Does industry expertise at engagement partner and audit firm level matter in emerging market? Evidence from Indonesia

Abstract

This study investigates the association of industry specialization at the engagement partner level and audit firm level with aggressive earnings management and modified audit opinion. The study employs a sample of 570 firm-year observations of manufacturing industries on the Indonesia Stock Exchange from 2014 to 2018 using a binary logistic regression model. First, this study finds no evidence of a relationship between industry specialization at the engagement partner level and audit firm level with aggressive discretionary accruals. Furthermore, the author finds evidence of a positive association between industry specialization at the audit firm level and aggressive real earnings management due to high audit quality. Finally, the study finds evidence that industry specialization at audit firm level is likely to issue modified audit opinion. This study contributes to the study of industry specialization at the engagement partner level and audit firm level, which is rarely performed in Indonesia. Policy makers and capital market players might learn some lessons from the audit quality of external auditors with industry specialists as the gatekeeper of the capital market. Moreover, this study has provided a valuable perspective to practitioners, researchers, and policy makers in other emerging markets regarding the quality of industry specialization at the partner and audit firm level.

Audit Quality of The Engagement Partner and Audit Firm

“…For example, Iatridis (2012) discovered that, despite the fact that companies audited by the Big Four have a high audit quality, institutional differences between the two groups are significantly different in terms of earnings conservatism (as measured by discretionary accruals), cost of equity, and agency costs. This study, in particular, extends the lines of the audit quality studies conducted in Indonesia with regard to audit quality at the partner level (e.g., Setiawan & Fitriany, 2011;Herusetya & Jaunanda, 2021).…”

“…However, Herusetya and Jaunanda (2021) found no evidence of audit quality as assessed by industry specialization from audit partners on aggressive accrual-based earnings management (hereafter ABEM) and real activities manipulation (hereafter RAM) employing a sample of industrial companies in Indonesia. Rather than that, they discovered that audit firm with industry expertise has a positive effect on aggressive RAM.…”

“…Lennox and Wu (2018), for example, document a significant increase in audit quality studies done at the partner level in America and Europe following the release of mandated information disclosure requirements from partners. Simultaneously, studies on the audit quality of audit partners located outside the United States of America have been conducted in Taiwan (e.g., Chin & Chi, 2009;Chi & Chin, 2011;Abodia et al, 2015;Hsieh & Lin, 2016), China (Gul et al, 2017), Indonesia (Herusetya & Jaunanda, 2021), and Malaysia (Hussin et al, 2018). These researches revealed that audit quality is more reliable when measured at the audit engagement partner level than when measured at the audit firm level (Hsieh & Lin, 2016;Chi & Chin, 2011).…”

“…As long as the author's observations, the audit quality studies for engagement partners in Indonesia are still rare, except for Setiawan and Fitriany (2011) and Herusetya and Jaunanda (2021). On the other hand, the Indonesian government has issued Government Regulation Number 20 of 2015(hereafter PP No.…”

“…Rather than that, they discovered that audit firm with industry expertise has a positive effect on aggressive RAM. Additionally, Herusetya and Jaunanda (2021) discovered that industry expertise increases the frequency of generating modified audit opinions (MAO) at the firm level but not at the partner level. As a result, their findings differ from those obtained in Taiwan (Hsieh & Lin, 2016;Abodia et al, 2015).…”