The impact of audit quality on earnings management and cost of equity capital: evidence from a developing market

Abstract

Purpose This study aims to examine the effects of audit quality on earnings management and cost of equity capital (COE) considering the impact of two owner types: government ownership and foreign ownership. Design/methodology/approach The study uses a panel data set of 236 Vietnamese firms covering the period 2007 to 2017. Because the two main dependent variables of the COE capital and the absolute value of discretionary accruals receive fractional values between zero and one, the paper uses the generalised linear model (GLM) with a logit link and the binomial family in regression analyses. The paper uses numerous audit quality measures, including hiring Big 4 auditors or the industry-leading Big 4 auditor, changing from non-Big 4 auditors to Big 4 auditors or the industry-leading Big 4 auditor, and the length of Big 4 auditor tenure. Big 4 companies include KPMG, Deloitte, EY and PwC, whereas the non-big 4 are the other audit companies. Findings The study finds a negative relationship between audit quality and both the COE capital and income-increasing discretionary accruals. The effects of audit quality on discretionary accruals and the COE capital depend on the ownership levels of two important shareholders: the government and foreign investors. Foreign ownership is negatively associated with discretionary accruals; however, the effect is more pronounced in the sub-sample of state-owned enterprises (SOEs), the firms where the government owns 50% or more equity, than in the sub-sample of Non-SOEs. Originality/value To the best of the knowledge, no prior similar study exists that used the GLM with a logit link and the binomial family regression. Global investors may be interested in understanding how unique institutional settings and capital markets of each country impact the financial reporting quality and cost of capital. Further, policymakers of developing markets may have incentives to improve the quality of financial reporting and reduce the cost of capital which should result in attracting more foreign investments.

Earnings management, market liquidity and capital access of seasoned equity firms in a transition economy

“…Smaller SEO firms and those with higher sales growth rates (GROWTH) or poorer performance (lower Transition economy Transition economy cash flows from operations) have higher DACCs. Hiring a Big Four auditor does not reduce SEO firms' DACCs, which is inconsistent with Le and Moore's (2023) finding that a significantly negative relationship between hiring a Big Four auditor and EM exists. This inconsistency is due to the different regression methods used in the two studies; we use OLS regression, whereas they use the generalised linear model with a logit link and binomial family regression.…”

“…non-Vietnamese citizens or firms) at the year-end and LOG(SALES) is the natural logarithm of total sales. Following Ding et al (2007) and Le and Moore (2023), we use log(sales) as a proxy for firm size. Dang et al (2018) compare different size measures used in literature and conclude that each measure has its own benefits and that a firm’s sales represent product market competition and are highly correlated with assets [log(sales) and log(assets) have a correlation coefficient of 0.92].…”

“…As a robustness test, we examine the impact of market liquidity on EM for SOCs and non-SOCs separately. As SOCs receive financial support from the government and have greater capital access from state-owned commercial banks, they have a lower incentive to manipulate earnings (Cheng et al , 2015; Le and Moore, 2023). Jiang et al (2020) find that Chinese firms with multiple blockholders have higher EM than firms with a single controlling shareholder.…”

“…Vietnam is a transitional economy with low financial reporting disclosure standards (Blenman and Le, 2014), low market efficiency (Gupta et al , 2014) and limited alternative sources of external capital (Le, 2019). Ownership structure and capital access are unique in Vietnam, where the government and foreign investors are key market participants (Le and Moore, 2023, 2022). Firms with high government or foreign ownership have easier access to capital, and therefore, lower motivation to manage earnings.…”

Working Capital Management and Stock Performance: Evidence from an Emerging Market

“…However, while Big 4 auditors have direct relationships with audit firms in Vietnam, they need local affiliated agencies in Bangladesh. Further, Big 4 auditors can reduce earnings management in Vietnam (Le and Moore (2021). Big 4 affiliates do not have an impact on curbing earnings management in Bangladesh ( Kabir, Sharma, Islam and Salat (2011).…”