around $3
trillion by the time of the completion of the research with strong evidence that this
amount will turn out to be significantly higher in the course of time.
Accounting theories and practices like the fair-value accounting method are deeply
implicated form the financial crisis and have been the subject of many research papers,
some of them already signaled. In the paper of Arnold (2009,) the gaps of theory and
method in accounting research that have contributed to the current situation are being
analyzed. Methodological gaps are detected in the relationship between the academic
research world and the “accounting in action” procedures. In this case, asset valuation
methods and off-balance sheet entities are the apples of discord. Bank assets valuation
and auditors’ requirement on consolidation of off-balance sheet entities are nowadays
issues with huge impact on solvency and going-concern worries. A very indicative example
of the unlimited off-balance sheet accounting practice is the case of Citigroup, which held
$1.3 trillion worth of assets off-balance sheet in 2008. Fair-value accounting is the number
one controversial subject with critics arguing that it has contributed to abnormal credit
expansion and increased the number of risky investments by all parties, thus more solid
modification of valuation rules is needed.
The Financial Accounting Standards Board (FASB) and the International Accounting
Standards Board (IASB) were of course “perturbed” by the international financial collapse
and the expanded public protests. Henry and Holzman (2009) analyze the usual debate
issue of off-balance sheet accounting and refer to the change in the off-balance sheet
accounting treatment by the FASB in September 2008. The changes aimed at eliminating
the concept of QSPEs in accounting standards through the obligatory report of
securitizations and SPEs on the balance sheets. In the same concept, a staff position was
issued at the same time dramatically expanding the disclosures about derivatives, both in
qualitative and quantitative requirements (like the derivatives’ nature, potential amount
of future payments, fair-value, and provisions about coverage of potential payments).
Concerning the “hot potato” of fair-value measurement, FASB also declared clarifications
in managements’ justification for asset valuation in illiquid markets, broker quoted, and
transaction prices in inactive markets, disorderly transactions and factors determining the
temporal or not impairment of an investment. Viewing from the same perspective, the
26
IASB decided on strict monitoring tactics in the US involved with fair value measurement
and financial instruments’ classification. A global advisory group forced with the task of
reviewing all reporting issues associated with the crisis was decided to be formed in a joint
action of the two regulatory boards.
3.3 Summary
This part of the study was focused on the presentation and explanation of the
fundamental causes of the still holding global financial crisis. Briefly, the causes can be
summarized in the collapse of the U.S. housing financing, the development of risky
structured financial instruments, and the establishment of inadequate banking practices
and regulation. Furthermore, a more detailed examination of the two controversial
accounting practices, namely the off-balance sheet and the fair-value reporting methods
was presented. The findings of future research will provide a clearer view for the causes
and the impacts of the financial crisis in all aspects of the business world. This study is
focused on independent auditors. Thorough and detailed analysis of the impacts of the
crisis specified on the external auditing profession along with a general analysis of
auditors’ professional code will also be provided in the subsequent chapter. Focus is
concentrated in the concept of audit conservatism, the audit fees, and the interrelations
between them.
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CHAPTER 4 – The external auditing profession, the impacts of the financial
crisis on external auditors, audit conservatism and audit fees
4.1 External Auditing
Auditing is the “accumulation and evaluation of evidence concerning information to
determine and to report on the degree of correspondence between this information and
the established criteria” (Elder, Arens & Beasly, 2006, pp. 4). Another definition of auditing
is “a form of independent attestation performed by an expert -the auditor- who expresses
an opinion about the fairness of a company’s financial statements” (Hall, 2008, pp. 36).
External audits are promoted as an assurance tool concerning all interested parties in the
financial statements of a company and need to be performed by competent and
independent Certified Public Accounting firms or Certified Public Accountants (CPAs in
both terms). That is the reason why they in addition are called independent audits.
External auditors are tasked with the duty of convincing the public that capitalist
corporations and management are not corrupt and that companies are made accountable.
More specifically, the objective of an audit of financial statements is to enable the auditor
to express an opinion whether the financial statements are prepared, in all material
respects, in accordance with an applicable financial reporting framework (International
Standards on Auditing ISA-200). From an agency theory perspective, external auditing is
considered a powerful tool for signaling or in reducing managers’ opportunistic behavior,
in cases like for example earnings management.
The profession is structured upon six basic principles of conduct, according to ISA-2002.
At first, auditing responsibilities should be exercised with sensitive professional and moral
judgments. The second principle requires from auditors to serve the public interest, honor
the public trust, and commit to professionalism in all their duties. The highest level of
integrity is the prerequisite for the maintenance and growth of public’s confidence.
Independence both in fact and in appearance and objectivity should be carried out in all
professional responsibilities. A member should demonstrate due care in order to keep
constantly in touch with the profession’s technical and ethical standards, while improving
competence and quality regarding the auditing tasks will keep professional responsibility
in the appropriate levels. The last principle involves the examination of the scope and
2
http://web.ifac.org/clarity-center/isa-200 accessed on 12th October 2010.
28
nature of the services provided by the auditor in order to maintain high professional
standards while conducting an audit.
One of the most significant facts in the history of the profession is the Sarbanes Oxley
(SOX) Act of 2002. Huge scandals of corporate and accounting frauds like the Enron case
led the American Congress to pass the SOX Act, considered from the majority of the
professionals as the most important legislation following the Securities Acts of 1933 and
1994 (Elder et. al 2006). Briefly, the provisions of the Act concern publicly held companies
and audit firms. The establishment of the Public Company Accounting Oversight Board
(PCAOB)3 and the external auditor’s report on the effectiveness of the company’s internal
control over financial reporting are attributed as the most significant regulated
constitutive elements.
With references on the relevant literature, concerning the auditing profession’s scope
and the discussion subjects, information that is more detailed will be provided. Research
has been focusing on several issues. The need for mandatory audits, going-concern
opinions, technical skills and size of audit or audited firms consist the most common ones.
While developing the Positive Accounting Theory, Jensen, and Meckling (1976) argued
that audited financial statements reduce the costs of funding. External parties rely on
auditors’ opinions in order to evaluate the financial position of the firm associated with
resources and obligations and consequently the companies are able to attract funds at a
lower cost. This leads ultimately to the increase of the value of the firm. Additionally,
increased demand for financial statement auditing is argued to take place when managers’
of firms are rewarded based on accounting results and when the firm holds debt defined
in accounting-based covenants in order to protect the debt holders’ interests, as signaled
by Deegan and Unerman (2006).
Arrunada (2004) criticizes the hyperbolic regulation of the auditing practices. He
characteristically states, “legislators have been using audit and financial crises as excuses
to introduce additional regulation into an industry already over-regulated” (pp. 635). The
method of trial and error is proposed against repeated regulation that provokes doubt and
3
“The PCAOB is a private-sector, nonprofit corporation created by the Sarbanes-Oxley Act of 2002 to oversee
the auditors of public companies in order to protect investors and the public interest by promoting
informative, fair, and independent audit reports. The Securities and Exchange Commission (SEC) has
oversight authority over the PCAOB, including the approval of the Board’s rules, standards, and budget”.
http://pcaobus.org/Pages/default.aspx accessed on 10th October 2010.
29
confusion. It is argued that markets have effective mechanisms that can locate and punish
audit failures themselves, without the introduction of new standards and rules of practice
that can be proved too “violent” and of questionable motivation. Though bankruptcies
and fraud are no special news nowadays, importance should be given in the causal reasons
for these unpleasant facts and in appropriate self-healing measures that can only come
from the driving forces of the markets. Government intervention should be limited and
oriented towards these self-healing measures and it is about time that auditing will no
longer be treated as the usual “fall guy.” The paper proceeds with references concerning
the three basic characteristics of auditing that should be taken into account when audit
regulation takes place. The first is professional judgment that enables auditors to decide
on unverifiable or costly for third parties information. The second is the specific nature of
audit quality. Focus in this case should be concentrated on the monitoring procedures
from the client’s side by the standard setting bodies. The last characteristic involves the
existence and effectiveness of private quality assurance techniques and concerns the
quality of an audit, which should be guaranteed within the borders of the specific needs
that an audit fulfils. Critic is expressed in other important issues of the auditing profession
too. The mandatory auditor rotation is argued to damage the two sides of audit quality,
namely technical competence and independence. Moreover, it has proved to be costly and
can be helpful in collusion between the audit firms that can create a form of oligopoly
market in the audit sector. The author concludes by suggesting that mandatory audits
should not expand in more firm categories than already present. Auditing and financial
reporting should be the outcome of the related parties’ requests in companies that are not
obliged to these tasks, enforcing timeliness, usefulness, and innovation in “financial
information in line with real user demand” (pp. 642).
The controversial subject of Going-Concern doubt is examined in the paper of Citron and
Taffler (2001). The self-fulfilling prophecy argument is investigated as to be the reason for
auditors not expressing a Going-Concern Opinion (GCO) when reasonable evidence
indicates such an opinion. According to the self-fulfilling prophecy theory, an event will
take place as soon as there is reference concerning it attributed completely to the
reference itself. Their research found no empirical support for such an argument. On the
contrary, three out of four reports containing a GCO were not followed by failure before
publication of a posterior set of accounts. More specifically, only the 15% of the
bankrupted companies that were examined between 1987 and 1994 were qualified with a
30
GCO prior to failure. The results show that it is the financial distress causing the
bankruptcies or the going-concern opinions, and not the disclosure by itself. Results also
impressively indicate that a GCO can cause an alert mechanism that will most likely result
in the survival of the company. However, authors point out the significance of moral
compunction when auditors express such an opinion. The self interest, consideration of
decision impact on the audited companies and the possibility of lack of professional skills
in making going-concern
estimations are factors influencing their decision making
process. Auditors themselves actually put focus on the self-fulfilling prophecy argument
and seem not to be guided only by the strict ethical propositions of the professional code
of conduct.
A contradicting to the before signaled research is the one of Bhimani, Gulamhussen &
Lopes (2009). They investigated the effectiveness of auditors’ GCO evaluation as an
external governance mechanism and proved that firms receiving a GCO are more likely to
default in comparison to those receiving a Clean Opinion (CO). They also found that the
size of the firm is negatively related to default, whereas the age is a contributory to
default factor.
The size of a firm and its implications on auditors’ report was the subject of the paper of
Reynolds and Francis (2001). Investigating Big Audit firms, they found no evidence
supporting favorable reporting for larger clients. However, more conservative reporting
for large clients was proved in connection with the greater litigation risk these clients face.
Roberts (2010) studied auditors’ independence in terms of impartiality or advocacy in
client conflicts. Impartiality is needed when auditors perform their auditing tasks, while
advocacy is diffused in tax settings. The results of his research proved the tendency of
auditors to exhibit self-interest in reacting to clients’ reporting preferences. As it is stated,
“experienced CPAs are as client-supportive in audit settings as they are in tax settings
when exercising their professional judgment” (pp. 29). Similar to this, he showed that
there is not a standards ruled behavior concerning impartiality in auditing followed by all
professionals.
There is a large amount of interesting and controversial issues throughout the
profession. However, more expanded reference on them lies out of the scope of this
31
research. The next part will provide more insight in the implications of the crisis in the
professional auditing sector in general.
4.2 Implications of the current financial crisis on the audit profession
The pervasiveness and severe consequences of the global financial crisis can be realized
in every sector of the business world. Concerning the auditing profession, the news of the
past two years has caused doubt on the assurance character of the financial auditing tasks.
On January 28 of 2008 Lehman Brothers, one of the biggest banks operating in the USA
received an unqualified opinion on its annual accounts for the year 2007. A clean bill of
health on its quarterly accounts followed, on 10 July 2008 (Sikka, 2009, pp. 869). It is more
than suspicious for the CPA firm that provided the assurance for the fairness of the
financial statements of the bank that Lehman Brothers filed for bankruptcy on 14
September 2008. The case is almost identical for many other financial enterprises all over
the world, which received an unqualified opinion on their financial statements published
soon before their public admittance of financial difficulties or dissolution. It is even more
disturbing to find out that these financial audits were conducted exclusively by one of the
Big Four Accounting firms-PricewaterhouseCoopers (PWC), KPMG, Ernst & Young, and
Deloitte & Touche. Table 1 in the APPENDIX section shows many cases like the previous
one signaled.
Nowadays auditors are more than ever obliged to defend their profession’s reputation
and perform their tasks with the highest degree of professionalism. Serving the public in
the most efficient way should be the number one priority. Despite the fact that the
primary responsibilities for the present situation burden banks and other financial
institutions, regulatory authorities and rating agencies and not the auditors, their role
creates reasonable questions about the interconnections with the these parties. The study
of Roberts (2010) proved the tendency of auditors to exhibit self-interest in reacting to
clients’ reporting preferences, and had strong implications concerning the principles of
independence and impartiality. It is plausible to think that auditors will be asked to audit
the financial statements of an enterprise in a more lenient and favorable way in the times
of a crisis, since the users of these financial statements put a lot of importance on
auditors’ reports.
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The issues of corporate governance and lack of transparency are currently brought into
light as significant factors causing the financial crisis (Rouse, 2009). The challenges for the
auditing profession are more than obvious, and it seems that the appropriate “authorities”
have already taken some action. Revisions of auditing standards and codes of ethics are
the usual solutions, whenever the auditing industry was facing a crisis (Sikka 2009). The
most relevant to this study, are the “Re-proposed Auditing Standards related to the
Auditor’s Assessment of the Response to Risk; Proposed Conforming Amendments to
PCAOB Standards”, with direct links to the conservatism concept. Following this direction,
the study of Humphrey, Loft & Woods (2009) gives insight “in the active nature of the
regulatory responses to the crisis and the shifting and competing influences among key
regulatory and professional participants in the global audit arena”. They focus their
interest on the need for audit researchers to be more sensitive to the future revised global
financial architecture. More publicly available and accessible knowledge of the workings of
international audit practice, the regulatory networks and the forces driving regulatory
policy and its impact at the level of practice are today prerequisites, according to their
findings, for balancing the unstable financial environment.
Other attempts from appropriate authorities, in order to escape the financial reporting
issues due to the crisis are signaled in this part. The Public Company Accounting Oversight
Board (PCAOB) in the USA is at moment processing the release of some new or revised
standards, trying to heal the “wounded” trust relationship with the public. The
International Financial Reporting Standards (IFRS) is also revising IAS 37, about provisions,
contingent liabilities, and contingent assets and all the Taxonomy standards in general.
IFRS has even established the Financial Crisis Advisory Group (FCAG). It would be more
than useful if these efforts lead to, as Herrmann et al. (2009) commented, an increase in
financial quality.
It cannot be disputed that the regulating authorities and investors have traditionally put
their focus on the corporate financial statements in order to assess risks and economic
exposure. However, creative accounting has become the most usual method for managers
to manipulate of their companies’ financial statements. In the banking sector only, an
early estimate suggested that despite the development of revised and new auditing
standards, banks had around US$ 5000 billion of assets and liabilities off balance sheet
33
(Financial Times, 3 June 2008; taken from Sikka, 2009). The amount is rather impressive
and reasonable doubts about the auditing tasks are created.
Traditionally, auditors were the ones to trust the savings of a lifetime. Regulating
authorities trusted the auditors when deciding about risk assessment and measures to be
taken. All in all, auditors have likely failed to prove that they are operating within an
objectivity scope, with strong-based moral values that enhance the relevant theories and
practices followed. The dominant auditing theories provided an insufficient basis for
understanding the transformations that were and can still be occurring in the international
political economy. Arnold (2009) argues that quantitative databases became the only
necessity concerning the conduction of financial audits and the professionals themselves
failed to predict and efficiently react to the effects of the crisis on financial reporting
standards, accounting firms and accounting methods. It is reasonable to argue that these
failures limit the potential of investigating, interpreting, and response to the crisis as it
continues to rise. Accounting and auditing practices are deeply implicated in the current
financial crisis and in proposals for recapitalizing financial institutions and restoring
stability to the global financial system.
Concluding, independent auditors play an important role in ensuring the integrity of
firms’ financial reports, since they can resist management’s opportunistic behavior by
emphasizing conservative financial reporting (Herrmann, Pornupatham & Vichitsarawong,
2008). Audit conservatism is a basic component of the principal standards of the
profession, focusing on this perspective and will be analyzed in the subsequent part.
4.3 Conservatism in audits
The general meaning of conservatism is caution or moderation in behavior or outlook. In
a more conceptual level, conservatism is a political attitude that advocates institutions and
traditional practices that have developed organically promoting stability and continuity.
Throughout this research, the definition that Basu (1997) used for conservatism in the
financial world will be used. Basu interpreted conservatism as “resulting in earnings
reflecting bad news more quickly than good news.”
Viewed from the same perspective, conservatism is the respected principle when the
recognition of unrealized losses is conducted within a short period, whereas the
recognition of unrealized gains is postponed until completion. Conservatism is a concept
34
generally applied in the accounting and auditing policies and procedures. Thorough
observation of accounting and auditing practices recognized models of consistently
prudent behavior as argued by Henderson, Peirson & Brown (1992). The professionals
were systematically overstating expenses and underestimating revenues in cases of
unclear estimations that required professional judgment of a higher degree. The
International Accounting Standards Board (IASB) refers to the content of “prudence” to
clarify conservatism. Prudence is defined
by the International Financial Reporting
Standards (IFRS, 2004, paragraph 37)4 as “the inclusion of a degree of caution in the
exercise of the judgments needed in making the estimates required under conditions of
uncertainty, such that assets or income are not overstated and liabilities or expenses are
not understated”. Accountants and of course auditors briefly summarize conservatism in
the following rule: “anticipate no profits, but anticipate all losses” (Basu, 1997, pp. 7).
The association between audit and accounting conservatism is undisputed. The financial
statements of a company are a product of managements’ selection concerning the
accounting methods used. These statements are audited by independent auditors who
express an opinion about the true and fair view of their disclosure. Auditors’ are entitled
to require modifications or changes in the preparation and presentation of the financial
statements if they conclude this is appropriate. Consequently, audit and accounting
conservatism are considered as the same concept, in that they are both responsible for
the same outcome: fair financial statements. This is particularly the perspective
considered in the present research. Auditing conservatism is proxied with the firm’s
accountants’ use of conservatism. The majority of the scientific studies are using the same
adjustment concerning audit and accounting conservatism, by not conducting a distinction
between the two concepts form the first place.
Another existent association is between audit risk and auditors’ conservatism. Audit risk
refers to the possibility of expressing a false opinion about the fairness of a firm’s financial
statements. Generally, auditors accept a level of risk or uncertainty while conducting their
duties. Auditors must estimate carefully this amount of risk and respond to it in the most
efficient way. This is something to be achieved by using conservatism in all the “risky”
areas of the audit.
4
International Financial Reporting Standards (IFRS), (2004), Framework for the Preparation and Presentation of
Financial Statements, (London, U.K.: IASCF).
35
Basu (1997) highlighted in his study the systematic differences between bad news and
good news periods in terms of timeliness and persistence of earnings. Firms’ stock returns
were used to distinguish bad and good news and it was proved that bad news is timelier
than good news. In addition, the concurrent sensitivity of earnings to negative returns is
two to six times higher than the concurrent sensitivity of earnings in the case of positive
returns. The relatively weaker association of the concurrent cash flow-return with publicly
available good news than the concurrent earnings-return association was another one of
his findings. In addition, the author found that unexpected earnings increases are more
persistent compared to the unexpected earnings declines. The overall conclusion of this
highly significant research drawn by the measurement of the sensitivity of earnings was
that conservatism has increased overtime.
Another study concerning the accounting conservatism by Easton and Pae (2004),
distinguished conservatism in two types: conservatism due to accounting rules and
conservatism associated with investments in positive net present value projects.
Conservatism is also distinguished in ex ante conservatism and ex post conservatism in a
large number of scientific studies. “Ex ante” or “unconditional” conservatism is related to
the accounting choices that in general underestimate the book value of net assets (Beaver
& Ryan, 2005; Feltham & Olson, 1995; Penman & Zhang, 2002; Qiang, 2007; CanoRodriguez, 2010; Li et al., 2007). “Ex post” or “conditional conservatism” writes down the
book value of assets under sufficiently adverse and not favorable circumstances (Basu,
1997; Ball et al. 2000; Pope & Walker 1999, 2003; Li et al., 2007; Beaver & Ryan, 2005;
Cano-Rodriguez, 2010;). Furthermore, the study of Krishnan (1994) argues that the overall
conservatism of the auditor can be viewed in the tendency of providing qualified opinions.
Findings demonstrate that any negative information gathered during the conduction of an
audit can produce the outcome of increased auditing conservatism. In addition, consistent
with the institutional theory, which argues that managers are pressured in a coercive,
mimetic, or normative way to adopt certain voluntary corporate reporting practices
(Deegan & Unerman, 2006, pp.299) increased conservatism is expected from the auditors’
side.
The study of Francis and Krishnan (1999) gave insight in the relationship between
auditor reporting conservatism and accounting accruals. More specifically, they examined
whether accounting accruals can increase the possibility of a firm receiving a modified
36
audit report concerning both issues of asset realization uncertainties and Going-Concern
difficulties. Accruals increase the inherent audit risk because they are considered as
“vulnerable” subjects of calculation errors by the authors. They indeed found that auditors
of high-accrual firms are more likely to issue modified opinions for asset realization
uncertainties and for Going-Concern problems. A second significant finding was that Big
audit firms (six at the time of the study) provided evidence of conservative professional
behavior, documenting an empirically tested reason for the perceived higher quality of
audits conducted by these firms. The higher level of conservatism by the Big audit firms is
manifested in the recognition of discretionary accruals and in a lower threshold provision
for the issuance of the two types of modified audit reports.
Consistent with the precedent findings is the study of Davis and Ashton (1997)
documenting that auditors reduce the threshold for the “substantial doubt” criterion in
order to decide on their Going-Concern opinion for highly financially distressed entities,
while assessing financial distress with a high degree. Similar results were found in Kinney’s
and Nelson’s (1996) research, revealing auditors’ tendency to disclose contingent losses in
a modified audit report in the case of limited or non-existent outcome information.
Carcello and Palmrose (1994) conducted a research that provided evidence that the
incidence and the magnitude of litigation in the case of a bankruptcy are severely lower if
a modified audit report has been previously issued. The “surprise” effect is demonstrated
as the reasoning for this finding, highly associated with third-party claims against auditors.
A modified audit report prepares stakeholders for a potential failure, thus minimizing the
possibility of sudden stock price decreases that usually result in litigation activities against
the auditing firm.
The significance of the external auditing tasks and conservatism used in them is also
highlighted in part in the paper of Bhimani, Gulamhussen & Lopes (2009). They
investigated the effectiveness of the auditor’s Going-Concern (GCO) evaluation as an
external governance mechanism. They proved that firms that receive a GCO are more
likely to default in comparison to those receiving a Clean Opinion (CO). Their findings
suggest that the information conveyed by GCO is respected by all related with the firms’
parties and these parties include of course the capital providers, banks. Considering the
fact that banks contribute significantly in firms’ liquidity, the key feature of conservatism is
pointed out here. Too much conservatism can cost a firm’s existence and can cause
37
unemployment to a few or even many employees, whereas too little can be proved not
enough. Auditors can be found in the inconvenient position of being accused for
professional negligence or even partiality and corruption.
Professional skepticism is a concept that by itself requires a significant level of
“professional” conservatism, meaning that the auditor should start and continue an audit
keeping a very objective and impartial position, reflecting the GAAP. Other issues though,
must be taken into consideration at this point, as implicated by the research of Kennedy &
Peecher (1997). Their paper examined how accurately auditors assess their own technical
knowledge and that of their subordinates. They came up to the rather disappointing
conclusion that auditors are overconfident in their technical knowledge. Audit supervisors
were proved to overestimate their own technical knowledge to predict the technical
knowledge of their subordinates. In addition, the technical knowledge gap between
supervisors and their subordinates increases the formers’ optimism about the skills of the
latter. These findings are highly associated with auditing conservatism. Overconfidence
can be easily translated into lack of due care accompanied by mistakes and failures that
are definitely not related with conservative auditing practices.
The paper of Li, Peasnell & Beekes (2007) tested the causal relationship between the
endogenous auditor choice and the magnitude of conservatism in earnings when
controlling for managers’ self-selection bias and balance sheet conservatism. Their
findings proved that no significant difference exists in earnings conservatism between Big
and Non-Big audit firms. No significant difference was found between the monitoring
power of Big and Non-Big audit firm auditors on clients’ earnings conservatism. Another
issue arising here is clientele’s size. The results of Reynolds and Francis (2001) in their
investigation concerning the magnitude of the interference between the audit reports and
the size of the client indicate the tendency of Big-firm auditors in reporting more
conservatively for larger clients.
Conservatism is a highly respected concept on audits. The ethical dilemmas, but also the
difficulties concerning the completion of a financial statement audit are daily issues an
auditor faces. However, at the same time auditors seem to be overconfident about their
skills, thus consequently less conservatism is used. If this situation remains unstable during
a crisis period then the results for the auditing profession will turn out to be catastrophic.
It will be very interesting from a scientific point of view to investigate how auditors’
38
conservatism has actually been affected during the recent financial crisis. Comparisons
with the prior-to-crisis levels of conservatism will provide us with a clear view of these
effects.
4.4 Audit fee
Audit fee is the amount payable to an auditor for the conduction of a financial audit. It is
also referred to as “auditors’ remuneration” and must be clearly distinguished from the
fees that are paid to the auditor for any other non-audit service.
A highly controversial issue that arises since the beginning of the profession, concerns
the audit fees. Since audit fees are determined by the management of the audited firms
and paid by the audited firms, auditors’ independence in fact and appearance is
reasonably questioned. It is undoubted that auditors themselves must be dedicated to the
keep the profession’s esteem in the highest level by conducting audits in accordance with
the professional standards of the appropriate regulatory boards.
The majority of the papers studying audit fees are concerned with their determinants,
price competition between audit firms and general trends in audit pricing.
Simunic (1980) was the first to conduct an innovative analysis on the pricing of audit
services. He gave insight in the dominant audit fee determinants and provided evidence
disclosing the prevalence of price competition in the market of the publicly held
companies’ audits. Moreover, he shed some light in the question arising relationship
between the employer, which is the audited company and its employee, which is the audit
firm. Although there is a contradicting interest between the two counterparties
concerning responsibility of ex-post litigation, it is argued that
“liability avoidance
motivation implies that at the time of the audit there is a mutuality in the auditee’s and
auditor’s private interests vis-à-vis the external world” (pp. 188).
Following Simunic’s analysis, Hay, Knechel & Wong (2006) distinguished the attributes of
audit fees. Client attributes are size, complexity, inherent risk, and profitability, and
leverage, form of ownership, internal control policies, governance and industry. Auditor
attributes consist of auditor quality, auditor tenure, and location. Engagement attributes
are report lag, “busy” season that refers to the popular fiscal year end, audit problems,
non-audit services, and reporting issues.
39
The controlling determinant of audit fees across the literature is the audited party’s size.
Size is usually measured in terms of total assets or even total revenues and always
positively related to audit fees. In Cobbin’s (2002) international research of the audit fee
determinants, the complexity and business risk of the firm and the size of the audit firm
are also pointed out as important elements in the determination of these fees. In the
study of Owusu-Ansah, Leventis & Caramanis (2010) investigating the factors pricing audit
fees in Greece, the results prove that audit fees are positively related with company size,
Big audit firms, auditee’s financial wealth. Surprisingly, auditor change affects audit fees in
a negative way. The most important contribution of this paper is that it provided evidence
for the existence of an endogenous relationship between audit fees and audit hours. The
authors conclude by highlighting the importance of other factors that can influence audit
fees, such as Board of Directors characteristics, audit committees’ existence and dynamic
role and effective implementation of internal control measures.
A more thorough investigation of the effects of the crisis on auditors’ conservatism will
be provided in the subsequent chapter that presents prior research concerning the
matter. The remainder of this part will give insight in the tight relationship between the
auditors’ use of conservatism and the audit fees.
4.5 The Association between Audit Fees and Audit Conservatism
Simply stated, audit conservatism is positively related to audit fees. This relationship is
quite easy to understand; when the use of audit conservatism is increased, more effort
and more hours are dedicated in the conduction of a financial audit. More audit hours are
compensated inevitably with higher audit fees.
Auditors’ reporting conservatism and the potential benefits from the establishment of
price premium charges were investigated by Simunic and Stein (1996). Their intention was
to demonstrate effective alternatives in order to mitigate the results of auditors’
hyperbolic use of conservatism. The empirical evidence of the study though proved to be
unenthusiastic in that there is no significant risk premium in audit fees.
In the paper of Willekens and Achmadi (2003), the issues of price competition in the
private client segment of the audit market and changes in the audit-pricing model are
examined. Evidence supports in general that increased concentration in the audit market
caused surprisingly increased instead of decreased price competition. The same results
40
were observed in the older study of Maher et al. (1992). A significant decrease in audit
fees was recorded between 1977 and 1981, which were years of increased competition in
the auditing market.
The interconnections of internal and external auditing were tested in the study of
Munro & Stewart (2010). An interesting conclusion that came out of this paper related to
audit fees is that external auditors’ lack of trust on internal audit work can result to
additional external audit fees emerging from additional audit hours. Extra fees are
undoubtedly an undesirable outcome for both the client and the audit firm, since clients
seek for the minimization of their expenditures and auditors strive hard for publics and
clientele’s trust and recognition of high professional esteem.
4.6 Summary
The focus of this chapter was towards the understanding of the external auditing
profession and the implications of the financial crisis on it. Emphasis was directed on the
professional standard of conservatism and the presentation of the incentives for increased
audit conservatism. Professional judgment and skepticism should be in the first row of
defense in the battle between the auditing profession and the current low levels of trust
from all third parties. Undoubtedly, auditors’ duty is to serve the public in an independent
and unbiased manner regardless of the environmental circumstances. Moreover, the
findings from a large number of scientific studies have shown that auditors have strong
incentives in completing their financial auditing tasks with an increased use of
conservatism. Audit fees were also analyzed, as well as the associations of audit fees and
auditors’ conservatism.
This relationship between audit fees and the degree of conservatism used by
independent auditors completing their professional tasks in a period of crisis will be
analyzed soundly in the next Chapter. An adequate number of scientific studies have
focused on the subject and their findings are almost identical. The correlation is highly
predictable: the interested in the financial statements of firm parties consider auditors as
the assurance experts in revealing the findings concerning the actual performance of the
firm. The subsequent part analyzes the results of prior research and provides sound
background concerning this expectation, and forms the model concerning the research
design of this study.
41
CHAPTER 5 – Prior Research
5.1 Prior Research investigation and Hypotheses development
Conservatism in external audits has been the main subject of many scientific papers. The
most commonly investigated subjects concern the differences between the audit firms’
size and the corresponding levels of conservatism, the going-concern opinions, and the
accounting accruals. Concerning all the before signaled subjects, prior research in general,
has shown that Big audit firms report more conservatively than non-Big audit firms in all
the afore signaled subjects and that all independent auditors are more likely to issue a
going-concern opinion after the enactment of the SOX-Act of 2002.
Basu (1997) conducted an empirical study on the conservatism principle that became
the basic model for all subsequent researches concerning conservatism. The main subject
of his investigation was the systematic differences between good and bad news periods in
the persistence and timeliness of earnings. He proxies concerning positive and negative
unexpected annual stock returns to “bad” and “good” news respectively and found firstly
that earnings are timelier or concurrently sensitive in reflecting publicly available “bad”
than “good” news. More precisely, the contemporaneous sensitivity of earnings to
negative returns is two to six times than that of earnings to positive returns. Secondly, he
found that negative earnings changes are less persistent than the positive ones. In
accordance with this asymmetry, he proved that the Earnings Response Coefficients (ERCs)
are higher for the positive earnings changes than for the negative earnings changes. The
last one of his findings was the stronger association of the concurrent earnings-return
association in comparison with the concurrent cash flow-return association for publicly
available “bad news” compared to “good news.” The examination period he used was
between 1963 and 1990 and argued of for the existence of simultaneous increases in
conservatism and in auditors’ exposure to legal liability during this period. The testing
sample consisted of all the firm-year observations concerning that period and was
investigated with a “reverse” regression method he established based on the model used
by Beaver et al. (1980). His findings are overall consistent with increased conservatism
over the three decades of investigation.
Basu, Hwang & Jan (2001) examined auditors’ conservatism between the different
quarterly earnings. They argued that auditors’ legal liability incentives are accounted for
42
fourth quarter earnings being systematically different from all other interim ones, thus
auditors determine earnings of fourth quarters and their components more conservatively
than managers did. Their study first showed that fourth quarters are more likely to be
involved with higher frequencies and magnitude of losses, negative extraordinary and
special items, and negative discontinued operations. Using Basu’s (1997) model they
measured conservatism by the difference in the coefficients and adjusted R²s from the
“reverse” regressions of quarterly earnings on concurrent quarterly positive and negative
unexpected returns, covering the twenty-four year period of 1975-1998 with in total
463.440 firm-quarter observations. They concluded that the difference in timeliness of
earnings to good and bad news is greatest in the fourth quarter, also consistent with
increased auditors’ conservatism. The authors provided also evidence of rational and quick
auditor responses to changes in their environment by showing that fourth quarter
earnings are more sensitive in high auditor liability periods. The clear assumption made at
this point is that since a crisis period is similar to a fourth quarter in terms of increased
frequencies and magnitudes of losses, negative items, and discontinued operations and
legal liability exposure, increased conservatism is to be expected from the auditors’ side
emerging from the current financial downturn.
The study of Francis & Krishnan (1999), provide similar implications while emphasizing
on auditors’ conservatism in relation with accounting accruals. It is argued that since
accruals increase inherent audit risk due to their increased potential manipulation by the
managers, auditors are more likely to issue a modified report for either asset realization
doubts or going concern problems, whereas the possibility increases in the case of a highaccrual firm. Auditors lower their threshold for issuing a modified audit report5, posed by
the authors as “auditor reporting conservatism” resulting in a higher amount of both types
of modified audit reports. The empirical part of the research was conducted with the
probit model (two level and three level probit models) of auditor reporting developed in
Krishnan (1994) and Krishnan and Stephens (1995). The authors focused on determining if
auditors’ likelihood of issuing a modified opinion differed between high-accrual and lowaccrual firms, after controlling for other factors that influence the decision of the audit
opinion. The final sample consisted of 2.068 stock exchange quoted U.S. companies and
the respective data was collected from the years 1986 and 1987. The conclusion was that
5
Davis & Ashton (1997) suggest in a more cynical way that conservative thresholds are an easy way for
auditors to be prudent and play it “safe.”
43
auditors are twice more likely to issue a modified audit opinion for high-accrual firms, and
on a second level that income-increasing accruals result in increased reporting
conservatism compared to income-decreasing accruals. Income-increasing accruals and
the selection of profit-increasing accounting practices by managers are expected in
turbulent times such as the current financial crisis period, enhancing the assumption for
increased audit conservatism during the current financial downturn. Francis & Krishnan
(1999) also extended their research by introducing the audit firm’s size variable and found
that only Big audit firms (six at the time) show evidence of reporting conservatism. This
finding contributes to the selection of this study’s sample that will consist of firms audited
by one of the Big audit firms.
Going-concern opinions were the main subject in the research of Geiger, Raghunandan
and Rama (2005) that investigated auditors’ reporting decisions associated with the
establishment of the SOX-Act. The SOX-Act was qualified as the result of enormous
legislative and media scrutiny that emerged from the continuous auditing failures of the
years before 2002. In December 2001, the congressional hearings concerning the Act
began, consequently this point was chosen as the distinguishing one for the periods
examined. The focus was concentrated in firms that had already entered bankruptcy.
Precisely, the authors examined the changes in the likelihood of bankrupt firms having
received a prior going-concern opinion. They hypothesized that auditors’ reporting
decisions would be more conservative after December 2001, leading to a higher possibility
of bankrupt firms having received a prior going-concern modified audit opinion. Their
sample consists of 226 firms that during the period between of 2000 and 2003 were
confronted with bankruptcy, and was tested through a multivariate logistic regression
model. The findings proved that after controlling for financial stress, default status, client
size, bankruptcy, and reporting lags, industry type and auditor size, auditors issued more
going-concern modified opinions after December 2001. In more detail, 70% of the
bankrupt firms had already received a going-concern opinion prior to the bankruptcy in
the 2002-2003 periods, while the percentage decreases significantly to 40% in the 20002001 periods. In order to confirm the results without any limitations emerging from
environmental conditions, they tested bankrupt firms from two different but with same
circumstantial outline periods, 2002-2003 and 1991-1992 respectively, characterized as
“recovery from recession” periods and found again that auditors issued more modified
going-concern opinions in the latter period than in the precedent one. The findings were
44
the same, verifying that the changes in the going-concern rates after December 2001 are
accounted in changes in client characteristics and auditors’ reporting practices. This
tendency of increased auditors’ conservatism was already signaled by Francis & Krishnan
(1999). The statistical analysis proved in numbers that 60% of the increased likelihood of a
going-concern modified opinion after December 2001 is attributed to the increased audit
conservatism rates. This evidence also supports the existence of strong self-correcting
dynamics within the audit profession’s scope. Lastly, another interesting finding that came
into spotlight was that the increased audit conservatism is associated with delays in the
auditing procedures. The associations between the audit fees and the delays in the
assuring procedures and the recession phases of the investigated periods draw the
attention on the strong association between auditors’ conservatism, audit fees, and the
financially stressed period of the last years. It is more than reasonable to assume that this
period is demanding for the use of increased conservatism during the conduction of
independent financial audits, which results in higher audit fees.
Another study that has contributed in the understanding of the timeliness in auditors’
increased levels of conservatism is that of Fargher & Jiang (2008). They hypothesized that
auditors would be more likely to issue a going-concern modified audit report to financially
stressed companies immediately after the turbulent for the independent auditing
profession period of 2000-2002. They confirmed this hypothesis after testing a sample of
1769 Australian stock exchange quoted companies for the pre-crisis period and 3344
Australian stock exchange quoted companies for the post-crisis period. The statistical
model used in was separated in a two-stage and a single-stage analysis of two multivariate
regression equations developed. In more detail, the going-concern modification rate was
increased from 8% in 1999 to 13% in 2003. However, while testing the years after the first
responding to the increased litigation, scrutiny, and public distrust against the audit
profession period, their findings provided insignificant evidence of increased audit
conservatism. This finding implies that auditors are more motivated to make use of
increased professional judgment and effort in crisis periods concerning their profession or
the business world in general. Additionally, research has shown increased audit effort
after 2002 (Bedard & Johnstone, 2005) and higher levels of professional skepticism in the
conduction of financial audits after the same year (Secru et al., 2006). These studies
provide stronger support in the expectation of increased audit conservatism during the
years of the proved financial crisis of 2008-2009, especially after the high-profile
45
professional collapse caused by huge financial institutions’ bankruptcies soon after
receiving an unqualified audit report.
Herrmann, Pornupatham, Vichitsarawong (2009) examined the impact of the Asian
financial crisis on auditors’ conservatism in general, and the differences between the
conservatism of Big Four and non-Big Four auditors during the investigated period. They
examined first the link between audit firms size and audit quality (Arrunanda, 1999;
Krishnan & Schauer, 2000; Malone & Roberts, 1999; Moizer, 1997). Secondly, while
investigating the link between conservatism and audit firm size (Basu et al., 2001; Chung
et al., 2003; Lee at al., 2003), they searched for the impacts of the Asian financial crisis on
auditors’ conservatism and separated their sample in Big Four and non-Big Four auditors.
They tested a sample consisting of 311 observations during the crisis period of 1997-1998
and 978 observations during the post-crisis period of 1999-2003 and discovered that
companies audited by Big Four firms report more conservatively than companies audited
by non-Big Four firms did. They also found out that Thai companies, in general, reported
more aggressively during the financial crisis and more conservatively in the period
following the financial crisis. More specifically, during the crisis the Big Four audit clients
reported more conservatively than non-Big Four audit clients did. The findings were not
the same when it comes to the post-crisis period: no difference was discovered in the
conservatism levels between Big Four audit clients and non- Big Four audit clients.
In order to test auditors’ behavior in turbulent times concerning the dominant Big Four
audit firms operating in the Netherlands, a research was conducted by the Netherlands
Authority for the Financial Markets (AFM) in September 2010. This body was established
by the Act on the supervision of audit firms in 20066, who determined the rules and the
duties of auditors performing statutory audits. The rules concern mostly the mandatory
licenses provided by the Authority regarding statutory audits, the mandatory supervision
of the audits by the Authority, and the compliance with handouts regarding the
fundamental aspects of the external auditing profession, which are independence,
competence, objectivity, and integrity. The research was conducted in 2009 and
concerned data for the financial statement audits operated by the Big Four audit firms:
KPMG, Ernst & Young, PriceWaterhouseCoopers, and Deloitte-Touche-Tohmatsu. These
firms conduct the 80% of total Sales statutory audits in the Netherlands.
6
http://www.afm.nl/~/media/Files/wetten-regels/wta/engels/enwta_act_on_the_supervision_of_audit_firms.ashx , accessed on 10th November
46
The research used a sample concerning data of 46 audits, reporting on the statements of
public interest entities (involved in the construction, real estate, automotive, banking and
insurance sectors, and municipalities, as well as housing associations) that are stock
exchange quoted. The findings were rather disappointing in that they showed that
auditors performed lower quality audits. Specifically, these lower quality audits were
related with lack of professional skepticism, insufficient audit evidence and
documentation, and insufficient reliance in the activities of other auditors such as the
internal auditors, the auditors of foreign subsidiaries and other experts such as IT
executives. Moreover, evidence revealed that auditors conducted insufficient systemoriented activities and that they had insufficient involvement in other firm activities. An
inadequate system of quality assurance was also found concerning the role of the
compliance officer and the system of internal reviews, along with a reduced level of
commitment regarding the considerations of the quality in carrying out an engagement
quality control. Additionally, another significant finding was that these audits were carried
out without complete records concerning any violations discovered and the relevant
actions taken. In relation with the investigated elements of this study, the research of the
official Dutch body authorized with the supervision of the external auditors proved the use
of decreased levels of conservatism.
The focus of this research would be concentrated on clients of both types of audit firms,
however the sample used was audited exclusively by Big Four audit firms. A contradicting
phenomenon exists, in that several banks and other enterprises around the world had
received an unqualified opinion soon before they filed for bankruptcy or completely
dissolved while being audited by one of the Big Four audit firms. Since this happened right
before the “explosion” of the crisis and the auditing profession came down in the light of
the microscope and the reputation and the public view was at stake (and still is), it is
reasonably expected that during the crisis period auditors’ conservatism would be
increased. In general, there are also contradicting scientific studies concerning the quality
of audits conducted by the Big and the non-Big audit firms. A detailed explanation
concerning this “higher quality” will be provided in the research design part, where the
choice of the sample of this study will be thoroughly analyzed and explained.
Gul et al. (2008) examined in their study the relationship between the Asian financial
crisis and the Accounting conservatism and Audit fees. Their first objective was to prove
47
that the Asian financial downturn between the years 1996-1997 was indeed a crisis. As
evidence concerning this statement, the authors decided to take into account the number
of the dissolved enterprises during the years observed. As expected, the number of
deregistered firms of the years 1996 and 1997 approximately doubled compared to the
one of 1995, and became approximately ten times the number of the deregistered firms of
1994. Their second hypothesis involved conservatism and audit fees during the crisis. 2061
Hong Kong registered and deregistered firms from 1990 until 1997 consisted the sample
for the empirical tests conducted. It is important here to note that they took into account
the rarely used, adversely related to the auditing conservatism concept of accounting
conservatism. Precisely, they argued that client favorable financial statements are
preferable in years of financial downturn and constitute the result of less accounting
conservatism. The less accounting conservatism is translated in an increased audit effort.
This is due to the fact that more evidence have to be accumulated and thorough
investigation through more substantial tests and analytical procedures have to take part
that result inevitably in increased audit fees. When firms report aggressively, a suspicion
of GAAP violation comes into light. Furthermore, inaccuracies and vagueness in the
financial statements reduce the reliability of accounting numbers and financial
statements’ disclosures. Despite the additional effort needed from the auditors to assure
for the fairness of the reported results, there is a higher possibility of a litigation and
damaged reputation emerging from materially misstated statements. This leads to more
conservative audit treatment and consequently higher audit fees.
Considering all the before signaled theory, the following hypothesis is formulated:
Hypothesis 1:
The current financial crisis has resulted in increased auditing conservatism during the
crisis period compared to the prior-crisis period, concerning the Dutch stock exchange
quoted companies.
Gul et al. (2008) extended their research on the relation between the increased levels of
audit conservatism and the audit fees. Evidence proved the positive relationship between
auditors’ conservatism and audit fees. Surprisingly interesting for the authors was the fact
that during financial downturns, managerial incentives for less accounting conservatism
increases audit fees “precisely when the firms can least affords such an increase” (pp. 1).
48
They argued that the decreased accounting conservatism level is highly significant because
it also addresses a hidden cost of the financial downturns7, the indirect effect of the
existent incentive contracts. The increased managers’ pressure for favorable reporting is
the main cause of the high audit fees, since they excluded inflation impacts and financial
crisis’s impacts per se on increased audit fees by examining a longer period of time that
confirmed their findings.
Another study confirming the causes of a boost in the audit fee amounts is the one of
Gul et al. (2003) investigating discretionary accruals and their relations with managers’
incentives and audit fees. The discretionary accruals are subject of thorough accounting
treatment, since they are uncertain accruals that can be easily manipulated. Consequently,
auditors increase the level of the inherent risk appraisal of the audit procedures leading to
increased audit effort and at the bottom line to higher audit fees. The sample consisted of
648 Australian firms of the year 1993 that were tested through a multiple-regression audit
fee model with Ordinary Least Squares (OLS) regressions. They formatted the findings of
their research concerning the audit fees in arguing that there is a positive association
between discretionary accruals and audit fees, ceteris paribus. Discretionary accruals were
proved lower in amount after the enforcement SOX-Act of 2002 as examined by Lai (2003),
thus it can be argued that they are treated with higher professional skepticism and higher
conservatism by auditors. Since discretionary accruals are positively associated with audit
fees, the reasonable assumption is that higher levels of auditing conservatism are also
associated with higher audit fees. Consistent with these findings, Shengupta & Shen (2007)
also proved that firms with poorer quality accruals is associated with higher audit fees,
due to the increased audit effort and professional skepticism demanded by the CPAs.
Jarva’s (2010) research is also consistent with increased audit fees emerging from
increased professional skepticism and audit effort. He examined the consequences of SFAS
142 goodwill write-offs with a sample of 277 SFAS 142 goodwill write-offs taken from the
period between 2002 and 2005, by using a two-stage statistical approach of a propensity
score matching method followed by a regression analysis. The evidence signaled that
write-off firms pay higher future audit fees. This suggests that auditors charge higher fees
7
Gul et al. (2003) also signaled other possible costs like the reduced credibility of financial reports, increased
cynicism, and loss of faith in accounting based systems and increased regulatory constraints, that are related
with auditors and accountants’ conservatism.
49
due to the extra effort necessary for the goodwill amortization and impairment testing or
due to the additional risk faced by themselves.
The findings of Jarva (2010) are consisted with efficient audit pricing, as it is the case for all
the referring studies. Their findings contributed broadly to the audit fee literature and to
the formation of the second hypothesized claim of this study.
High audit fees already existed at the times right before the financial crisis’s breakdown.
In addition, the unqualified opinions presented to firms that went bankrupted soon after
these opinions came public, the investigation of the differences in the audit fees during
the current global financial crisis consists the second primary concern of this research,
which is constructed as following:
Hypothesis 2:
The current financial crisis has resulted in increased audit fees, because of the increased
audit efforts, concerning the Dutch stock exchange quoted companies.
Since the current financial crisis has undoubtedly affected the external auditing
profession in a major scale, both hypotheses are expected to be confirmed. The focus of
this research is the magnitude and the orientation of these impacts respectively. Another
interesting issue to be investigated is if conservatism plays the most important feature of
the audit fee amount, in the case of increased auditors’ conservatism. It can be argued
that it could be sidelined from the auditors’ efforts to attract more or retain their clients
by negotiating fees in order to adjust to the inevitable severe liquidity shortages emerging
from the financial downturn. A brief summary highlighting the prior research’s findings is
provided with the subsequent Table form. These prior studies, their research designs and
findings constitute the fundamental foundation of the hypothesized claims and the
empirical examination of this study.
50
Summary of prior research:
Authors
Object
Sample
Methodology
The
Every firm-year The
conservatism
observation
Outcome
(Year)
Basu (1997)
concept and the between
timeliness and years
persistence
“reverse” Negative
regression
earnings
the model that he changes
1963- created
are
timelier but less
of 1990
persistent,
earnings
Earnings
Response
Coefficients
(ERCs)
are
higher
for
positive
earnings
changes
Basu (1997)
The
Every firm-year The
conservatism
observation
concept and the between
timeliness and years
persistence
“reverse” Negative
regression
earnings
the model that he changes
1963- created
of 1990
are
timelier but less
persistent, ERCs
earnings
are higher for
positive
earnings
changes
Francis
& Auditors’
2.068
Krishnan
conservatism
(1999)
relation
stock Krishnan’s two Auditors
exchange
with quoted
are
level and three more likely to
U.S. level
model
probit issue a modified
accounting
companies
audit
opinion
accruals
(from the years
for high-accrual
1986 and 1987)
firms
and
incomeincreasing
accruals result
in
higher
conservatism
51
Authors (Year)
Object
Geiger,
Auditors’
Sample
226 firms that
entered
into
Raghunandan & reporting
bankruptcy
Rama (2005)
decisions
during
the
associated with
period between
the
2000 and 2003
establishment
of the SOX-Act
Fargher & Jiang Auditors’
(2008)
propensity
issue
to
Going-
Concern
Opinions
after
the 2000-2002
period
Methodology
Multivariate
Auditors issue
more
goinglogistic
concern
regression
modified
model
opinions after
December 2001
and increased
audit
conservatism is
associated with
delays in audit
procedures
1769 Australian Two-stage and Auditors
are
more likely to
stock exchange single-stage
quoted
analysis of two issue a goingconcern
companies for multivariate
modified audit
the
pre-crisis regression
report
to
period
and equations
financially
3344 for the developed
stressed
post-crisis
companies
immediately
period
after the crisis
period,
concerning the
profession
between 20002002
2061
Hong Basu’s
Accounting
Gul, Srinidhi & The
Asian
Shieh (2008)
crisis Kong registered “reverse”
financial
Outcome
conservatism
and its impacts and
regression
dropped
on
model
significantly
Accounting deregistered
conservatism
firms from 1990
during the crisis
and Audit fees
until 1997
period,
resulting in a
boost
in
auditors’
conservatism
52
and audit fees
Authors (Year)
Object
Sample
Gul, Chen
& Discretionary
Tsui (2003)
Methodology
648 Australian Multiple-
Discretionary
accruals,
firms
accruals
managers’
1993 year
incentives
of
the regression
(same
and
the
fee model
Economic 277 SFAS 142 Multivariate
consequences
of
SFAS
goodwill write- regression
142 offs taken from analysis
goodwill write- the 2002-2005
offs
Netherlands
Authority
Supervision
of audit firms
and
as audit fees are
“reverse”) audit positively
audit fees
Jarva (2010)
Outcome
related
Write-off firms
pay
future
higher
audit
fees
period
of 46
audits
of Survey
Big Four firms
public interest
performed low
Financial
entities
quality
Markets (2010)
conducted
2008
in
audits
regarding
the
investigated
statutory audits
5.2 Summary
The theoretical background concerning audit conservatism, audit fees, and their
changes due to financial crises was analyzed in the preceding part. Overall, empirical
research has found that audit conservatism and audit fees are positively related and that
in crisis periods both elements show increasing tendencies. The hypotheses developed
concern the so far not investigated financial crisis that started in 2008 and the changes
regarding the two auditing elements. The sample and the research design of the empirical
examination that will test these hypotheses will be the subject of the subsequent chapter.
The expectation is that both hypotheses will be verified, assuring that the current financial
crisis has resulted in increased auditors’ use of conservatism and audit fees.
53
CHAPTER 6 – Research Design
6.1 Research approach
The two main research approaches used to test phenomena are the qualitative and
quantitative approaches.
Qualitative research is regarded as the “inquiry” method accounted for the investigation
and understanding of more conceptual features, such as meanings, concepts,
characteristics and behaviors. In short, it investigates the way and the reasoning for
humans’ decision-making. It is involved with non-numerical data; consequently, the role of
the researcher becomes asymmetrically significant. Since it does not allow generalizations,
it is recognized as the least scientific one. The testing sample is small and specifically
chosen concerning the particular cases examined. The results are analyzed and
subjectively interpreted by the conductor of the research and can only explain the specific
subjects under investigation. The findings of such a research easily and reasonably can be
questioned considered as biased.
This study is concerned with the examination and the assessment of specific variables and
the relationship between them, consequently this kind of research, the quantitative one,
cannot be selected as the appropriate empirical method. In order to analyze and prove the
type and the magnitude of the variables and their interconnections, “harder” scientific
evidence is required such as strictly interpreted numerical data.
Quantitative research on the other hand, is regarded as the empirical investigation of
measurable properties and phenomena and the relationships among them. The aim of a
quantitative research is to determine the relationship between an independent and a
dependent (or outcome variable) feature. In addition, a quantitative research is also used
concerning the examination and the explanation of the mechanisms of treatment or
behavioral procedures. In order to test the association between the two types of variables
based on observation and/or prior research findings, specific hypotheses are developed.
The corresponding findings are attributed to the results of the mathematical models
established to correspond to the specific hypotheses.
Since it is the most appropriate and objective one, this kind of research, the quantitative
one, is the one used concerning the empirical testing in this study. Studies targeted to
54
quantifying relationships can be either descriptive, or experimental. The descriptive type is
used for simple measurement of the examined elements, no modification in conditions or
behavior is attempted. In contrast, experimental studies involve measurements that are
taken and then intervened or modified, in order to examine the results of these testing
procedures. The results of a statistical research are considered robust, reliable and can be
generalized due to the employment of scientific –mathematical- models. The data used for
quantitative research is more efficient and can test hypotheses as the ones developed in
the precedent chapter. Furthermore, the tested sample can be as large as adequate for
the establishment and the scientific recognition and approval of the statistically produced
findings. It is important though, to select a representative sample of the population so that
findings are considered unbiased, objective, and generalizing. Additionally, this type of
research has more advantages in that it is less time consuming and expensive.
The goal of this study is to determine the relationship between the emergence and the
impacts of the current financial crisis (independent element) and auditors’ conservatism
and audit fees (dependent elements). Consequently, it is clear that the quantitative type
of research instead of the qualitative one is the most suitable. The specific statistical
model used is analyzed in the subsequent parts.
6.2 Research methodology
Verschuren and Dooreward (2007) defined the quantitative types of research in surveys
and experiments. Surveys are conducted through cross-sectional and longitudinal studies
with questionnaires or interviews that are aimed to estimate the characteristics of a
population, while experiments are used to determine a cause-and-effect relationship.
Furthermore, they distinguished three categories of experimental procedures, namely
laboratory, quasi-experiment, and simulation. Quasi-experiments involve elements that
are not randomly assigned to different groups in order to measure outcomes, but grouped
according to a characteristic that they already possess. This is going to be the scientific
approach of this study, since the data tested are thoroughly selected and categorized.
Moreover, the financial crisis starting in 2008 is considered the “cause” element and
auditors’ conservatism and audit fees are considered the “effect” elements, a fact that
excludes the surveys approach from the first place.
55
This study is investigating the impacts of the global financial crisis of the last 3 years
(2008-2010) on auditors’ conservatism and the audit fees. In order to process their data,
the majority of the scientific studies investigating conservatism, either in accounting or
auditing activities, use the model of Basu (1997). As already commented, Basu used a
multivariate regression model. The ordinary least squares (OLS) method estimates the
unknown parameters in a linear regression model. This is achieved by minimizing the sum
of squared distances between the observed responses in a set of data, and the fitted
responses based on the used regression model.
The underlying assumptions of the OLS model are:

The response variables are uncorrelated with each other.

The errors have zero mean

The errors have finite second moments that are the same for all units
(Homoscedasticity)
Basu’s hypotheses concerned the systematic differences between good and bad news
periods in the timeliness and in the persistence of earnings, due to the better specification
of OLS standard errors and test statistics when the lagging variable is specified as the
dependent one. Specifically, his first and primary hypothesis was that the slope coefficient
and R2 from a regression of annual earnings on annual unexpected returns (negative for
“bad news” and positive for “good news”) are higher concerning the negative unexpected
returns than concerning the positive ones. Indeed his findings were consistent with his
prediction. The specific statistical model he used to investigate the use of conservatism is
demonstrated in the subsequent part of this chapter.
The Basu model is selected as the most appropriate regarding the conduction of this
study. The impacts of the crisis in audit fees are investigated by running the statistical
model used in Gul et al. (2003), in order to define the relationship between the dependent
and the independent variables. Overall, both analyses will consist of regression models as
far as the statistical testing is concerned.
6.3 Measuring auditors’ conservatism and audit fees
Basu (1997) measured conservatism as the asymmetrically recognized bad and good
news in contemporaneous earnings. Within the same concept, the empirical approach of
56
this study associates audit conservatism and audit fees with the estimation risk attributed
to the asymmetric recognition of bad and good news in earnings. The model he used
proxied good news by unexpected positive stock returns and bad news by unexpected
negative stock returns as presented:
Xit/Pit-1 = b0 + b1DRit + b2Rit + b3Rit * DRit + ε (1)
Where:
Xit = Earnings per Share for firm 1 in fiscal year 1
Pit-1 = Price per Share at the beginning of the fiscal year
Rit = Returns
DRit = Dummy variable, which takes the value 1 if Rit < 0 (the case of negative returns) and
0 if Rit > 0 (the case of positive returns)
ε = error term
The interaction between the dummy variable and the return measures the difference in
the sensitivity of earnings concerning negative and positive returns. Referring to return,
the ratio of Return on Equity (ROE) will be used. Consequently, due to the increased
sensitivity of earnings regarding bad news than regarding good news, the coefficient b3 is
positive concerning conservative reporting. Briefly, the greater the degree of
conservatism, the greater will be the value of b3.
In order to estimate the change in auditors’ conservatism, this formula provides the
basic form regarding the modified version of Basu’s model used in this study. The
statistical testing will be conducted through a cross-sectional regression analysis for the
years before and the years during the financial crisis. Two testing procedures will be
conducted: four linear regression analyses for each one of the selected years before and
the years during the financial crisis (2005, 2006, 2008, 2009) and two pooled regression
57
analyses concerning the combined data of the two different periods, before and during
the financial crisis (2005-2006 Panel, 2008-2009 Panel). The explanation for the specific
years selected will be presented in the subsequent part concerning all the information
about the sample used.
The adjusted model is developed as follows:
Xit/Pit-1 = b0 + b1DRit + b2Rit + b3Rit * DRit + ε
(2)
In detail, the coefficient relating to auditors’ conservatism in both periods (before and
during the crisis) is b3. Consistent with the developed hypothesis, the expectation is that b1
will be positive and of medium significance for the period before the financial crisis (20052006), denoting the same trend in auditors’ conservatism. Additionally, according to the
presented theory b3 will turn out to be positive and of higher significance regarding the
period during the financial crisis (2008-2009), denoting a similar significant increase in the
degree of audit conservatism during the downturn years.
As commented thoroughly in the findings of prior research studies, the effects of the
financial crisis on auditors’ conservatism are expected to result simultaneously in changes
in the amounts of audit fees. These changes will be investigated using the OLS regression
model with natural log of external audit fees (LAF) as the dependent variable and
conservatism (CSV) and other control variables as independent variables. The results of
the investigation of the second hypothesis developed will be found through the empirical
model structured as follows:
LAFit = b0 + b1 CSVit + b2 SIZEit + b3 QRit + b4 LEVit + b5 INVRECit + b6 ROIit + ε (3)
Where:
LAFit = Natural log of external audit fees
58
CSVit = Dummy variable, which takes the value 1 in years of lower auditors’ conservatism
and the value 0 in years of higher auditors’ conservatism
SIZEit = Natural log of total assets
QRit = Ratio of current assets less inventory to current liabilities
LEVit = total debt to book value of equity (leverage)
INVRECit = Book value of inventory and receivables to total assets
ROIit = Earnings before extraordinary to total assets
ε = error term
Concerning the measurement of the level of audit fees, this model is used in most of the
relevant scientific studies (Gul et al., 2008; Francis & Wang, 2004; Ferguson et al., 2005).
As observed, several control variables that will be explained in detail in the next
paragraph.
6.4 Control Variables
The regression model presented will estimate the impact of the current financial crisis
on the magnitude of the audit fees. It concerns seven control variables. The control
variable CSVit, is regarded as a dummy variable that was explained previously in the
presentation of the model. To denote the absence or presence of some categorical effect
that is likely to shift the outcome, dummy or else indicator variable is one that takes only
the values of 0 or 1. Concerning the testing of the second Hypothesis, relating the use of
conservatism in auditing with the audit fees, CSVit is the most significant variable.
Continuing the investigation of the variables, the necessity exists to provide concerning
the five remaining “plain” control variables in the model more detailed information, and
the reasoning concerning their inclusion in the statistical model:
SIZE
SIZE refers to the auditee’s size. As already commented, larger firms have higher
incentives to manipulate their financial statements, either because of management
59
compensation incentives upwards, or downwards emerging from government actions and
taxing regulations.
QR
QR refers to the quick ratio, which indicates the short-term liquidity of a firm. Since it is
used to show the company’s ability to cover its short-term obligations with its own liquid
assets, the higher the ratio, the better the position of the company is.
LEV
LEV is the debt/equity ratio that measures the financial leverage of a company. It captures
the effect of the financing practices of a firm by indicating the proportion of debt and
equity that the company uses in order to finance its assets. If the ratio is high, then a
company is considered to finance aggressively its growth with debt, potentially resulting in
additional interest expenses. Additionally, firms with a LEV variable of higher degree are
exposed to higher litigation risk, consequently resulting in the expectation of increased
audit fees.
While the precedent analyzed quick ratio (QR) is informative about the short-term capital
structure of a company, the debt/equity ratio (LEV) informs about the long-term capital
structure of the company.
INVREC
INVREC is a variable associated with inventories and receivables. Firms exhibiting higher
INVREC levels are reasonably associated with more complex and time consuming financial
audits, and they are more likely to getting charged with higher audit fees.
ROI
ROI is the return on investment variable, which is generally appreciated as performance
evaluation measure. In this form, it is an indicator of the assessment of the overall audit
risk. Firms with lower ROI ratios are less likely to experience litigation risk. Consequently,
the higher the ratio, the higher the audit fees charged to a firm.
The primary expectation concerning the results of the regression analysis is that audit
fees will be found positively related to auditors’ conservatism. Stated in numbers, it is
60
expected that the coefficient b1 for the conservatism measure will be found positive and
significant. The investigation of the impacts of the crisis in audit fees will be examined with
two linear regression analyses for the years 2008 and 2009 respectively, and one pooled
regression analysis concerning the combined data of the two years, determining the
combined results.
6.5 Sample selection
Concerning the audit conservatism and the changes of the audit conservatism due to
the emergence of the global financial crisis, two periods are investigated: 2005-2006 for
the period before the financial crisis and 2008-2009 for the period during the financial
crisis. On the other hand, concerning the potential changes in audit fees due to the
emergence of the global financial crisis, only one period can be investigated and that is the
2008-2009 period. Since Dutch firms were obliged to declare their auditors’ remuneration
after July 2008, this investigated period consists of years that are both during the financial
crisis. Lack of data concerning the amounts of audit fees in the period before the
emergence of the crisis and specifically for the years 2005 and 2006 limits the conduction
of a comparison between the two different periods,
In sum, 51 Dutch stock exchange quoted firms were investigated. Specifically, 17 firms
from the Dutch AEX index, 23 firms from the Dutch AMX index, and 11 firms from the AScX
index were examined. The initial sample consisted of the 25 firms of the three separate
indexes, totaling in 75 firms. The firms were later reduced in the ones fulfilling certain
criteria. The criteria involved the existence of the firms in the four investigated years
(2005, 2006, 2008, and 2009), and of course the existence of all required data concerning
elements of the firms’ financial statements. Firms with omitting values and firms that were
not active during the investigated years were excluded from the initial sample of 75 firms
and resulted in the final used sample of 51 firms.
It is necessary to signal that the data concerning the audit fees involves solely the fees
paid regarding the financial statements’ audits of the firms.
61
Concerning the highly contradicting subject of the difference in audit quality between
the Big and the non-Big Four audit firms, there is a large number of scientific papers argue
about different findings. Lang & Maffet (2010) argue that the quality of the information
provided by accounting data is likely to be higher if such data are audited and assured by
one of the Big audit firms. Ajona et al. also (2008) hypothesized that Big firm auditors are
less tolerant of the establishment of new income-increasing manipulations and
consequently have stronger monitoring power in reducing management’s opportunistic
practices. Evidence, though, disclosed that Big audit firms superior performance in codelaw countries is only context specific, not overall general and depends on the specific
audited firm’ “audit risk model”. Consistent with the higher-quality argument of Big firm
audits, Myers et al. (2010) found that Big firm auditors after the enactment of the SOX-Act
of 2002 became more accurate in issuing Going Concern modifications8. In the study of Gul
et al. (2008), the statistical model used consisted of a variable concerning the audit firm’s
size. The content of this variable was interpreted as a proof of audit quality in that, Big
firm audits were considered as the only high quality ones. Furthermore, Hermann et al.
(2008) showed that during the Asian financial crisis of 1996-1997, Big audit firms’ clients
compared to non-Big audit firms’ clients were more sensitive to bad news than non-Big
audit firms’ clients were signaling. Big audit firms’ faster adjustments and responses in
environmental changes. However, in the same study, evidence proved no significant
difference in the use of conservatism between the two different firm categories in the
post-crisis period, indicating that non-Big firm audits are conducted with higher quality
professional standards through the presence of time. Additionally, in the paper of CanoRodriguez (2010) concerning conservatism in the audits of Spanish stock exchange quoted
firms, evidence proved that in the absence of essential litigation and reputation risk Big
auditors are conducting audits of higher quality, while at the same time they tend to be
over-conservative in furious professional times. Li et al. (2007) after searching the
influence of auditor choice in earnings conservatism found no significantly stronger
monitoring power of Big firm auditors on auditee’s earnings conservatism in comparison
with the same power of non-Big firm auditors.
8 More precisely, Myers et al. (2008) compared Big and non-Big audit firms’ going concern opinions after the
enactment of the SOX-Act of 2002. Their findings were consistent with increased conservatism from the nonBig audit firms and higher levels of accuracy from the Big audit firms. Their tests were based on the number of
both Type 1 (i.e. auditors a issue going concern opinion to a firm that does not declare bankruptcy after all)
and Type 2 misclassifications (i.e. auditors fail to predict and report a going concern modified opinion to a firm
that subsequently declares bankruptcy) of going concern modified opinions.
62
Overall, theory has been contradicting concerning the Big and non-Big audit firms’
performances, however a higher number of studies have shown evidence of higher quality
audits conducted by the Big audit firms. One of the Big audit firms audits the majority of
the Dutch stock exchange quoted companies: consequently, no significance, exists in
relation with the audit firm’s size variable.
6.6 Summary
Summarizing this part, an insight in the research design of this study was presented. In
order to investigate auditors’ conservatism and audit fees during and prior to the current
financial crisis, quantitative research was selected as the most appropriate type of
research. Precisely, in order to test the hypotheses developed, the empirical method of
regression analysis with ordinary least squares (OLS) will be used. The corresponding
models were presented and the reasoning concerning their selection as well. Additionally,
an analysis of the variables of the models was provided.
The results from the statistical analysis of the models, concerning the modification of
auditors’ conservatism and audit fees, along with any other essential subjects discovered
are demonstrated and commented in the subsequent chapters.
63
CHAPTER 7 – Research results and analysis
This chapter will comment on the results of the statistical investigation conducted to
determine the impacts of the current financial crisis on auditors’ use of conservatism and
on the audit fees regarding Dutch CPAs. The analysis of the results concerning Model 2 is
demonstrated in the first part of the chapter, which focuses on the impact of the crisis on
auditors’ use of conservatism, and second concerning Model 3 in the subsequent part of
the chapter that focuses on the impact of the crisis on the level of the auditors’ fees. First,
the descriptive statistics of the sample tested will be demonstrated along with a reference
to interesting observations. Second, the evidence of the regression analyses of the two
statistical models used will be presented and a thorough analysis of this evidence will be
commented. The analysis is performed in order to interpret the corresponding numerical
findings in the examined changes in the relationships between the tested variables.
Additionally, an explanation concerning the reasoning of the findings will be commented.
The overall empirical analysis will be briefly signaled in the last part of the chapter, which
contains the summary.
7.1 Analysis of the investigation concerning the impact of the current financial crisis on
auditors’ use of conservatism
Model 2 was used to determine of the effects of the current financial crisis on auditors’
conservatism level. Model 2 was specified as:
Xit/Pit-1 = b0 + b1DRit + b2Rit + b3Rit * DRit
7.1.1 Descriptive statistics for Model 2
Table 1: Descriptive statistics concerning the sample of the pooled regression analyses
2005-2006
PERIODS:
2008-2009
MEAN
MEDIAN
ST.DEV
EPS
*1,70
1,13
2,13
-2,15
Xit/Pit-1
21,97
15,07
31,35
*19,34
19,17
0,06
0,00
VARIABLES
Rit
DRit
MIN
MAX
MEAN
MEDIAN
ST.DEV
MIN
MAX
10,89
*0,39
0,77
2,21
-9,43
4,63
0,45
227,39
19,71
14,19
24,57
0,64
227,39
16,77
62,14
67,60
*0,21
12,37
46,91
-240
59,88
0,24
0,00
1,00
0,22
0,00
0,41
0,00
1,00
64
Where:
EPS= Earnings per Share
Xit/Pit = Closing Price of Share for the year prior to the investigated one used for the Price of Share
of the beginning of the investigated year
ROE=Return on Equity
DRit=Dummy variable of the Return.
The descriptive statistics presented involve the sample used for the analyses of the
pooled regressions concerning the two investigated and compared periods of 2005-2006
and 2008-2009. The sample used consisted of 51 Dutch stock exchange quoted firms
(n=52). The demonstrated features involve basic statistical terms that are explained
subsequently. “Mean” presents the average value of the variables, while “Median”
presents the median value of the variables. “STDEV” presents the deviation from the
average value of the examined variables, “Min” presents the lowest value of the variables,
and finally “Max” gives the maximum existing value of the variables.
The 51 investigated firms were selected from the AEX, AMX, and AScX indexes after
controlling for missing and omitted data. As observed in Table A, all corresponding
features show dramatic decrease in the period 2008-2009 which is during the current
financial crisis, than in the period of 2005-2006 which is before the current financial crisis.
This is a proof regarding the severe negative effects of the crisis on the financial position of
the investigated firms and the significant amount of distress they suffer.
The most indicative features concern the mean EPS, which amounted to 1,70 in the
2005-2006 period and 0,39 in the 2008-2009 period, and the mean ROE, which was 19,34
in the 2005-2006 period and 0,21 in the 2008-2009 period. It is worth to signal that due to
the limited number of firms used in the sample, no observations were excluded as outliers.
7.1.2 Pearson’s correlation testing
The Model 2 is the statistical model used to investigate the relationships between both
the dependent variable and the independent variables. These variables may relate with
each other in a significant level, jeopardizing the validity of the results. If two or more
independent for example, variables relate with each other significantly, they are
measuring approximately the same thing, consequently each variable can only explain in
part the relationship with the other variable. This ultimately decreases the explanatory
value of each variable separately and the explanatory power of the model in total.
65
In order to examine the relationship between all the variables in Model 2, a Pearson’s
correlation test was conducted. The subsequent matrix schemes demonstrate the findings
of the tests concerning the two investigated periods prior to and during the financial crisis.
First, the matrix concerning the period prior to the financial crisis is presented.
Table 2a: Pearson’s Correlation test concerning the period 2005 -2006
Rit (Return
Xit/Pit-1
Xit/Pit-1
Pearson
DRit
On Equity)
Rit*DRit
1
Correlation
Sig. (2-tailed)
N
DRit
Pearson
51
-,426**
1
Correlation
Sig. (2-tailed)
,002
N
Rit
Pearson
(Return On Equity)
Correlation
Sig. (2-tailed)
51
103
,476**
-,679**
,000
,000
51
102
102
,449**
-,803**
,707**
,001
,000
,000
51
103
102
N
Rit*DRit
Pearson
1
1
Correlation
Sig. (2-tailed)
N
103
**. Correlation is significant at the 0.01 level (2-tailed).
The Pearson’s correlation matrix over this period shows that a significant negative
relationship exists between the return variable Rit and the dummy return variable DRit
amounted to -0,697. The correlation coefficient may range from –1 to 1, where –1 or 1
indicates a “perfect” relationship between the variables, as can be observed by the table
in the cells showing the relationship between the exact same variables. The further the
coefficient is from 0, regardless of whether it is positive or negative, the stronger the
66
relationship between the two variables. Negative coefficients tell us that an inverse
relationship exists: when one variable increases, the other one decreases. In addition, a
significant correlation between the Xit/Pit-1 and the Rit variables amounted to +0,476 and
between the Xit/Pit-1 and the Rit*DRit variables amounted to +0,449, which is significant only
on the 0.01 level (2-tailed). All the variables are found to be statistically significant at the
0.01 confidence level. Consequently, all the presented variables will be used.
The next table presents the relevant information for the period 2008-2009, during the
current financial crisis.
Table 2b: Pearson’s Correlation test concerning the period 2008 -2009
Rit (Return
XPricePrev
XPricePrev
Pearson Correlation
DRit
On Equity)
RitDRit
1
Sig. (2-tailed)
N
DRit
Rit (Return On Equity)
Rit*DRit
Pearson Correlation
102
-,456**
1
Sig. (2-tailed)
,000
N
102
102
,501**
-,510**
Sig. (2-tailed)
,000
,000
N
101
101
101
,468**
-,501**
,850**
Sig. (2-tailed)
,000
,000
,000
N
102
102
101
Pearson Correlation
Pearson Correlation
1
1
102
**. Correlation is significant at the 0.01 level (2-tailed).
The Pearson’s correlation matrix concerning this period shows again that a significant
negative relationship exists between the return variable Rit and the dummy return variable
67
DRit amounted to -0,510. A significant correlation is shown between the dependent Xit/Pit-1
and the Rit variables amounted to +0,501 and between the Xit/Pit-1 and the Rit*DRit variables
amounted to +0,468, which is significant in the 0.01 level (2-tailed). Again, all the variables
are found to be statistically significant at the 0.01 confidence level. Consequently, all the
presented variables will be used as well.
7.1.3 Coefficients’ analysis - Results investigation
The subsequent tables demonstrate the results regarding the coefficients of the
variables concerning the pooled regressions conducted in order to examine the effects of
the current global financial crisis on auditors’ conservatism, as generated by the E-views
computer program. Because of the extended options on the pooled regression method of
analysis that is used in this study, combining data of more than one year in each examined
period, concerning this empirical analysis the E-views program was selected instead of the
more common SPSS program. In order to determine whether omitting a variable is likely to
result in specification bias or whether the variable is irrelevant, it is easier using the Eviews software program to try alternative versions of an OLS model.
The tables presented subsequently, concern the pooled regression analyses conducted
for the two investigated periods prior to and during the financial crisis respectively.
Table 5: Results of the pooled regression analysis for the 2005-2006 period
Dependent Variable: Xit/Pit-1 (Conservatism)
Method: Panel Least Squares
Periods included: 2
Cross-sections included: 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient
b0 (constant)
0.119369
b1 (dummy Return on Equity- DRit)
0.032213
b2 (Return on Equity- Rit)
0.002381
b3 (sensitivity of earnings to negative
and positive returns- Rit*DRit)
0.013453***
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
Std. Error
t-Statistic
Prob.
0.057147
0.170847
0.002550
2.088794
0.188548
0.933679
0.0423
0.8513
0.3553
0.007752
1.735462
0.0894
0.774969
0.515694
0.136417
68
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
An important element of this and the subsequent table is the R squared. It indicates that
only the 77,5% of the dependent Xit/Pit-1 variable is explained by the included independent
variables, by reflecting the correlation coefficient of the model.
The coefficient of determination (R-squared) measures how good the regression line of
the sample fits in the data. It can take values from 0 to 1, while the larger the value, the
better the goodness of the fit is. R squared increases with the addition of extra variables in
the regression. A bigger R squared though, does not mean a more scientific model. The
addition of extra variables may be completely irrelevant. The choice of the variables
should be guided strictly by theory and specific hypotheses. Furthermore, in cases with
many variables in the regression it is better to use the Adjusted R-squared, but this does
fact does not affect this regression analysis’ conduction.
Table 6: Results of the pooled regression analysis for the 2008-2009 period
Dependent Variable: Xit/Pit-1 (Conservatism)
Method: Panel Least Squares
Sample 2008-2009
Periods included: 2
Cross-sections included: 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient Std. Error
b0 (constant)
0.046549
b1 (dummy Return on Equity- DRit)
0.066475
b2 (Return on Equity- Rit)
0.002481
b3 (sensitivity of earnings to negative
and positive returns- Rit*DRit)
0.006355*
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
t-Statistic
Prob.
0.049482
0.179170
0.001582
0.940729
0.371014
1.568573
0.3517
0.7123
0.1235
0.002361
2.692002
0.0098
0.734228
0.434527
0.245812
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
The E-views program used for the empirical research of this study generates in general
the standardized coefficient, which is preferred compared to the simple coefficient one.
69
Consequently, by analyzing the outcome information of the pooled regression analysis,
Model 2 is formulated as:
a) Xit/Pit-1= 0,112 + 0,032*DRit+ 0,002*Rit+ 0,013*Rit*DRit ,
concerning the period 2005-2006
b) Xit/Pit-1= 0,046 + 0,066*DRit+ 0,002*Rit+ 0,006*Rit*DRit ,
concerning the period 2008-2009
According to the presented results, the b3 coefficient is the most significant variable,
indicating the financial crisis’ effects on auditors’ conservatism. Precisely, for the period
2005-2006, b3 = 0,013. This value is significant at the 0,10 significance level and as
predicted, it is positively related with the Xit/Pit-1 variable, measuring auditors’
conservatism. Regarding the 2008-2009 period, b3 = 0,006 and that is a significant value in
the 0,01 significance level. The relation between the sensitivity of earnings to positive or
negative returns that proxies auditors’ conservatism and the ratio of earnings per share
(EPS) to the price of the share at the beginning of the year, is also positive but in a
decreased level, contradicting Hypothesis 1. According to this Hypothesis, the b3 of the
2005 and 2006 years should be lower in value than the b3 of the 2008 and 2009 years.
However, 0,013 > 0,006, which is not consistent with the stated predictions. Overall, the
pooled regression analysis shows that auditors’ conservatism was in fact higher in the
years before the financial crisis, than in the years during the financial crisis. This is
opposite to the prediction of higher conservatism levels in the years during the financial
crisis compared to the years before the financial crisis.
Similar evidence was found in the study of Herrmann et al. (2008) though, which
showed increased levels concerning auditors’ conservatism in the subsequent of the crisis
years compared to the years during the financial crisis. In periods of crisis, auditors are
according to this evidence found more confused in comparison with the years before or
after a financial crisis, regarding to their use of conservatism.
The results of the statistical model show relatively lower audit conservatism during the
years of the financial crisis compared to the years before the emergence of the crisis. It
can be argued that these findings are partly associated with the Dutch accounting
regulations’ system. The Netherlands is a code law country; all laws and consequently
70
accounting regulations are strictly prescribed and defined in detail. Consequently, less
professional judgment is required. Auditors are likely to rely in the prescribed standards
and practices seeking for the assurance of their professional due care, instead of
exercising high professional judgment and make efforts in order to adjust to the increased
levels of audit skepticism that is required in turbulent times.
Recent developments in the Dutch auditing profession though are in a higher degree
associated with the particular results. Specifically, the recent research conducted by the
Netherlands Authority for Financial Markets (2010) found that Big Four auditors were
performing lower quality statutory audits during 2008, which was the first year of the
crisis. The quality of the audits are in a significant degree related with the levels of
professional conservatism, in that high quality audits are conducted with the use of higher
conservatism levels.
So far, these two studies are the only ones investigating auditors’ behavior in the last 2
years (2008 and 2009) and they have both found evidence of limited loyalty in the high
professional standards regarding financial statement audits.
Complementary evidence is presented, concerning the results generated by the linear
regression analysis conducted for each investigated year.
7.1.4. Complementary evidence concerning data for the years 2005, 2006, 2008 and 2009
The subsequently presented tables contain information about the coefficient results
after running a simple linear regression analysis using Model 2 for each year separately.
This statistical investigation was conducted in order to provide additional support to the
primary pooled regression analyses of the investigated periods. However, evidence turn
out to be mixed and consequently do not fulfill their goal, in that these results cannot be
considered as scientifically robust.
The lower validity level of the linear regression analyses is also shown by the lower value
of the R, and Adjusted R squared.
71
Table 7a: Linear regression analysis for the year 2005
Dependent Variable: Xit/Pit-1 (Conservatism)
Method: Least Squares
Sample (adjusted): 1 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient
Std. Error
t-Statistic
Prob.
b0 (constant)
0.102877
b1 (dummy return on equity- DRit)
-0.109904
b2 (return on equity- Rit)
0.003878
b3 (sensitivity of earnings to negative
and positive returns- Rit*DRit)
0.004028
0.072819
0.184970
0.003136
1.412773
-0.594172
1.236567
0.1646
0.5554
0.2227
0.006027
0.668284
0.5074
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
0.249980
0.199979
0.222742
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
Table 7b: Linear regression analysis for the year 2006
Dependent Variable: Xit/Pit-1 (Conservatism)
Method: Least Squares
Sample (adjusted): 1 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient Std. Error
b0 (constant)
0.135292
b1 (dummy return on equityDRit)
-0.220671
b2 (return on equity- Rit)
0.000588
b3 (sensitivity of earnings to
negative and positive returnsRit*DRit)
-0.001488
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
t-Statistic
Prob.
0.038301
3.532360
0.0009
0.265775
0.001467
-0.830295
0.400521
0.4106
0.6906
0.009178
-0.162088
0.8719
0.105665
0.048579
0.125253
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
72
Table 7c: Linear regression analysis for the year 2008
Dependent Variable: Xit/Pit-1 (Conservatism)
Method: Least Squares
Sample (adjusted): 1 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient
Std. Error
t-Statistic
Prob.
b0 (constant)
0.040159
0.015771
b1 (dummy return on equity- DRit)
-0.090427** 0.037378
b2 (return on equity- Rit)
0.001922* 0.000405
b3 (sensitivity of earnings to negative
and positive returns- Rit*DRit)
-0.001158*** 0.000586
2.546447
-2.419222
4.743966
0.0143
0.0196
0.0000
-1.976487
0.0541
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
0.503369
0.470980
0.093950
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
Table 7d: Linear regression analysis for the year 2009
Dependent Variable: Xit/Pit-1 (Ratio of earning to previous price year)
Method: Least Squares
Sample (adjusted): 1 51
Xit/Pit-1=b0+b1*DRit+b2*Rit+b3*Rit*DRit
Coefficient Std. Error
t-Statistic
Prob.
0.054431 0.086957
b1 (dummy return on equity- DRit)
0.324860** 0.152921
b2 (return on equity- Rit)
0.002774 0.004861
b3 (sensitivity of earnings to negative
and positive returns- Rit*DRit)
0.001817 0.005087
0.625949
0.5344
-2.124365
0.570705
0.0389
0.5709
0.357134
0.7226
b0 (constant)
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
0.411633
0.374077
0.349777
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
73
The value of the coefficient as the outcome of the separate linear regression analyses
conducted b3 varies regarding to each examined year, even in the years consisting one
investigated period. For instance, b3= 0,004 and positively related with conservatism in
2005, while at the same time b3= - 0,001 and negatively related with conservatism in 2006.
The results are contradicting with each other, in the sense that both years are included in
the prior to the crisis years and should at least show the same sign. However, the value of
each coefficient is considered insignificant.
The case remains the same concerning the second investigated period of 2008-2009,
which is during the current financial crisis. The coefficient b3 equals to - 0,001 for 2008 and
0,002 for 2009 respectively.
Consequently, no robust conclusion can be stated regarding the evidence of the sole linear
regression analyses of the four investigated years. The impacts of the crisis on auditors’
conservatism can be explained only from the results of the two conducted pooled
regression analyses concerning the two investigated periods before and during the current
financial crisis.
Concluding this part, Hypothesis 1 was not confirmed. Auditors make use of less
professional conservatism, while conducting audits of financial statements during the
current crisis period than in the years before the financial crisis. Hypothesis 2, following
Hypothesis 1, signaled the relationship between the current financial and the expected
increased levels of conservatism during the current crisis with the amounts of the audit
fees. The increased levels of audit fees were hypothesized, originating from the increased
use of audit conservatism. The results of the Model 3 investigating this Hypothesis are
demonstrated and commented on the subsequent part.
7.2 The impact of the current financial crisis, concerning the auditors’ fees
As stated in the research design part, the sample for the investigation of the relationship
between the emergence of the current crisis and the audit fees will be limited in the
period 2008-2009. Lack of data for the years 2005-2006, which consists the period before
the current financial crisis, is attributed to the fact that Dutch stock exchange quoted firms
were not obliged to declare their paid amounts of audit fees before 2008. Contrary to the
previous Model 2 method of investigation, the empirical analysis concerning Model 3 will
be conducted using the linear regression method due to the limited amount of the
investigated years.
74
A pooled regression analysis will be conducted additionally for the two examined years,
both during the current financial crisis, but its findings are not considered as valid as the
ones generated by the linear regression method.
Model 3 was specified as:
LAFit = b0 + b1 CSVit + b2 SIZEit + b3 QRit + b4 LEVit + b5 INVRECit + b6 ROIit
7.2.1 Descriptive statistics for Model 3
The subsequent tables contain the description of the sample used in order to investigate
the changes in auditors’ fees in relation with the current financial crisis. The description
concerns the variables forming Model 3, which were produced by certain financial
elements derived from the firms’ reports.
Table 8: Descriptive statistics concerning the sample of the linear regression analyses
YEAR:
2008
VARIABLES:
MEAN
LAF
CSV
SIZE
QR
LEV
InVREC
ROI
Audit fees
0,4334856
1
3,2846716
1,0381858
0,9943605
0,4243657
0,0325625
**132,75247
MEDIAN
0,3679147
1
3,282998
0,9192385
0,8258015
0,3484227
0,0531162
2,333
ST.DEV
MIN
0,8666023
0
0,7381846
0,7476751
0,8157817
0,4738197
0,1242431
809,4464
-1,3187588
1
1,78044693
0,10237155
0
0,00705467
-0,4781492
0,048
ST.DEV
MIN
0,8221802
0
0,8438311
0,9779419
0,8074121
0,3523816
0,1327138
716,6275
-1,3187588
1
1,74727971
0,07575758
0
1,1127E-05
-0,5736986
0,048
MAX
3,7150837
1
5,3017022
4,8568637
3,3855422
2,9208192
0,277135
5189
YEAR:
2009
VARIABLES:
MEAN
LAF
CSV
SIZE
QR
LEV
InVREC
ROI
Audit fees
0,3491675
1
3,3428261
1,101269
0,7999485
0,3712019
0,0313749
**111,85216
MEDIAN
0,2552725
1
3,2206148
0,9316952
0,6274416
0,291078
0,0375558
1,8
MAX
3,6823256
1
6,2773786
6,6311812
4,1213873
1,6570335
0,3020946
4812
75
Where:
LAFit = Natural log of external audit fees
CSVit = Dummy variable, which takes the value 1 in years of lower auditors’ conservatism and the
value 0 in years of higher auditors’ conservatism
SIZEit = Natural log of total assets
QRit = Ratio of current assets less inventory to current liabilities
LEVit = total debt to book value of equity (leverage), INVREC it = Book value of inventory and
receivables to total assets
ROIit = Earnings before extraordinary to total assets.
*Numbers are provided in thousands (x1000).
The most interesting element of the descriptive statistics table is the simple numerical
change in the level of the audit fees between 2008 and 2009. As observed, the average
amount of the audit fees stated in the last row of the “MEAN” column is amounted to
132,75247 € in 2008 and 111,85216 € in 2009. Consequently, the actual amount of audit
fees decreased in the second year of the period during the financial crisis. This can be
signaled as an indicator for the results of the statistical regression analysis testing the
impacts of the financial crisis on auditors’ conservatism.
Overall, the majority of the other variables are slightly decreased, demonstrating the
general influence of the crisis on the financial prosperity of the sampling firms.
The variables are calculated using data from the financial statements of the tested firms.
Descriptive statistics for the corresponding data used are provided in Table B in the
APENDIX part.
7.2.2 Pearson’s correlation testing
Two Pearson correlation tests were conducted for the two investigated years
respectively. The matrix of the first test is presented in the next page.
76
Table 9a: Pearson’s Correlation test for the year 2008
LAF
LAF
Pearson
CSV
SIZE
QR
LEV
INVREC
ROI
1
Sig. (2-tailed)
N
CSV
41
Pearson
.
Sig. (2-tailed)
.
N
SIZE
Pearson
Sig. (2-tailed)
N
QR
-,232
-,299*
,144
,033
41
51
51
Pearson
,096
,076
-,225
Sig. (2-tailed)
,550
,598
,113
41
51
51
51
Pearson
,049
-,215
-,005
-,003
Sig. (2-tailed)
,763
,129
,972
,981
41
51
51
51
51
Pearson
,220
,078
,005
-,047
,272
Sig. (2-tailed)
,179
,594
,975
,749
,058
39
49
49
49
49
Pearson
N
N
ROI
,000
51
N
INVREC
1
41
Sig. (2-tailed)
LEV
,747**
N
1
1
1
1
49
a. Because at least one of the variables is constant, this cannot be computed.
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).
Overall, the table provides evidence of insignificant correlation between the examined
variables. A strong positive correlation exists as expected, between the dependent
variable LAF and the independent variable SIZE, valued at +0,747 and significant to the
0.01 significance level (2-tailed). This is consistent with the findings of prior research,
which has shown that the size of the firm is the most important determinant of the
amount of the audit fees (Simunic; 1980, Hay, Knechel & Wong; 2006, Cobbin; 2002,
Owusu-Ansah, Leventis & Caramanis; 2010).
77
The second strong correlation found is a negative one, between two independent
variables, the QR (Quick Ratio) variable and the SIZE variable, amounted to -0,299, which is
significant in the 0.01 01 significance level (2-tailed). No other significant correlation
between the variables was discovered.
According to these findings, there is no strong correlation between the variables of the
model, consequently its explanatory power is considered as adequate in providing
scientific evidence. Similar results correspond to the Pearson correlation test conducted
for the year 2009.
Table 9b: Pearson’s Correlation test for the year 2009
LAF
LAF
Pearson
CSV
SIZE
QR
LEV
INVREC
ROI
1
Sig. (2-tailed)
N
CSV
Pearson
1
Sig. (2-tailed)
N
SIZE
Pearson
Sig. (2-tailed)
N
QR
-,191
-,275
,210
,051
45
51
51
Pearson
,193
,053
-,221
Sig. (2-tailed)
,203
,711
,120
45
51
51
51
Pearson
,000
-,277*
-,103
,005
Sig. (2-tailed)
,997
,049
,471
,975
45
51
51
51
51
-,070
,134
,166
-,254
,087
,647
,349
,246
,072
,542
45
51
51
51
51
Pearson
N
N
ROI
,000
51
N
INVREC
1
45
Sig. (2-tailed)
LEV
,633**
Pearson
Sig. (2-tailed)
N
1
1
1
1
51
a. a. Because at least one of the variables is constant, this cannot be computed.
78
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).
Table 9b demonstrates no significant correlation between the examined variables,
able to jeopardize the explanatory power of the model used. A positive correlation exists
between the dependent LAF variable and the independent SIZE variable amounted to
+0,633, which is significant in the 0.01 level (2-tailed). An important negative correlation is
observed in 2009 between the dependent variables INVREC and SIZE that equals to -0,277.
Consequently, it is proved that no strong correlation exists between the variables of the
model and its explanatory power is considered as adequate in generating robust results.
In addition, the APENDIX section provides the Pearson correlation test for the pooled
regression analysis of the years 2008 and 2009 together. Since Model 3 will be analyzed
only by the linear regression analyses of the years, no further comments on the Pearson
correlation test for the pooled regression is considered necessary. The next part of the
chapter consists of the coefficient results and analysis from the empirical testing.
7.2.3 Coefficients’ analysis - Results investigation
Table 10 contains the coefficient results generated by the linear regression of Model 3
by the E-views computer program concerning the first year of the crisis.
Table 10: Results of the linear regression analysis for the year 2008
Dependent Variable: LAF (Natural log of audit fees)
Method: Least Squares
Sample (adjusted): 51
LAF=b1*CSV+b2*SIZE+b3*QR+b4*LEV+b5*INVREC+b6*ROI (no constant term)
Coefficient
Std. Error
t-Statistic
Prob.
b1 (conservatism dummy-CSV)
b2 (auditee’s size-SIZE)
b3 (quick ratio-QR)
b4 (debt/equity ratio-LEV)
b5 (inv+rec/total assets-INVREC)
b6 (return on investment-ROI)
-3.034780*
0.923337*
0.072869
0.127765
0.400920***
-0.179190
0.608940
0.150616
0.190935
0.127768
0.212388
0.812039
-4.983710
6.130414
0.381643
0.999971
1.887673
-0.220666
0.0000
0.0000
0.7052
0.3246
0.0679
0.8267
Model Summary
R-squared
Adjusted R-squared
S.E. of Regression
0.573765
0.509184
0.590000
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
79
According to these findings, the Model 3 is now formulated as:
LAFit = b0 -3,035 CSVit + 0,932 SIZEit +0,073 QRit + 0,127 LEVit + 0,4 INVRECit
-0,179 ROIit
Inconsistent with the expectations, the dependent variable LAF is found negatively
related with the audit conservatism level. CSV is a dummy variable, taking the value 0
since 2008 was hypothesized as a year of increased audit conservatism. Precisely, the
coefficient b1 = -3,035 that measures the effect of conservatism on the audit fees, is
negative and significant in the 0.01 level (2-tailed).
Hypothesis 2 stated that increased audit conservatism would result in increased audit
fees due to the increased audit efforts, a claim that is rejected by the results of the
empirical investigation. At this point, it is worth to signal however, that auditors’
conservatism was found decreased in the years during the financial crisis, rejecting
Hypothesis 1 needed to investigate Hypothesis 2.
The evidence arising from this empirical analysis and the actual audit fee amounts reveal a
price competition trend in the audit sector, starting from 2008, the first year of the
financial crisis. This fact is additionally consistent with the rejection of Hypothesis 1, since
evidence proved that auditors were less conservatism during the crisis years than in the
years before the crisis. Decreased conservatism is related lower audit effort and
consequently with lower audit fees. This argument is consistent with the lower quality
audits found by the research of the Netherlands Authority for Financial Markets in 2009,
regarding statutory audits conducted in 2008.
Furthermore, the findings of this regression analysis are inconsistent with the results of
the study of Gul et al. (2003) concerning the impact of the Asian financial crisis of 19961997, which has shown increased audit fees during the crisis years. However, the findings
of this research also showed increased use of auditors’ conservatism, a fact that was not
verified from the statistical tests of this research. The different results of this research and
the afore-mentioned one can be attributed to a large number of factors though. It is
undoubted that the magnitude of the consequences of the global crisis is more prevalent
and severe compared to the precedent Asian one. In the 12 years that have intervened,
highly significant developments of the audit profession have taken place along with the
establishment of new structured financial instruments generated to finance investments
that are much more complicated to audit. Additionally, the Dutch accounting system is
80
less flexible as far as the adjustment in new environmental circumstances is concerned,
since it is specified by code law legislation.
Another strong relation was found between the SIZE variable and LAF. The coefficient of
the SIZE variable, b2, amounts to +0,923. This value is significant in the 0.01 level (2-tailed).
Indeed, prior research has shown that the size of the audited firm is probably the most
significant determinant if the audit fees, related with litigation risk, the “big pocket”
theory, audit hours and complexity of the financial audits (Simunic; 1980, Hay, Knechel &
Wong; 2006, Cobbin; 2002, Owusu-Ansah, Leventis & Caramanis; 2010).
The third important relationship discovered was the one between LAF and the dependent
variable INVREC. The corresponding coefficient b5 is again positive and equal to +0,4 that is
significant in the 0.1 level (2-tailed).
The analysis of the coefficients of the variables used in the model, concerning 2009 is
provided at this point, in order to establish the results of 2008.
Table 11: Results of the linear regression analysis for the year 2009
Dependent Variable: LAF (Natural log of audit fees)
Method: Least Squares
Sample (adjusted): 51
LAF=b1*CSV+b2*SIZE+b3*QR+b4*LEV+b5*INVREC+b6*ROI (no constant term)
Coefficient
Std. Error
t-Statistic
Prob.
b1 (conservatism dummy-CSV)
b2 (auditee’s size-SIZE)
b3 (quick ratio-QR)
b4 (debt/equity ratio-LEV)
b5 (inv+rec/total assets-INVREC)
B6 (return on investment-ROI)
-2.424243*
0.697685*
0.081575
0.129521
0.623401***
-0.506234
0.570076
0.130387
0.104271
0.121506
0.367060
1.008620
-4.252494
5.350888
0.782333
1.065959
1.698365
-0.501907
0.0001
0.0000
0.4387
0.2930
0.0974
0.6186
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
0.459104
0.389759
0.642270
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
81
According to the presented findings, Model 3 is now formulated as:
LAFit = b0 -2,424 CSVit + 0,697 SIZEit +0,082 QRit + 0,130 LEVit + 0,623 INVRECit
-0,506 ROIit
The results of 2009 are found similar to the ones of 2008. More specifically, a negative
relation was proved concerning audit conservatism and the audit fees. The coefficient b1 =
-2,424 that measures the effect of conservatism on the audit fees, is negative and
significant in the 0.01 level (2-tailed). It is reduced compared to the 2008 value of -3,035,
indicating a less negative relationship between the dependent and the independent
variable in 2009. These results are found to be consistent with the findings of the prior
research concerning the audit fees, which are commented in the previous analysis and in
chapter 4.
The second strong relationship discovered was found between the SIZE variable and
LAF. The coefficient b2 of the SIZE variable is equal to +0,697, which is significant in the
0.01 level (2-tailed). Compared to the year 2008, the coefficient b2 has decreased, but in
an insignificant degree.
In addition, the INVREC variable is positively associated with the dependent LAF
variable. Its coefficient b5 is equal to +0,623 that is significant in the 0.10 level (2-tailed). In
comparison with 2008, the coefficient of the INVREC variable has decreased, again though
in an insignificant level.
The coefficients of the variables of Model 3 are slightly increased in 2008, compared to
the ones in 2009, except for the INVREC coefficient, which reduced in a minor scale.
Combining the coefficient results with the average of the audit fee amounts demonstrated
in the descriptive statistics table, it is argued that the amount of audit fees has decreased
during the second year of the crisis. It is also argued that the decreased amount of audit
fees relates to the media scrutiny and public criticism generated by the many bankruptcies
of banks that had previously received an unqualified audit opinion.
Overall, the two Hypotheses developed in this scientific research are rejected. Increased
audit conservatism is indeed associated with higher audit fees; however, this was not the
case concerning the investigated Dutch firms audited by the Big Four audit firms. Dutch
auditors’ are found to be less conservative during the financial crisis period, and the Dutch
audit fees are found to support negative tendencies through the years of the financial
crisis instead of positive ones, as hypothesized.
82
Since the auditing profession is an evolving organism that should adjust to the
environmental changes, it can be argued that the financial crisis per se has been partly
involved with the lower amount of audit fees. Furthermore, the small investigated period
examined concerning the two first years of the financial downturn can comprise a bias in
the procedure of the research and the interpretation of its results. However the rejection
of Hypothesis 1 & and Hypothesis 2 is in accordance with the results of the research
conducted by the Netherlands Authority for Financial Markets, which became available to
the public in September 2010. The findings showed that Dutch Big Firm auditors were
involved with low quality statutory audits during the financial crisis, specifically in 2008. It
seems as if the auditors are currently more concerned with the commercial part of their
profession resulting in lower and more competitive fees charged by using decreased levels
of professional conservatism, which could lead to the inevitable sacrifice of the quality of
their audit tasks.
In association with the Agency Theory, the results of this research can be attributed to
the incentive contracts of both the managers and the auditors. In such negative financial
circumstances as the current ones, managers are likely to support aggressive reporting
practices to manipulate the firm’s financial statements in a more favorable and profitable
way, motivated by self-interests. Auditors are additionally found weak and in fact,
unwilling to prevent such opportunistic behavior as shown by the lower amounts of audit
conservatism and audit fees charged. Furthermore, it is argued that the independent
auditing profession in The Netherlands is going through a price competition phase, as
shown by the lower amounts of fees charged and the findings of the Authority of Financial
Markets concerning lower quality audits completed by the Big Four Auditors.
The analysis of the empirical investigation of the variables of this research has reached
its end at this point. Additionally, a pooled regression analysis was also conducted in order
to test the impacts of the current crisis in the audit fees, concerning the years 2008-2009,
as a complementary statistical research. Since the R squared of the regression is very low,
the interpretation of such a pooled analysis could be problematic. This in addition, is
attributed to the fact that the examined period of 2008-2009, which is during the current
financial crisis, cannot be compared with another period due to lack of data.
Consequently, the results of the pooled regression analysis cannot be considered
83
scientifically robust and will not be commented. Table C in the APENDIX section contains
the results of this pooled regression analysis.
7.3 Summary
This chapter was dedicated to the empirical investigation and analysis of the developed
Hypotheses, concerning the impacts of the current financial crisis on auditors’ use
conservatism and the audit fees. The two developed statistical models were regressed, in
order to demonstrate robust scientific results concerning the hypothesized claims. In order
to provide more thorough analysis of the examined sample and to analyze the explanatory
power of the statistical models used to determine the relationships between the
dependent and the independent variables, descriptive statistics and Pearson correlation
tests were conducted and presented.
Descriptive statistics and Pearson correlation tests were conducted and presented
Model 2 tested the effect of the crisis on auditors’ level of professional conservatism. The
testing was conducted by a pooled regression analysis between the periods of 2005-2006
and 2008-2009, prior to and during the emergence of the current crisis. The outcome of
this analysis contradicted Hypothesis 1, by providing evidence of increased conservatism
in the period 2005-2006. It was expected on the contrary, that auditors make use of
increased conservatism during the financial crisis period of 2008-2009.
Concerning Hypothesis 2, Model 3 was tested in order to determine the effect of the
crisis on the audit fees. Because of the increased levels of conservatism that were
hypothesized, audit fees were expected to show increased amounts. Evidence generated
by the coefficient results and analysis, signaled a negative relation of the auditors’
conservatism and audit fees, rejecting hypothesis 2.
A reasoning concerning the produced results was also demonstrated, in order to explain
the rejected Hypotheses and the findings of the empirical research. A brief reference to
the causes of these results along with a presentation of the limitations of the research and
subjects arising for further research is provided in the subsequent concluding chapter.
84
CHAPTER 8 – Conclusion, Limitations, and Further research suggestions
8.1 Conclusion
The goal of this research was to investigate potential differences in auditors’
conservatism and audit fees in The Netherlands, attributed to the current global financial
crisis that emerged in 2008. The results of the empirical investigation of the tested
variables found that Dutch auditors are found to be less conservative while performing
their professional tasks during the financial crisis period between the years 2008 and 2009
in comparison with the period between the years 2005 and 2006, prior to the crisis’ boost.
In addition, lower amounts of audit fees were charged in 2009 compared to the ones
charged in 2008. This indicates that the external auditing profession in The Netherlands is
experiencing nowadays a turbulent phase, emerging from price competition practices and
lower quality audits. The research provides evidence regarded to the Big Four audit firms,
as the tested sample concerning 51 Dutch stock exchange quoted firms was audited
exclusively by the Big Four audit firms.
8.2 Limitations
This research had faced certain limitations that can partly affect its findings, as every
scientific study conducted. First, the sample was limited to 51 firms. The rest of the
scientific studies investigating audit conservatism and audit fees in crisis periods were
using samples of hundreds or even thousands of firms, as shown in the prior research part.
Additionally, lack of data regarding the audit fees in the years prior to the crisis has limited
the investigation of the audit fee development between the years during the current
financial crisis. However, the overall validity of the research is considered as scientifically
adequate to produce robust results.
8.3 Further research suggestions
It is suggested that further research shall focus on the tendency of the audit
conservatism and audit fees, through a bigger period, concerning all the financial crisis
years. The association between audit quality and audit conservatism firstly, and audit
quality and audit fees secondly is likely to produce interesting findings regarding the
general scope of the external auditing profession. Additionally, in order to examine
accounting policies and discover relevant auditing weaknesses, the common or recently
85
introduced accounting and reporting practices used in the financial statements of the
firms during the current crisis period shall be investigated.
86
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91
APENDIX
Table A*
*The table was originally published in Sikka’s paper “Financial crisis and the silence of the
auditors” Accounting, Organizations and Society, pp.870.
92
Table B: Descriptive statistics concerning the elements of the financial statements used
for the formation of the variables, concerning Model 3
Years:
VARIABLES
Debt
Inventories
Current Assets
Current Liabilities
Common Equity
Book Value Per Share
Common Shares Out.
Income Bef.Ext. Items
Total assets 20082009
Audit Fees
Earnings Per Share
Return On Equity
Net Income
Total Receivables
2008,2009
MEAN
MEDIAN ST.DEV
MIN
MAX
2130,46
415,45
4642,29
0,00
24466,57
1017,68
141,35
3119,16
0,00
19132,18
3656,98
737,80 11196,98
5,00
83697,26
3123,61
539,34
9845,20
6,09
75769,82
4185,53
596,33 14104,14
12,53
95228,84
11,77
7,48
15,94
0,09
135,56
405,43
72,91
976,99
7,39
6157,37
557,01
55,55
2191,02 -1044,00
18016,92
27990,44
121,816
0,39
0,21
510,61
1763,16
1764,82 188835,27
1,995 757,81364
0,77
2,21
12,37
46,91
40,79
2145,32
316,18
6746,79
55,88 1893994,00
0,048
5.189,000
-9,43
4,63
-240,82
59,88
-1113,00
17881,47
0,66
55904,92
Table C: Results of the pooled regression testing concerning the investigation of the
audit fees in relation with the emergence of the financial crisis in the years 2008-2009
Dependent Variable: LAF
Method: Panel Least Squares
Periods included: 2
Cross-sections included: 49
LAF=b1*CSV+b2*SIZE+b3*QR+b4*LEV+b5*INVREC+b6*ROI (no constant term)
Coefficient
Std. Error
t-Statistic
Prob.
b1 (conservatism dummy-CSV)
b2 (auditee’s size-SIZE)
b3 (quick ratio-QR)
b4 (debt/equity ratio-LEV)
b5 (inv+rec/total assets-INVREC)
b6 (return on investment-ROI)
0.129445
0.121406
-0.160031***
-0.238801*
-0.061332
0.207141
0.435818
0.103419
0.090709
0.090662
0.168829
0.708222
0.297015
1.173919
-1.764222
-2.633954
-0.363279
0.292481
0.7672
0.2438
0.0814
0.01
0.7173
0.7706
Model Summary
R-squared
Adjusted R-squared
S.E. of regression
0.122648
0.069795
0.637069
*,**,*** indicate significance at 0.01, 0.05, 0.10 significance level
93
94