Auditor characteristics and the financial reporting quality: the moderating role of the client business strategy

Abstract

PurposeThis study examines whether and how a client's business strategy can affect the relationship between auditor characteristics and financial reporting quality.Design/methodology/approachIn this study, auditor industry specialization and tenure were used as proxies for auditor characteristics. The client business strategy was measured using the resource allocation index method. Finally, discretionary accruals are used to assess financial reporting quality. This study includes 1,450 firm-year observations and 145 companies listed on the Tehran Stock Exchange (TSE) over a ten-year period from 2011 to 2020. The research hypotheses were analyzed using a multivariate regression model and panel data.FindingsThe results show that auditor industry specialization increases financial reporting quality. This relationship improves when the client's business strategy deviates from the industry–normal strategy. The research findings state that auditor tenure has a positive association with financial reporting quality, and this relationship is strengthened when the company's business strategy deviates from the normal industry strategy.Practical implicationsThe findings of this study provide important evidence for investors, firm management, and auditing firms. Investors must consider the auditor characteristics when selecting companies listed on the TSE. Managers of Iranian companies are advised to consider the auditor's characteristics when choosing an audit firm to increase financial reporting quality. Audit firms should evaluate their business strategies in audit planning to increase the quality of financial reporting.Originality/valueTo the best of the authors’ knowledge, this is the first empirical study to examine the relationship between auditor characteristics and the financial reporting quality in the emerging capital market by considering the clients' business strategy.

Organization capital and modified audit opinion

“…, 2011; Chen et al. , 2005; Liao and Radhakrishnan, 2016; Rusmin, 2010; Soroushyar, 2023). In contrast, prior literature (Bradshaw et al.…”

“…The independent variable A AC j i;t is the level of the estimated discretionary accruals of firm i classified in industry j in year t. The level of the discretionary accruals (A AC j i;t ) is estimated using the cross-sectional modified Jones model (Charitou et al, 2007). The ability to reduce the magnitude of the discretionary accruals and the intensity of accrual earnings management has been used in literature as a measure of the first dimension of audit quality, which is an auditor's technical ability to detect a misstatement in a firm's financial statements (Alareeni, 2019;Chen et al, 2011;Chen et al, 2005;Liao and Radhakrishnan, 2016;Rusmin, 2010;Soroushyar, 2023). In contrast, prior literature (Bradshaw et al, 2001;Butler et al, 2004) also provides evidence that auditors are less likely to issue modified opinions for earningsmanagement reasons.…”

The Effect of the Characteristics of the Audit Firm and Client on the Application of the Business Risk Audit Approach

“…Specialized firms may also have access to specialized tools and resources, allowing them to gather and analyze relevant data more efficiently (Ebenezer et al, 2023). On the other hand, audit firms lacking specialization in a certain area may struggle to identify all potential risks for their clients, resulting in an incomplete or inadequate assessment (Afsaneh, 2022). Therefore, businesses should carefully consider the specialization of their chosen audit firm when implementing the business risk audit approach (Johannes, 2022).…”

“…This increases the level of business risk and requires the auditor to apply a more thorough approach to obtain sufficient evidence and provide an accurate opinion on the financial statements. Therefore, both auditors and clients need to recognize the importance of strong internal control systems in mitigating business risk and ensuring a successful audit engagement (Afsaneh, 2022;Uday et al, 2022). The integration of information technology into audit processes is indeed an essential trend, as businesses increasingly rely on computer systems for their transactions.…”

Auditor industry specialization and cost of equity on earnings management: the moderating role of institutional ownership

“…Iranian SEO required the use of trusted auditors’ services. Under these regulations, the trusted auditing firms are evaluated annually to increase competition in the auditing market (Soroushyar, 2022). However, the regulatory changes have caused significant changes to the capital market and audit environment in Iran.…”