Audit quality, joint or single audit regimes: An empirical study of the consequence of Joint

audit abandonment in Denmark

Zahra Shahrokhshahi

Dr. Josep Garcia Blandon

May 2019

Joint audit

Joint audit associates with audit task accomplished by two separated auditors in which both of them are responsible for the final report

In Denmark:

Obligatory joint audit regulation in Denmark was abandon in 2005 because of,

1. Lack of evidence for higher audit quality in joint audit regime

2. commonly accepted higher audit fees in joint audit regime

In Europe:

Green Paper of European Community (European Commission, 2010) propose joint audit to improve audit market in Europe

The current legislation persuade firms to apply voluntary joint audit by extension of audit rotation period from 10 to 24 years (European Commission, 31 May, 2016)

Hypothesis development 1. Does Joint audit affect audit quality? Theoretical evidences

Joint audit potentially could affect two components of independence and competence of audit quality

Auditor competence:

Pros,

1. Four eyes expected to have more detecting ability than two eyes

2. During auditor rotation, the remained auditor will keep the gained knowledge and expertise in the company

3. In joint audit, both auditors attempt to control each other to protect their reputation

Cons,

1. When two auditors co-audit several companies, their extensive knowledge of each other result in cross review procedures and diminish their scrutiny

2. Auditors have potential to prevent the exchange of adequate information with their co-auditor to preserve their competitive capability

Hypothesis development 2. Does Joint audit affect audit quality? Theoretical evidences

Auditor independence:

Pros,

1. Joint audit distributes audit fee between co-auditors

2. Two independent auditors are more difficult to be bribed by the client

Cons,

1. Competition between the two audit parties motivate them to please the client to achieve higher share of the work by opinion sopping

Any other issue?

• Free rider problem decrease auditor’s effort and audit quality

• However, perhaps individual auditor in a co-working environment is aware of the free rider problem and increase her/his effort

Hypothesis development Does Joint audit affect audit quality? Theoretical evidences

• The scarce empirical studies suggest no difference in audit quality as a consequence of joint audit

1. No shift in accrual based audit quality of Danish companies during 2002-2010 (Lesage et al. 2017)

2. Joint audit in Danish public firms dose not provide better accrual based audit quality, studying post regulation change (Holm, Thinggaard, 2018)

3. Comparison of audit quality between France with mandatory joint audit regime, and UK and Italy with single audit regime represent no change in accrual based measures (Andre et al. 2016)

4. Comparison between joint audit regime in France with single audit in 350 S&P European companies, no accrual based difference in audit quality observed. Although joint audited firms show higher audit quality based on measure of meeting market target (Blandon et al.2018)

Hypothesis

There is no difference between audit quality of mandatory joint audit and single audit regimes

What needs to be improved?

Main concerns about previous studies:

1. The comparison between two or more countries may suffer from differences in regulations and audit environment

2. The comparison in one country but between two different periods of time perhaps is subject to omitted variable issue

3. Audit quality measure mostly limited to accrual based substitutes

The current research:

Applying Dif-in-Dif methodology based on Danish change of audit regulation in 2005

1. Provide the chance to compare two audit regimes in the same country

2. Dispel the endogeneity problem (omitted variable issues and Simultaneity)

3. Extra analysis that show joint audit regime provides higher audit quality based on restatement

Research design

• First control group: Finland, Norway, Sweden

• Second control group: France

Change of 2005

2003-2004 2005-2006

First control group Single audit regime Single audit regime

Treatment group Mandatory joint regime Single audit regime

Second control group Mandatory joint regime Mandatory joint regime

First analysis

Second analysis

Model

Audit Quality = α + β Interaction + λ controls + firm effects + year effects

Dependent variable:

Audit quality which is substituted for

Abnormal discretionary accruals in signed, absolute, positive and negative values

Working Capital accruals in signed, absolute, positive and negative values

Variable of interest:

First analysis: Interaction= Pre-Treatment * Treated

Second Analysis: Interaction= Post-Treatment * Treated

The model contains firm and year fixed effects and the error term is clustered based on industry

Sample selection and validating assumption

Sample selection:

Panel data of publicly traded companies in Denmark, Finland, Sweden, Norway and France

During period of 2003-2006 that contains change in regulation of 2005

For each individual analysis, the initial sample is matched based on various control variables

Validating assumption:

Treatment and control groups should share a parallel trend before (after) the change in regulation

Panel A: Matched Nordic sample in comparison with treatment group during (2005-2006)

Treated First control Differences P-value N. Obs

AAC -0.001 0.004 -0.005 0.522183

166

ABAAC 0.045 0.051 -0.005 0.341183

166

POSAAC -0.044 -0.049 0.005 0.57495

79

NEGAAC 0.046 0.052 -0.006 0.45488

87

AWAC -0.058 -0.589 0.53 0.247179

165

ABAWAC -0.058 -0.589 0.533 0.246179

165

POSAWAC 0.075 0.081 -0.005 0.873112

89

NEGAWAC -0.282 -1.373 1.091 0.32467

76

Panel B: Matched French sample in comparison with treatment group during (2003-2004)

Treated Second control Differences P-value N. Obs

AAC 0.001 -0.006 0.007 0.311181

139

ABAAC 0.041 0.048 -0.008 0.169181

139

POSAAC -0.041 -0.052 0.011 0.16987

87

NEGAAC 0.04 0.042 -0.002 0.76694

52

AWAC -0.592 1.21 -1.806 0.769180

134

ABAWAC 9.055 3.915 5.139 0.399180

134

POSAWAC 9.288 4.91 4.37 0.62182

70

NEGAWAC -8.86 -2.82 -6.03 0.47898

64

Results-1First analysis Nordic countries

Signs AAC ABAAC POSAAC NEGAAC

Interaction ? -0.011 -0.006 -0.016 -0.015 0.002 -0.016 -0.017 -0.001

(0.601) (0.757) (0.429) (0.447) (0.965) (0.687) (0.608) (0.973)

Cross- 0.055** -0.398* -0.04*** -0.131 0.106 0.308 -0.001 -0.07

Leverage +/- 0.001 0.001 0.001* 0.001* -0.000 0.000 0.000 0.001

Loss +/- -0.002 -0.006 0.004 0.003 -0.007 0.017 0.002 0.011

Inst-shareholder - 0.001 -0.003** -0.001*** -0.001 -0.001 -0.005 -0.000 -0.001**

Twobig4joint - -0.000 0.004 -0.004 0.003 0.012 -0.005 -0.02 -0.013

Onebig4joint - 0.002 0.001 0.008 0.007 0.007 0.026* 0.013 -0.004

Big4joint - -0.001 0.005 -0.001 0.003 0.014 -0.009 0.009 0.011

Size - 0.072* 0.017 0.012 0.019

Cash operation +/- -0.86*** 0.032 -0.93*** -0.605***

ROA +/- 0.013*** 0.001 0.014*** 0.008**

Growth opportunity +/- 0.003 0.004 0.003 0.001

PPE growth +/- -0.025 -0.013 0.001 -0.021

Age + -0.182* 0.036 -0.04 -0.042

MTB+ 0.002 0.005* -0.011 0.012*

F-shareholder ? -0.024** 0.01 -0.029 0.002***

N.obs 522 517 522 517 251 249 271 268

Overall R-squared 0.576 0.814 0.675 0.687 0.82 0.911 0.742 0.832

Results-2First analysis Nordic countries

Sign AWAC ABAWAC POSAWAC NEGAWAC

Interaction ? -2.372 -2.35 0.197 0.915 -0.008 0.072 0.193 -1.487

(0.569) (0.551) (0.93) (0.733) (0.954) (0.646) (0.986) (0.925)

Cross - -0.356 -1.22 2.17** 3.49 -0.009 -4.767 -2.41 -6.086*

Leverage +/- -0.103 -0.102 -0.04 -0.035 0.005 0.002 -0.009 0.049

Loss +/- 0.328 0.323 -0.138 0.022 -0.017 -0.105 2.417 4.24

Inst-shareholder - 0.059 0.167 0.013 0.047 -0.001 -0.014 4.97 0.068

Twobig4joint - -3.987 -3.66 -0.982 -0.566 -0.267* -0.22*** 1.328 0.241

Onebig4joint - 0.085 0.359 -0.499 -0.356 -0.024 -0.098 3.176 2.55

Big4joint - -2.658 -2.25 1.51 2.28 -0.067 -0.075 -2.698 -3.328

Size - -0.257 -4.571 0.862 1.74

Cash operation +/- -1.78 -0.57 0.018 -3.66

ROA +/- 0.171 -0.053 -0.011 0.531

Growth opportunity +/- -1.59 -2.044 0.015 1.61

PPE growth +/- -0.332 -3.275 -0.342 3.11

Age + 2.63 -2.696 0.085 -1.288

MTB + -0.061 0.215 0.028* 0.259

F-shareholders ? 2.84** -2.23*** 0.245 -1.585

N.obs 520 515 520 515 313 311 207 204

Overall R-squared 0.965 0.966 0.987 0.989 0.999 0.999 0.992 0.995

Results- 3Second analysis France

Signs AAC ABAAC POSAAC NEGAAC

Interaction ? -0.011 -0.001 -0.01 -0.008 -0.001 0.000 -0.033 -0.038**

(0.572) (0.521) (0.355) (.459) (0.982) (0.997) (0.148) (0.025)

Cross - 0.066 0.023 0.038 1.548***

Leverage +/- 0.001 0.001 0.001 0.001* 0.001 0.000 0.001 0.001**

Loss +/- -.009 -0.005 0.015 -0.032

Inst-shareholder - -0.005 -0.016** 0.004 -0.304***

Twobig4joint - -0.005 0.005 -0.007 -0.001 0.017 0.021 -0.024 -0.001

Onebig4joint - 0.001 0.007 -0.003 -0.001 0.008 0.019 0.003 0.001

Big4joint - 0.005 0.014 -0.01 -0.004 0.024 0.022 0.006 0.022

Size - 0.04 0.003 0.025 -0.075*** 0.083***

Cash operation +/- -0.88*** 0.109 -0.72*** -0668

ROA +/- 0.014*** 0.001 0.008** 0.011*

Growth opportunity +/- -0.005 0.004 0.009 0.06

PPE growth +/- -0.03*** -0.021 0.001 -0.003 0.01 0.004 -0.003 -0.009

Age + -0.012 0.033 -0.066* 0.033*** 0.028*

MTB + 0.003 0.001 0.003 0.006

F-shareholder ? 0.009 0.021** 3.78* 0.438***

N.obs 542 542 542 542 298 298 244 244

Overall R-squared 0.675 0.856 0.785 0.793 0.887 0.933 0.85 0.934

Results- 4Second analysis France

Sign AWAC ABAWAC POSAWAC NEGAWAC

Interaction ? 2.32 2.172 -2.26 -2.197 -0.005 0.052 6.744 6.88

(0.315) (0.377) (0.345) (0.376) (0.953) (0.608) (0.371) (0.379)

Cross - -3.55** 4.014 -1.826 -3.72

Leverage +/- 0.002 0.005 0.001 -0.004 0.002 0.002 0.031 0.025

Loss +/- -0.000 0.013 -0.05 1.135

Inst-shareholder - 0.233*** 0.003 -0.03 -2.291

Twobig4joint - -0.174 -0.785 0.463 0.734 -0.202*** -0.181*** 0.739 1.105

Onebig4joint - 0.074 -0.088 -0.123 -0.038 -0.022 -0.026 1.859 2.155

Big4joint - -2.274 -2.57 2.212 2.361 -0.011 -0.013 -2.779 -2.728

Size - 0.002 1.25** -0.387 -0.595 0.668 0.392 3.85 4.44

Cash operation +/- 2.537 -3.671 -0.016 -0.919

ROA +/- -0.013 0.032 -0.012 0.093

Growth opportunity +/- -1.266 0.349 0.152 0.264

PPE growth +/- 0.027 0.219 -0.132 -0.192 -0.195 -0.196 2.12 2.52

Age + 0.178 0.08 -0.48 -2.177

MTB + -0.163* 0.141 0.018 0.134

F-shareholders ? -0.044 0.026 4.065

N.obs 540 540 540 540 331 331 209 209

Overall R-squared 0.995 0.995 0.995 0.996 0.906 0.9 0.998 0.997

Additional analysis 1. RestatementNordic countries

sign Restatement

Interaction ? -6.02*** -5.78***

(0.000) (0.000)

Cross - -3.84 2.52*

Leverage +/- -0.008 0.027

Loss +/- 0.598 0.94

Inst-shareholder - 0.011 0.113*

Twobig4joint - 0.119 0.378

Onebig4joint - 2.147 1.829

Big4joint - -4.22*** -3.68***

Size - -2.57***

Cash operation +/- 2.68

ROA +/- 0.208*

Growth opportunity +/- -0.329

PPE growth +/- -0.626

Age + 0.438

MTB + -0.408

Fa- shareholders ? -0.028

N.obs 337 335

Additional analysis 1. RestatementFrance

sign Restatement

Interaction ? 1.7** 1.768**

(0.038) (0.037)

Cross - -2.318

Leverage +/- 0.012 0.022

Loss +/- 1.252

Inst-shareholder - 0.051

Twobig4joint - -0.235 -0.214

Onebig4joint - -0.246 -0.337

Big4joint - -3.961*** -4.411***

Size - -4.488*** -1.388

Cash operation +/- 0.703

ROA +/- 0.24**

Growth opportunity +/- -2.28*

PPE growth +/- -0.105 -0.275

Age + 0.479

MTB + -0.355

F- shareholders ? -0.165

N.obs 326 326

Additional analysis 2. Drop voluntary joint audit Nordic countries

Signs AAC ABAAC POSAAC NEGAAC

Interaction? -0.023 0.025 -0.047 0.01

(0.25) (0.175) (0.161) (0.834)

Cross - -0.014 0.005 3.11*** 0.03***

Leverage +/- 0.001 0.001 0.001 0.001

Loss +/- -0.004 0.007 -0.01 0.004

Inst-shareholder - 0.002*** 0.000*** -0.084*** 0.001***

Twobig4joint - -0.004 -0.014 0.022 -0.019

Onebig4joint - 0.001 -0.002 -0.013 0.006

Big4joint - -0.024 0.025* -0.018 0.015

N.obs 346 346 163 183

Overall R-squared 0.593 0.705 0.939 0.744

Additional analysis 2. Drop voluntary joint audit Nordic countries

Signs AWAC ABAWAC POSAWAC NEGAWAC

Interaction ? -2.734 2.731 -0.189 -1.565

(0.416) (0.563) (0.175) (0.837)

Cross - -1.128 -0.198 -0.144 0.327

Leverage +/- -0.149 -0.027 0.008 0.094

Loss +/- 4.146 -0.613 -0.274** 3.491

Inst-shareholder - -0.043 -0.01 -0.004*** -0.041

Twobig4joint - -4.305 -1.578 -0.384*** 4.203

Onebig4joint - 1.968 -1.959 -0.129** 2.045

Big4joint - -2.647 2.565 -0.21*** -4.678

N.obs 344 344 210 134

Overall R-squared 0.381 0.875 0.999 0.869

Additional analysis 3. Short term effect Nordic countries

Signs AAC ABAAC POSAAC NEGAAC

Interaction ? -0.001 -0.011 -0.023 -0.01

(0.966) (0.635) (0.466) (0.904)

Cross - 0.097 -0.013 0.084 0.024

Leverage +/- 0.001* 0.001 0.001 0.001

Loss +/- 0.001 0.001 0.017 -0.02

Inst-shareholder - 0.001 -0.001*** -0.000 -0.001

Twobig4joint - -0.02 -0.029 0.61 -0.011

Onebig4joint - -0.027 -.015 0.012 -0.001

Big4joint - -0.017 -0.011 -0.022 0.005

N.obs 340 340 163 177

Overall R-squared 0.771 0.806 0.893 0.834

Additional analysis 3. Short term effect Nordic countries

signs AWAC ABAWAC POSAWAC NEGAWAC

Interaction ? -2.972 -0.315 0.167 1.99

(0.612) (0.924) (0.656) (0.792)

Cross - -3.547 1.71 0.194 1.88

Leverage +/- -0.18 -0.035 0.012 0.022

Loss +/- -2.441 -0.407 0.067 -1.76

Inst-shareholder - -0.011 -0.026* -0.001 -0.004

Twobig4joint - 1.579 0.543 -0.682 -4.78

Onebig4joint - 2.261 -0.645 -0.291 -0.177

Big4joint - -0.508 2.145 -0.203 -4.675

N.obs 338 338 218 120

Overall R-squared 0.963 0.995 0.999 0.999

Additional analysis

4. Unmatched sample

Matching process supposed to provide results based on more comparable treatment and control groups, but considerably limit the number of observations

The result is almost consistent with previous findings for the both analysis

5. New control group of Finland and Sweden

The control group for the first analysis contains Norway

is not a European Union member

Dose not have voluntary joint audit observation

The results is consistent with previous findings

Conclusion

Main findings:

Audit quality of joint audit and single audit regime is similar by accrual based measures

Firms with joint audit have lower chance of reporting financial restatement by 0.027 times

Confirms previous findings, however provide supports European audit directives

Limitation:

The results is based on Danish audit market experiment and dose not necessarily generalizable