hudaib and cooke - 2005 - the impact of managing director changes and financial distress on audit qualification and auditor switching

COOKE* director/chief executive officer MD and financial distress together with five control variables type of audit firm; audit fees; gearing; time; and company size on first, audit opi

The Impact of Managing Director Changes and Financial Distress on Audit Qualification and Auditor

Switching

MOHAMMAD HUDAIB ANDT.E COOKE*

director/chief executive officer (MD) and financial distress together with five control variables (type of audit firm; audit fees; gearing; time; and company size) on first, audit opinion and secondly on auditor switching Based on a sample of 297 UK listed companies between 1987 and 2001, we find that companies that are financially distressed and change their MD are most likely

to receive a qualified audit report, ceteris paribus In addition, we find evidence

of both familiarity and intimidation threats and that the probability of a switch increases with the severity of qualification.

auditor switching, auditor independence

1 INTRODUCTION

External auditors are thought to provide value by adding tothe reliability and credibility of financial reporting throughindependent audit (Porter, Simon and Hatherly, 2003) This

* The authors are respectively from the University of Bradford and the University of Exeter They would like to acknowledge the helpful comments of the anonymous referee, Dr R.Haniffa, Dr K.McMeeking, B.Pearson and Professors D.Citron, F.Gul, R.J.Taffler, M.J.Tippett and S.Zeff (Paper received July 2003, revised and accepted November 2004)

Address for correspondence: T.E.Cooke, Department of Accounting and Finance, School of Business and Economics, University of Exeter, Streatham Court, Exeter EX4 4PU, UK.

e-mail: tecooke@exeter.ac.uk

fundamental principle arises from three forms of control vided by an audit: preventive, detective and reporting.However, auditors will not be able to provide these controlsand hence add value to financial reports if they are not inde-pendent of the parties being audited, particularly the managingdirector (MD) who, de facto, determines the auditors’ appoint-ment, dismissal and fees (Taylor and Turley, 1986; Mitchell

pro-et al., 1991; and McInnes, 1993).1 Here lies the potential blem Appointment, retention and fees are determined by theclient but the auditors must remain independent to report tostakeholders Independence distinguishes the auditor-clientrelationship from other professional-client relationships

pro-Taylor and Glezen (1997) make the point that in the US ‘noother standard in the Code of Professional Conduct is moreimportant than independence, which is often defined as theability to act with integrity and objectivity’ (p 57) The import-ance attached to independence in the US is illustrated by therecent formation of an Independence Standards Board (ISB) bythe joint effort of the Securities and Exchange Commission

to financial or other self-interest conflict that may involve thepotential loss of a client In contrast, the self-review threatrelates to difficulties that may arise when reviewing prior-yearsaudits and avoiding past mistakes The advocacy threat mayarise if the auditor promotes (advocates) the position of a client.The familiarity threat suggests that regardless of time duration,the auditor may be over-influenced by senior executives and

1 The auditors’ appointment, dismissal and remuneration are subject to approval by shareholders at an annual general meeting (de jure) but an auditor is unlikely to wish to retain an audit where there has been a fundamental disagreement.

2 ISB was created in 1997 but ceased operation in July 2001 but its work has been adopted by the SEC effectively from November 2000.

become too sympathetic An over-trusting relationship canimpair objectivity by less rigorous testing than might beexpected from an independent relationship Another threat toobjectivity may result where the auditor is intimidated by threat(actual or feared) from a dominating personality, such as adirector or manager The threat may impair the objectivity of

an audit opinion through the potential of an audit switch, andmay be linked to the self-interest threat

To establish whether the familiarity and intimidation threatsare present in the UK auditing environment is extremely diffi-cult because of the problem of observability of the behaviouralrelationship However, Beattie, Fearnley and Brandt (2001)operationalised this unseen aspect of auditor-client relationship

by conducting in-depth matched interviews with both auditorsand clients’ management who admitted to experiencing abnor-mal negotiation over significant accounting issues Another wayforward is to use proxies to enhance our understanding of thecontext and this is the approach adopted here We appreciatethat there is a difficulty of observing an intimidation threat, thatmay involve a threat to remove the auditor, but recognise that

we are able to observe actual auditor switches As a result, weuse actual dismissal as a proxy for the intimidation threat since it

is an observable consequence of the threat Linking audit reportqualification with auditor switching may help us to understandthe intimidation threat

Specifically, our work investigates, in a UK context, the ciations that: audit report qualifications have with changes inManaging Director (MD) and financial distress; auditor switchhas with audit report qualification, MD change and financialdistress; and auditor switch has with the severity of audit reportqualification

asso-Our proxies are: change in MD, financial distress, tion and auditor switching with five other control variables viz.audit fees, type of audit firm, auditee size, gearing and timeacting as control variables The prime variables (financialdistress, change in MD and qualification) are proxies for afamiliarity threat and together with auditor switching act as aproxy for an intimidation threat The limited number of studiesconducted in the context of the UK environment providesmotivation for this research Only Citron and Taffler (1992

qualifica-and 1997) have investigated such issues in the UK qualifica-and our workextends their contribution by looking at the factors and relation-ships in greater depth Specifically, Citron and Taffler (1992and 1997) focused mainly on the relationship between dis-tressed companies with only one type of audit qualification,going concern.

Part of the motivation for this study is that work undertaken

in the US (see, for example, Shank and Murdock, 1978;Krishnan et al., 1996; and Dye, 1993) may or may not becapable of generalisation to other environments The businessand audit environments in the US differ in several ways to thatprevailing in the UK so that the interrelationship of factorsinfluencing audit opinions and switching, and therefore auditindependence, may differ Such differences include:

(i) nature of the business environment

(ii) non-audit services (NAS)

(iii) supervisory bodies (e.g SEC, AICPA – US; DTI,ICAEW, ICAS – UK)

(iv) the legal environment

(v) the extent of litigation and class actions

The business environment or form of capitalism differs betweenthe two countries Chandler (1990) classifies the US as competi-tive managerial capitalism whereas the UK business environmentwas thought to be personal capitalism Lazonick and West (1998)classify the US as managerial whereas the UK was classified asproprietary

If fundamental differences in capitalist structures existbetween the US and UK then it is possible that their auditenvironments also differ With respect to the audit environ-ment, the first difference between the two countries is the extent

to which non-audit services (NAS) may be provided by theindependent auditor In the US, the Securities and ExchangeCommission (SEC) does not permit an auditor of a listedcompany to provide services that may be in conflict with thatduty, except in the past Arthur Andersen (Lowe and Pany,1995) For example, the SEC’s regulations state that auditingand accounting services may not be provided for any SEC-registered company since to do so would impair independence

There is no direct equivalent in the UK although members ofthe ICAEW, for example, are provided with an ethical guide Apossibility is that when a client in the UK is in financial difficul-ties the auditor may be compromised because to severely qualifythe accounts could lead to insolvency and the loss of both auditand non-audit services.3 For users of accounts in the UK, it isdifficult to assess the degree of compromise because, while auditfees are disclosed non-audit services fees were not overthe entire period of review Non-audit services fees have beendisclosed with effect from 30 September, 1992.

Of considerable importance is the fact that the UK does nothave the equivalent of the SEC Certain functions undertaken

by the SEC are dispersed in the UK through the accountingprofession, the London Stock Exchange, the Financial ServicesAuthority and the Department of Trade and Industry.However, the resources available to these disparate organisa-tions are very small compared to those available to the SEC Afurther aspect is that US regulation stems from the SEC and ismandatory which contrasts with the voluntary arrangement ofthe professional body, the AICPA Whilst the AICPA has enfor-cement powers over its members there is no compulsion for anauditor to be a member of the Institute In the UK in contrast,

an auditor must be a member of a recognised accounting body

or approved by the Secretary of State (Section 389, CompaniesAct 1985) A further difference is that the UK is subject toEuropean Directives and in this context the Eighth Directive

on the qualifications and work of auditors (see, for example,Evans and Nobes, 1998a and 1998b) is relevant The UK hasimplemented the Directive although the specific requirements

to ensure auditor independence have been delegated to ber states Furthermore, there has been a major innovation inthe form of corporate governance procedures implemented bythe London Stock Exchange that do not apply in the US (Citronand Taffler, 2000; and Financial Reporting Council, 2003).Differences also exist between the US and UK with respect tothe extent of litigation in which the former is far greater with a

mem-3 Other services provided by auditors include accountancy and bookkeeping assistance, company secretarial help, consultancy services, investigation work, receivership work and taxation work (Moizer, 1985, p: 38).

consequential impact on the perceived business risk of auditors.The extent of the difference may be difficult to quantify sincemany cases are settled out of court to avoid an adverse impact

on reputation and the loss of income resulting from staff ing court for long periods of time The role of the SEC may besignificant since it has a low tolerance threshold and is not aparty to settlements out of court.4Such powers contrast sharplywith those of the Secretary of State in the UK

attend-In the US, class actions and contingency fees are common butare relatively uncommon in the UK (Woolf, 1986) Over the lastfive years contingency fees have become more common in the

UK but over the period of analysis of this paper, the UK and USdiffered markedly Auditors in the UK are implicitly permitted

to accept contingent contracts offered by their audit clientswhile auditors in the US are permitted to accept contingentfees for non auditing work as long as they are not from theiraudit clients (Dye et al., 1990) In the UK, liability to thirdparties is limited to special circumstances (Caparo Industriesplc v Dickman and Others, 1990) whereas in the US:

the auditor’s potential liability for ordinary negligence under common law definitely extends to third parties with primary beneficiary relationships, often extends to third parties with foreseen relationships, and sometimes extends to third parties with foreseeable relationships (Taylor and Glezen,

1997, p 111).

Differences in environments suggest that results found in the

US may not be applicable to the UK Our analysis involves anexamination of 297 UK listed companies between 1987 and

2001, with the logistic regression results indicating that the ability of an audit qualification is greatest for a financially dis-tressed company that changes its MD, followed by a financiallydistressed company that does not change its MD This seems toindicate that qualification is driven more by financial conditionthan MD change, thus indicating the existence of a familiaritythreat Results also show that the probability of an auditorswitch is at its highest when a financially distressed company

prob-4 For example, it brought enforcement actions against accounting firms and companies: Arthur Andersen LLP, Xerox, Waste Management etc., and almost all of them are settled with the imposition of a financial penalty and a denial by the accused of any wrongdoing.

changes its MD, followed by non-distressed companies thatchange its MD This indicates that MD change is more influen-tial than financial distress in explaining auditor switching.Results also indicate that distressed companies that do notchange their MD and receive qualified audit opinions aremore likely to switch their auditors, indicating the existence of

a dismissal or intimidation threat Another important finding isthat the propensity to switch increases with the severity ofqualification

The paper is organised as follows The next section reviewsprior research in the area and Section 3 provides an under-standing of the underlying a priori relations Subsequentsections consider the research methods, the empirical results,and finally Section 6 provides a summary and discussion

2 PRIOR RESEARCH

The literature on audit qualifications and auditor switching isinterrelated but will be dealt with separately, as much as possi-ble, to enhance our initial understanding Variables that havebeen advocated as explanatory factors of audit qualificationinclude audit fees (McKeown et al., 1991; and Firth, 1980aand 2002), financial distress and company size (Haskins andWilliams, 1990; and Citron and Taffler, 1992), managementchanges (Burton and Roberts, 1967; and Carpenter andStrawser, 1971), type of audit firm (Warren, 1980; Shank andMurdock, 1978; and Chow and Rice, 1982), reporting disputes(Magee and Tseng, 1990), and asymmetric information (Dye,1991)

Firth (1985) and McKeown et al (1991) have argued thatlarger auditees benefit from their bargaining power over feelevels and as a result are less likely to receive a qualified auditopinion i.e the self-interest threat to objectivity and indepen-dence Firth (1980a) also found that most UK respondentsperceive high fees from a client to be detrimental to indepen-dence Based on a cross-sectional model that includes auditopinions to explain the level of audit fees, Firth (2002) found

a positive but insignificant association between the two variables

A study by Beattie, Brandt and Fearnley (1999) found feedependence to be the most important threat in the UK

The Guide to Professional Ethics issued by the ICAEW (2001)recognises a self-interest threat:

if the recurring fees from a client company or group of companies constitute a substantial proportion of the fee income of an audit firm, a self-interest threat is likely to arise, so as to imperil objectivity (Section 4.1, Integrity, Objectivity and Independence: Guidance on specific areas of threats, p 229).

The threat is very real even when the fee income does notconstitute a substantial proportion of fee income where an auditfirm has difficulty in replacing lost clients Even for large auditfirms, mergers and acquisitions of corporate clients in the 1980sand 1990s created displacement problems Consequently, thisvariable is incorporated into our analysis i.e the larger the feelevel the less likely a qualified audit opinion will be issued since

a client would not tolerate an audit qualification when higherthan average audit fees have been paid Unlike DeAngelo(1981), who classified high audit fees based on the ratio of feespaid to the audit firm’s total fees, this study uses the ratio ofaudit fees paid to auditees’ total assets as a proxy for high auditfees.5 The reason for adopting this ratio rather than the ratioused by DeAngelo (1981) is because it is the auditee whoexecutes dismissal and therefore the focus should be on theauditee rather than the audit firm

Auditee size is another important explanatory variablebecause of the auditors’ self-interest threat Several studieshave found that smaller companies are more likely to receivequalified audit opinions than larger auditees and subsequently

Firth (2002) found that an association between size of auditeeand qualification was statistically significant Both audit qualifi-cation and auditor switching are thought to be functions of thesize of the client i.e the smaller the company the higher theprobability of audit qualification and subsequent switching This

5 If a company has a high level of assets, it may be anticipated that the audit required will be substantial and paid fees will be higher A high ratio of paid fees to company’s total assets indicates that the company is paying higher than average fees for the size of assets it owns.

6 This could be attributed to larger auditees receiving more public attention than their smaller counterparts and as such, are more likely to comply to rules and regulations and maintain proper accounting system.

variable is incorporated into our analysis i.e the larger theauditee size, the less likely a qualified audit opinion will beissued and also less likely for the auditor to be replaced.The evidence that large audit firms are more likely to issuequalified audit reports than their smaller counterparts is some-what mixed Whereas Warren (1980) did find a significantassociation between the two variables, Shank and Murdock(1978) found otherwise Chow and Rice (1982) put the differentfindings down to the type of statistical tests and their own work,using a conditional logit model, supported the work of Warren(1980) Additionally, Krishnan et al (1996) found that smallercompanies in the US are less likely to be audited by Big 6 firms7and also tend to switch auditors following a qualified auditreport, more than larger firms audited by Big 6 firms.DeAngelo (1981) has argued that large audit firms have greaterincentives to avoid criticism that could harm their reputationand Dye (1993) suggests that because of their ‘deeper pockets’they are more likely to disclose problems because of theirgreater risk exposure To control for this possible effect thetype of audit firm was incorporated into our analysis, althoughwith some uncertainty as to the expected direction.

Research to date suggests that financial distress is very tant in the issuance of an audit qualification (Haskins andWilliams, 1990; and Citron and Taffler, 1992) In testing forthe presence of opinion-shopping in the UK, Lennox (2000)found that high leverage companies are more likely to receivemodified audit reports, but in the subsequent period Financialdistress poses two main self-interest problems for the auditor.First, the loss of audit income and associated consultancy workand secondly, the increase in probability of legal action againstthe auditor The problem is likely to be most acute in goingconcern qualifications but other forms of qualification may bethe harbinger of financial difficulty For this reason we classifiedfinancial condition into non-distress and distress and incorpo-rated it as an explanatory variable i.e the greater the financialdistress the higher the probability of audit qualification

impor-7 This may be attributed to smaller companies not needing to pay the premium price levied by the Big 6 audit firms Simon and Francis (1988) report that Big 8 fees have been persistently estimated at 16% to 19% higher than non-Big 8 audit fees.

Another motive for including non-distressed companies is tocontrol for the possible effect of auditees’ financial condition

on auditor switching as proposed by Chow and Rice (1982)

using company Z-scores which are composite measures based

on published accounting information of auditee solvency/insolvency position (Taffler, 1983) Operationalisation of thisvariable is explained in detail in the next section

because new management attempts to disassociate from vious relationships and prefers to deal with familiar parties(Burton and Roberts, 1967; Carpenter and Strawser, 1971;and Beattie and Fearnley, 1995) A paper by Beattie andFearnley (1998) provides further evidence in relation tomanagement change They report that 35% of auditor changecompanies cite top management changes as a reason for beingswitched However, Chow and Rice (1982) found that manage-ment change is not significant to explain switching Similarly,Schwartz and Menon (1985) found that neither change in MDnor qualified audit reports in failing companies leads to switch-ing It is noticeable that the extant literature (e.g Chow andRice, 1982; Schwartz and Menon, 1985; and Krishnan et al.,1996) fails to consider the interactive effects of distressed/non-distressed companies and MD change/no-MD change on type ofaudit report and subsequently their interactive effects onswitching As suggested earlier, companies that receive qualifiedopinions may switch their auditors regardless of the solvency ofthe companies However, it is possible that audit qualificationmay be triggered by financial distress or MD change, or indeed

pre-by both Expectations about the direction of association areoutlined in the next section

8 For example, Schwartz and Menon (1985) recognised that their findings of no significant association between audit qualifications and switching and between manage- ment changes and switching in failing companies may be due to failure in incorporating non-financial distressed companies in their sample This issue is addressed in this research.

9 We follow the approach adopted by Schwartz and Menon (1985) and Firth (2002) in using the managing director as a proxy for management because such individuals are likely to be full-time executives In contrast, a chairman might be a non-executive member of the Board.

Most of the factors influencing audit qualification also ence switching and in the same direction The most commonreason cited in the literature for switching is audit qualificationalthough once the qualification has been given the threat ofdismissal is substantially reduced In reality, it is the intimida-tion threat that jeopardises independence although the threat isnot observable What is observable are actual switches i.e actualdismissal which are, in effect, being used as a proxy for situa-tions where switching was threatened Chow and Rice (1982)found a significant positive association between qualifiedopinions and subsequent auditor switching based on their study

influ-of a sample influ-of US listed companies In similar studies influ-of Australianand Hong Kong companies, Craswell (1988) and Gul et al (1992)respectively, found results consistent with Chow and Rice (1982).Based on ‘going concern qualifications’ (giving an opinion on theuncertainty of the client remaining in business in the foreseeablefuture) and distressed companies, the study by Citron and Taffler(1992) found a positive association between the presence of ‘goingconcern’ qualification and auditor switching in distressed UKquoted companies for the period 1977–1986 Research, such asthat by Smith (1986) and Krishnan (1994) tend to disagree,suggesting that auditors are switched, not because of the type ofaudit opinions issued, but due to the auditors being too strict intheir auditing procedures

The relationship between audit opinion and switching is notuni-directional The propensity to switch can influence auditors’opinion, an argument at odds with the empirical work men-tioned earlier Among those who believe that an intimidationthreat is due to disagreement over a reporting policy that maycause the auditor to qualify (especially if other auditors arelikely to share such professional judgment) include DeAngelo(1982), Magee and Tseng (1990), Dye (1991), Teoh (1992) andKrishnan et al (1996) For instance, Teoh (1992) argued thatthe threat of switching by clients can influence the auditors’opinion and consequently, independence As a result, the audi-tor will have to weigh the situation between being independentand giving a qualified opinion or facing the possibility of actualdismissal

Dye (1991) proposes conditions that may cause a company toswitch its auditor and the auditors’ incentives to attest to a given

report and argued that when the client and auditor possesssymmetric information about the company’s financial report,the auditor would not be replaced On the other hand, if asym-metric information exists and the auditor is likely to issue aqualified opinion, then it is highly likely that the auditor will

be replaced

In addition, DeAngelo (1982), in rejecting the hypothesis of

an association between switching and qualification, argued thatthe causation may run in both directions i.e qualified opinionscan cause auditor switching and vice-versa Similarly, Krishnan

et al (1996) confirmed the findings of previous studies on thepositive effect of a qualified opinion on auditor switching andfurther suggest that auditors are more likely to issue qualifiedopinions (in period t0) when there is a potential for the company

to switch (in period t1)

3 CONCEPTUAL FRAMEWORK

The relationships between audit opinion, switching and thevarious explanatory variables suggested in the literature arecomplex Our conceptual framework for investigating the inter-active effects of MD change and distress, on audit opinion isshown in Figure 1 The figure illustrates the interactive ele-ments being considered Relationship 1 in the figure illustratesthe possible influence of the two variables under investigation,

MD change and financial distress as well as the control variables(type of audit firm, audit fees, time and company size) on auditopinion while relationship 2 indicates the influence of the vari-ables including audit opinion on auditor switching

Figure 2 illustrates the hypothesised interactions of MDchange and financial condition on audit opinion When a client

is in financial difficulties, the auditor has greater business riskwhich increases the probability of a qualified audit opinion Riskmay increase with the size and public visibility of the client.Figure 2 shows that the probability of receiving a qualification

is highest when the company is financially distressed andchanges its MD A change in MD may be a signal of a corporateproblem and together with financial distress is likely to increasethe business risk of the auditor considerably and therefore thehigher the probability of qualification At the other extreme, no

Figure 2 The Hypothesised Interactions of MD Change and Financial Distress

Increasing probability of a qualified audit opinion

unqualified opinion

Figure 1 The Relationships Between Audit Opinion, Explanatory Factors and

Switching

1 2

2 1

2

Relationship 1: The possible influence of MD change, financial distress and the control variables on

audit opinion

Relationship 2: The possible influence of MD change, financial distress, qualification and the

control variables on auditor switching.

MD change and strong financial standing will result in a lowprobability of a qualified opinion Between these two possibili-ties are two others We hypothesise that the probability of anaudit qualification is greater for no MD change and financialdistress than for MD change and financial health because of theimplications for perceived business risk of auditors We furtherhypothesise that the familiarity threat is present when distressedcompanies do not receive a qualification especially when there is

no change in MD The argument for such an assumption is thatdistressed companies are expected to receive a qualified auditopinion but if such companies received an unqualified auditopinion and do not change their MD this may be because aclose relationship exists between the auditor and the client Onthe other hand, distressed companies that experience changes

in MDs and subsequently receive an audit qualification, suggeststhat auditors act in a professional manner

We also hypothesise that the same variables that influenceaudit opinion are likely to explain auditor switching togetherwith the type of audit opinion However, the interrelationshipbetween MD change and financial distress may be different tothat illustrated above In the case of distressed companies, achange in management is seen as desirable to resuscitate anailing company with a qualified opinion (Schwartz and Menon,1985) To extend the literature, we expect that the twoextremes will be as for audit qualification The probability of aswitch will be highest when the company has a qualified auditreport, is distressed and changes its MD The lowest probability

of a switch, even when a company receives an audit tion, will be when the entity is financially healthy and does notchange its MD We believe that the two intermediate positionswill be reversed when compared to the factors influencing auditopinion because the influence of MD change is likely to behigher than financial distress in explaining auditor switching.Alternative allegiances of the new MD or because the newmanager may wish to make a fresh start may increase the prob-ability of a switch The practice of engaging new auditors by thenew MD based on familiarity may affect independence Wehypothesise that the relationship will be as illustrated inFigure 3 We further hypothesise that a dismissal threat is pre-sent when a financially distressed company that does not change

qualifica-its MD considers switching qualifica-its auditor subsequent to an auditqualification.

A further explanation of auditor switching is that probabilitiesmay be affected not only by the above factors but also by theseverity of qualification (Craswell, 1988; and Gul et al., 1992)

We hypothesise that, given the other explanatory variables(audit fees; type of audit firm; auditee size; financial health;

MD change), the probability of switching will increase with theseverity of audit qualification as illustrated in Figure 4

Figure 4 Severity of Audit Qualification and Probability of Auditor Switching

Except for: limitation of scope

Except for: fundamental uncertainty on going concern

Except for: disagreement on accounting treatment

Except for: disagreement on disclosure matters

Unqualified with paragraph

Disclaimer Subject to GC: Material & Fundamental Except for: Accounting matters Subject to GC: Material but Not Fundamental

Figure 3 The Hypothesised Interactions of Qualification, MD Change and

Financial Distress on Auditor Switching

Health Distress

Financial Distress

Increasing probability of auditor switching

changing its auditor subsequent to qualification

4 RESEARCH METHODS

(i) Data Collection and Identification of Variables

A cross-sectional review of audit reports of a sample of nies listed on the London Stock Exchange over a period from

selected was initially 317 companies out of a population of 1,800companies, based on the table of general scientific guidelines forsample size decisions provided by Sekaran (1992) A stratifiedsampling approach was then used to derive the size of eachstratum (see Column 4 in Table 1) However, 20 companieswere eliminated from the sample because of missing data giving

a final sample of 297 in five sectors excluding the financial sector11and the breakdown is shown in Column 6 in Table 1

The final sample is considered to be representative of financial UK companies The study is a longitudinal survey of

non-15 years and after adjusting for the entry/exit of companies thetotal number of corporate annual reports considered was 4,176.Information on the research variables was mainly extractedfrom annual reports Table 2 provides a summary of the oper-ationalisation of the variables

Table 1 Population and Sample Size Classified by Industrial Sector

Sector (1)

No of

No of Companies

No of Companies Included (6)

we assume a one-year lag in the linked effect.

11 Companies in the financial sector were excluded because differences in regulatory environment may impact on audit fees and differences in the content/format of financial statements will affect accounting ratios.