ournal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017) Journal Homepage: www.ifasra.com/jafep Publisher: www.ifasra.com
Examining the Modifying Effect of the Auditor Size and Non-audit Services on the Relationship between Firm Size and Earnings Management among the Tehran Stock Exchange Listed Companies 1
Seyedhossein Naslmosavi , Mohammad Nematoghli
2
Abstract The present study aims to investigate the modifying effect of the auditor size and non-audit services on the relationship between firm size and earnings management in the listed companies in Tehran Stock Exchange. Auditor size and non-audit services are taken as moderating variables, firm size as the independent variable and the profit management as the dependent variable. The study was designed based on the firms listed in the Tehran Stock Exchange during the years 2010 to 2013. Based on the systematic elimination, 79 companies were selected as sample. Industry, financial leverage and market value to book value were considered as control variables. The results showed that the size of the auditor had a significant impact on the relationship between firm size and earnings management. Non-audit services also had a significant impact on the relationship between firm size and earnings management of listed companies in Tehran Stock Exchange. Keywords: auditor size, non-audit services, firm size, earnings management.
1. Introduction The audit reduces the asymmetric information between managers and shareholders through the credit to the financial statements. Previous research demonstrated that larger audit institutions have higher audit quality and better control of their earnings management (DeAngelo, 1981; Arrunada, 1999). The researchers found that large audit firms under management cause adjustment of the profit, but large non-audit services have the opposite effect to these adjustments. Based on evidence which are less convincible, it seems that the smaller audit firms due to non-audit services have better ability to protect corporate profits. Generally, although non-audit services to large companies enhance the quality of financial reporting, it can be less responsive to customer pressure (Elifsen and Knivsfla, 2016). Studies have recognized the important dual effects of the non-audit services on the earnings quality. On the one hand, large non-audit services lead to an increase in economic bonds between auditors and clients (managers) which reduce the objectivity of the auditors (DeAngelo, 1981). On the other hand, non-audit services by auditors lead to the increase in the auditor's ability to detect errors in financial reports (Arrunada, 1999). For example, auditors by providing the non-audit services could have an understanding of the companies risk, internal systems and controls and achieve corporate tax perspective.
1
Assistant Professor, Department of Accounting, Islamic Azad University, Qaemshahr Branch, Qaemshahr, Iran. Email:
[email protected] 2 Department of Financial Management, Islamic Azad University, Ayatollah Amoli Branch, Amol, Iran.
Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
Furthermore, large non-audit services increase economic bonds between auditors and clients (principals). This detracts from the objectivity of the auditors (DeAngelo, 1981). On the contrary, nonaudit services by auditors would increase the auditor's ability to detect errors in financial reports (Arrunada, 1999). For example, auditors and non-audit services could risk an understanding of the company, internal systems and controls and achieve corporate tax perspective. The quality of audit firms affects the potential access to the benefits of non-audit services. Lim and Tan (2013) suggested that audit firms that are larger and have higher quality, such as the expert auditor has the most benefits of the non-audit services. However, Elifsen and Knivsfla (2016) found that small audit firms and non-expert auditors make use of providing audit services business. The size and expertise of non-audit services affects auditors. Larger companies are more likely to commit the earning management (di Donato and Fiori, 2012; Llukani, 2013). The earnings quality is related to various aspects of audit firms, especially the audit firm (Francis, 2011). For example, studies about the supply of equity shows that large audit firms reduce earnings management (Zhou and Elder, 2004). In addition, a fee for non-audit services negatively affects earnings quality (Schneider et al., 2006). Providing non-audit services by auditors to audit independence for auditors can be harmful and beneficial at the same time (Lim and Tan, 2013). According to the different findings from different studies as mentioned above, the present study tries to examine the modifying effect of the auditor size and non-audit services on the relationship between firm size and earnings management among the listed companies on Tehran Stock Exchange.
2. Methodology 3. Research Hypotheses
The auditor size significantly affects the relationship between firm size and earning management of the listed companies in Tehran Stock Exchange The non-audit services significantly affects the relationship between firm size and earning management of the listed companies in Tehran Stock Exchange
3.1 Population of the study Since the scope of the investigation was since the beginning of 2010 until the end of 2013, so a total of 79 companies were selected by the systematic sampling. For this purpose, those companies were selected which: 1. had not changed their activities from 2010 to 2013 2. had fiscal year end at the end of December and had not changed it 3. did not participate in group investment companies or financial intermediation such as insurance company and bank 4. were listed in the Stock Exchange prior to 2010 5. had stocks under transaction during the investigation period 6. had required information on the stock exchange By applying all these limitations, a total of 79 companies were selected as the sample of the study.
4. Definition of key terms 4.1 Auditor size It is a two dimensional variable that gets number 1 in case of selecting the Audit Office as the great auditor and zero in case of selecting other auditing institutions (Mahdavi et al., 2011).
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Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
4.2 Non-audit services Because diverse non-audit services are provided by the audit firms to the employers, thus 10 nonaudit services whose provision may have an impact on the auditor independence were identified. These non-audit services are as follows: (1) Correction of account, (2) design and implementation of information systems, (3) insurance consulting services, (4) internal audit services, (5) legal advice, (6) a management services, (7 ) product analysis and marketing, (8) managers, (9) tax advice (10) tax audit. If at least one of the above services is carried out by the Institute for a firm, a value of 1 is considered otherwise a zero value is taken into account.
4.3 Firm Size The natural logarithm of the book value of total assets of the firm has been employed in this study.
4.4 Earning Management The modified Jones model was used in this study for the measurement of earnings management, because this model was able to solve the problem of research. This model is as follows:
:Total accruals (profit before extraordinary items minus operating cash flow) in year t for the study of i :Total assets at year t-1 to participate in the study i :Changes in income during the year t-1 to t to participate in the study i :Changes in accounts and notes receivable for the years t-1 to t i study :The gross amount of property, plant and equipment for the study in year t i Then the estimated coefficients was obtained from the regression of the company under study to estimate the amount of accruals management for each sample by subtracting the unmanaged accruals from the sum of accruals as follows:
:Management components of accruals under the company i in year t is equal to the sum of discretionary accruals
4.5 Industry Type 37
Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
Based on the classification of the Tehran Stock Exchange
4.6 Financial Leverage Ratio of total debt to total assets
4.7 Market value to book value The ratio of market value to book value of equity
4.8 Research regression model
Regression model of the first hypothesis
Regression model of the second hypothesis
:earning management :firm size :non-audit services :type of industry :leverage
4.9 Data analysis Data analysis with respect to this research, variables, hypotheses and methodology is done using Eviews 7 software to test hypotheses and meaningful relationships between variables and EXCEL is used for calculations. Jarek test to verify the normality of variables - was whether to use. In this study, the significance of the regression analysis including significant test of the regression coefficients will be a significant test. Also, hypotheses are tested using regression model included heterogeneity of variance test, F test Limer and Haussmann test.
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Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
4.10
Results
Analysis of variance changes ARCH LM is used for testing the variance change in the present study. ARCH LM test results of variance changes are as follows:
Table 1: ARCH LM test of variance changes
Sig.
F value
description
0.086
0.645217
F-statistic
0.086
1.918411
Obs*R-squared
P-value of 5%
Considering table 1, F statistics is not significant at 5 % p value. Thus the assumption of variance homogeneity is approved and variance change is rejected. Testing the significance of the fixed effects model Table 2: F-Limer test and Haussmann p-value *0.008 *0.015
df 78 78
p-value *0.006
df 32
F-Limer F value 1.514785 162.175112 Haussmann F value 5.748623
description Cross-section F Cross-section Chi-square description Cross-section F
* 5% p-value Since based on regression and F-Limer and Haussmann test, the p value was less than 5, so the
Levin and Lin method Test 3: Collective unit root test on the variables and Levin and Lin method Variables
Value
p-value
As auditor
4.157
*0.0152
Non-audit services
3.369
*0.0230
size of the company
-5.521
*0.0012
Earnings management
-7.748
*0.0018
Financial Leverage
6.001
*0.0023
Market value to book value
-4.487
*0.0310
Industry Type
5.154
*0.0014
* p-value of less than 5% According to Table 3, examining the values calculated and probability of their acceptance, it is shown that the null hypothesis is rejected for all the volatility of the variables and all variables are at stable level.
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Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
First Hypothesis Table 4: Regression of research variables Effect
Error of
coefficient
estimation
Fixed
0.354
Auditor size
Variable
t statistics
Sig.
0.142
2.492
*0.047
-0.448
0.114
-3.929
*0.024
size of the company
-1.625
0.369
-4.403
*0.019
Auditor Size * Size Enterprises
-1.035
0.324
-3.194
*0.026
Financial Leverage
0.441
0.432
1.023
0.075
Market value to book value
0.694
0.559
1.241
0.069
Industry type
0.241
0.062
3.887
*0.025
Table 5: Significance of the research model ANOVA
R
Durbin-
Sig.
F
Watson
Modified coefficient
**0.000
74.241
1.996
0.421
Determination coefficient 0.433
**error level of 1% According to Table 4, since the Durbin-Watson test statistic is at a distance of 1.5 to 2.5 the correlation between errors and regression is rejected. Given the significance of the test F (74.241) at the level of error smaller than 0.01, it can be concluded that the research regression model consisting of independent variables and the dependent control, a good model and a set of independent variables and the dependent variable and can explain the control variable. The coefficient of determination is 0.421, indicating that 42.1 percent of the total variation of the dependent variable, dependent to independent and control variables in the model. Variable impact factor of the auditor on the relationship between firm size and management is- 1.035 which reflects the negative impact of the auditor on the relationship between firm size and profit management. However, given the significant level of variable size t-auditor relationship between firm size and earnings management (0.026), the lower the level of 5 percent to 95 percent rejected H0 hypothesis can be stated the size of the auditor has a significant impact on the relationship between firm size and earnings management of listed companies in Tehran Stock Exchange. The research model is as follows:
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Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
Testing the second hypothesis H0: The non-audit services significantly has no effect on the relationship between firm size and earning management of the listed companies in Tehran Stock Exchange H1: The non-audit services significantly affect the relationship between firm size and earning management of the listed companies in Tehran Stock Exchange.
Table 6: Regression of research variables
Effect coefficient
Error of estimation
t statistics
Sig.
Fixed
0.558
0.147
3.795
*0.029
Auditor size
0.369
0.096
3.843
*0.022
size of the company
-1.548
0.336
-4.607
*0.012
Auditor Size * Size Enterprises
1.005
0.327
3.073
*0.037
Financial Leverage
0.547
0.532
1.028
0.086
Market value to book value
0.336
0.331
1.015
0.087
Industry type *error of less than 5 %
0.627
0.112
5.598
*0.006
Variable
Table 7: Model significance
R Determination coefficient 0.555 **error level of 1 %
Modified coefficient
DurbinWatson
0.542
2.013
ANOVA Determination Modified coefficient coefficient 75.148 **0.000
According to Table 4, since the Durbin-Watson test statistic is at a distance of 1.5 to 2.5 the correlation between errors and regression is rejected. Given the significance of the test F (75.148) at the level of error smaller than 0.01, it can be concluded that the research regression model consisting of independent variables and the dependent control, a good model and a set of independent variables and the dependent variable and can explain the control variable. The coefficient of determination is 0.421, indicating that 42.1 percent of the total variation of the dependent variable, dependent to independent and control variables in the model. Variable impact factor of the auditor on the relationship between firm size and management is- 1.035 which reflects the negative impact of the auditor on the relationship between firm size and profit management. However, given the significant level of variable 41
Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
size t-auditor relationship between firm size and earnings management (0.026), the lower the level of 5 percent to 95 percent rejected H0 hypothesis can be stated the non-audit services have a significant impact on the relationship between firm size and earnings management of listed companies in Tehran Stock Exchange. The research model is as follows:
5. Conclusion The results showed that the size of the auditor had a significant impact on the relationship between firm size and earnings management of listed companies in Tehran Stock Exchange. Non-audit services also had a significant impact on the relationship between firm size and earnings management of listed companies in Tehran Stock Exchange. Following suggestions are made based on the results: It is suggested to the shareholders, potential investors and other interest groups in their decision about the possibility of profit in the company's management to consider the size of the company and its auditors to consider in their decisions. It is suggested to the shareholders, potential investors and other interest groups take the non-audit services in the companies where they want to invest serious and thereby reduce their investment risk. The Board of Directors of the Company is recommended to pay attention to the issue of the size of audit firms and non-audit services that management is willing to pay it because the size of audit firms and non-audit fees for the service can be strongly affected by the probability of being manipulated by the firm management.
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Journal of Applied Finance and Economic Policy Vol. 1 No. 1 (OCT, 2017)
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