Board Structure and Modified Audit Opinions: Evidence from the Portuguese Stock Exchange

Abstract

Prior research has found evidence that some characteristics of the board of directors influence the quality of financial reporting. In this study we extend the literature by analysing a different dimension of financial reporting quality, the probability of a firm receiving a modified audit opinion. To this end, we considered a sample of companies listed on Euronext Lisbon where, unlike the current situation in other markets such as the US, firms can publish financial statements not in accordance with GAAP. Using 171 firm-year observations for the period 2002-05, the evidence we report is consistent with the hypotheses that firms with more diligent and independent boards are less likely to receive a modified audit opinion. Results are robust to different specifications and also show that the existence of dividend payments, financial health, performance and growth opportunities are additional factors associated with the likelihood of a modified audit opinion. Our analysis also shows that the transition in 2005 to a reporting framework based on international accounting standards is strongly related with better financial reporting quality. SUMMARYThe board of directors has a potentially crucial role in ensuring the quality of companies' financial reporting practices. However, different board characteristics may affect the quality of the board's supervision of the financial reporting process. These may include the presence of non-executive directors, board size, the frequency of its meetings and the existence of CEO-Chairman duality, among other characteristics. Previous research has found that some of those characteristics have an important influence on the probability of financial statement fraud or the occurrence of earnings management practices. However, no research so far has focused on a particular dimension of financial reporting quality, the existence of modified audit opinions.

Corporate governance, accounting and finance: A review

“…The relationship does not appear to hold in France, where the size of the audit firm is independent of the client's level of earnings management, a result attributed to the lower litigation risk under the French Civil Code (Piot and Janin, 2007). Firms with higher reporting quality are more likely to be issued with a clean audit opinion, while evidence from Portugal suggests firms with more independent boards are less likely to receive a modified audit opinion (Farinha and Viana, 2009). Auditors make judgments on the amount of audit work required, based upon characteristics of the client.…”

Institutional Investors on Boards and Audit Committees and Their Effects on Financial Reporting Quality

“…3 The presence of a qualified audit opinion has been shown to be informative with respect to stock returns (Choi & Jeter, 1992) and bankruptcy events (Kennedy & Shaw, 1991). Bartov et al (2000), Butler et al (2004), Chen et al (2001), Farihna and Viana (2009), among others, use the audit opinion as a proxy for accounting quality.…”

“…The dependent variable (IA) is a dummy variable that equals 1 when the company receives a qualified audit opinion, and zero otherwise. Some other papers have used audit opinion as a proxy for financial reporting quality (Bartov et al, 2000;Butler et al, 2004;Chen et al, 2001;Farihna & Viana, 2009;García Blandón & Argilés Bosch, 2013;Pucheta-Martínez & de Fuentes, 2007).…”

“…Previous literature shows that big auditors provide higher quality services (Teoh & Wong, 1993) and that they are also better able to express a qualified opinion (Farihna & Viana, 2009;Lennox, 1999). Thus, we propose BIGFOUR as a dummy control variable that equals 1 if the opinion is issued by a Big Four audit firm, and zero otherwise.…”

“…However, accounting quality is a noisy theoretical construct that is operationalized using a range of measures, the validity of which is unknown relative to the theoretical constructs of interest (Suberi, Hsu, & Wyatt, 2012). 1 In line with Bartov, Gul, and Tsui (2000), Butler, Leone, and Willenborg (2004), Chen, Chen, and Su (2001), Farihna and Viana (2009), and Pucheta-Martínez and de Fuentes (2007), among others, we use the audit opinion as a proxy for accounting quality. According to Farihna and Viana (2009), whereas the audit opinion is observable, discretionary accruals (i.e., the proxy for earnings management generally used in the prior literature) are unobservable and must be estimated using models that can lead to wrong conclusions due to specification problems (Dechow, Richardson, & Tuna, 2003;Dechow, Sloan, & Sweeney, 1995;McNichols, 2000).…”