Authors: Georgios Simitsis, Maria Kyriakou

Title: Audit Quality and Corporate Governance in the UK context. Do Corporate Governance Structures Improve Audit Quality?

Abstract

Audit failures stimulated the debate on audit quality. As a consequence, the regime in the relevant market altered with a shift from self-regulation, to independent regulatory oversight. In the UK, the Financial Reporting Council (FRC) shaped promptly an “Audit Quality Framework” and assumed responsibility for market oversight. Audit market regulators are not confined to auditor monitoring. They also impose several corporate governance structures and describe thoroughly their duties. The aim of this study is to assess the implications of corporate governance structures on audit quality.

Audit quality can only be approximated by various metrics due to its subjective nature. Ongoing research suggested numerous metrics - DeFond and Zhang (2014) offer a comprehensive literature review on the subject. Most of the research work approximates audit quality based on models that incorporate the magnitude of accruals. Dechow (1994) suggests that the levels of discretion over the recognition of accruals can lead to earnings manipulation. This study employs the level of abnormal current accruals (Ashbaugh et al., 2003). Kothari et al. (2005) in a seminal paper suggest that discretionary accruals estimates are correlated with firm performance. We opted for the performance adjusted current accruals (PCA) metric to approximate audit quality (Gunny and Zhang, 2013).

An alternative way to approximate audit quality is indirectly, by auditor size. Big auditors have greater resources, level of professional expertise and worldwide presence. These characteristics add value to their audits (Lin and Liu, 2009, 2010). Hence, the selection of a big-4 auditor is considered to offer audits of a higher value.

Our focus is the UK market for the period 2010-2020, just after the regulatory changes briefly described above. We find that board size, as well as audit committee independence is positively related to audit quality. This argument is consistent with relevant research (Sarhan et al., 2019; Lin and Liu, 2009). Additionally, we suggest that a dominant CEO that chairs the board seems to have a negative impact on audit quality. The results are robust even when we apply the alternative methodology of auditor size. Our conclusions reinforce the arguments in favor of rigid corporate governance structures imposed from market regulators. This study contributes to a fruitful debate on audit quality and its’ determinants.