The impact of audit quality on firm performance empirical evidence in vietnam

In this thesis, audit quality is measured by three variables including audit rotation, audit reputation and audit experience whereas firm performance is proxied by accounting profits ROA

UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY VIETNAM THE HAGUETHE NETHERLANDS

VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE IMPACT OF AUDIT QUALITY ON FIRM PERFORMANCE:

EMPIRICAL EVIDENCE IN VIETNAM

A thesis submitted in partial fulfillment of the requirements for the degree of

MASTER OF ART IN DEVELOPMENT ECONOMICS

DECLARATION

“I certify the content of this thesis entitled “The impact of audit quality on firm performance: empirical evidence in Vietnam” has not already been submitted for any degree and is not being currently submitted for any other degrees

I certify that, to be the best of my knowledge, any help received in preparing this thesis and all sources used, have been acknowledged in this dissertation”

Signature

Lê Thị Anh Thư

Date: November ……., 2016

ACKNOWLEDGEMENT

First and foremost, I would like to express my gratefulness and my dearest thank to

my supervisor, Dr Lê Hồ An Châu for her guidance and support during my thesis completion

In additional, I would like to thank Dr Trương Đăng Thụy, who also gave me the useful help for my research More special thanks for all lecturers and staffs at Vietnam-Netherlands Program and my VNP 21 classmates

Furthermore, thanks to the support from my colleagues at Gia Cat Consulting and Auditing Co., Ltd who create more conditions for me to complete this thesis

Last but not least, I would like to express my many thanks to my family and my friends, who encourage and support to me in both mental and physical during the thesis process

ABBREVIATIONS

CSMAR: China Stock Market Accounting Research

ICAEW: Institution of Chartered Accountants in England and Wales

ISA: International Standards Auditing

IFAC: International Federation of Accountants

GAO: Government Accountability Office

HOSE: Hochiminh Stock Exchange

PCAOB: Protecting Investors through Audit Oversight

TPP: Trans-Pacific Strategy Economic Partnership Agreement

UKFRC: United Kingdom Financial Reporting Council

VACPA: Vietnam Association of Certified Public Accountants

WTO: World Trade Organization

ABSTRACT

This study empirically examines the impact of audit quality on firm performance in Vietnam Audit quality is considered as an external monitoring factor which objectively affects firm performance In this thesis, audit quality is measured by three variables including audit rotation, audit reputation and audit experience whereas firm performance is proxied by accounting profits (ROA), market value (Tobin’s Q) and risk of bankruptcy (Z-score) The dataset includes 268 listed non-financial companies in Vietnam over the period from 2010 to 2015 The results show that there is no relationship between audit rotation, audit reputation and audit experience on Tobin’s Q and Z-score However, audit reputation and audit experience are insignificantly correlated with firm profitability The effect of audit rotation on ROA is positive, suggesting that companies which have audit rotation are more likely to have higher profits This implies that the change of audit firm increases the independence of auditors as well as enhances audit quality and hence positively affects firm performance

Key words: audit quality, audit rotation, audit reputation, audit firm experience, firm performance, listed companies, Vietnam

TABLE OF CONTENTS

CHAPTER 1:INTODUCTION 1

1.1.PROBLEM STATEMENT 1

1.2.RESEARCH OBJECTIVES AND RESEARCH QUESTIONS 3

1.3.RESEARCH METHODOLOGY AND DATA 3

1.4.RESEARCH CONTRIBUTION 4

1.5.THESIS STRUCTURE: 4

CHAPTER 2:THEORETICAL FRAMEWORK AND EMPIRICAL EVIDENCE OF AUDIT QUALITY AND FIRM PERFORMANCE 5

2.1THEORETICAL LITERATURE OF AUDIT QUALITY AND FIRM PERFORMANCE 5

2.1.1 Audit quality definition and relevant theoretical framework 5

2.1.1.1 Agency Theory 6

2.1.1.2 The stakeholder theory 7

2.1.1.3 Theory of Asymmetric Information 9

2.1.2 Definition and measure of firm performance 10

2.2.EMPIRICAL EVIDENCE ABOUT THE IMPACT OF AUDIT QUALITY ON FIRM PERFORMANCE 11

2.2.1 The impact of audit rotation on firm performance 12

2.2.2 The impact of audit reputation on firm performance 16

2.2.3 The impact of audit firm experience on firm performance 17

2.2.4 The effect of Vietnamese Auditing Standards (VSA 220) on “Quality control of financial statements audit activities” on firm performance 18

2.3.THE CONCEPTUAL FRAMEWORK 19

CHAPTER 3:RESEARCH METHODOLOGY AND DATA 20

3.1.DATA COLLECTION 20

3.2.METHODOLOGY 20

CHAPTER 4:DATA ANALYSIS AND EMPIRICAL RESULTS 27

4.1.DESCRIPTIVE STATISTICS AND BASIC ESTIMATION 27

4.1.1 Descriptive Statistics 27

4.1.2 The correlation matrix of variables 32

4.1.3 Heteroskedasticity 34

4.1.4 Identification of Endogeneity Problem 34

4.2.REGRESSION RESULTS AND DISCUSSION 35

4.2.1 Audit quality and firm performance measured by ROA: 35

4.2.2: Audit quality and firm performance measured by Tobin’s Q: 38

4.2.3: Audit quality and firm performance measured by Z-Score 39

CHAPTER 5:CONCLUSIONS AND POLICY IMPLICATIONS 41

5.1.MAIN FINDINGS 41

5.2.POLICY IMPLICATION 42

5.3.LIMITATION AND FURTHER RESEARCH 43

REFERENCES 44

APPENDIX 50

LIST OF TABLES

Table 1: Rules on mandatory audit firm rotation and mandatory auditor rotation for

listed companies 49

Table 2: The Z-Score level 23

Table 3: Summary of variables and predicted sign of coefficient 26

Table 4: Categorized business fields 27

Table 5: Descriptive Statistic 28

Table 6: Correlation matrix 33

Table 7: Heteroskedasticity test 34

Table 8: Endogeneity test 35

Table 9: System GMM estimation of firm performance measured by ROA 36

Table 10: System GMM estimation of firm performance measured by Tobin’s Q 38

Table 11: System GMM estimation of firm performance measured by Z-Score 39

Table 12: Companies in year of establishment 52

LIST OF FIGURES

Figure 2.1: The Agency Theory 7

Figure 2.2: The Stakeholder model of the corporation 8

Figure 2.3: The Asymmetric Information Theory 10

Figure 2.4: The Analytical Framework 20

Figure 4.1: The prediction of relationship between audit firm experience and ROA 30

Figure 4.2: The prediction of relationship between

audit firm experience and Tobin’s Q 31

Figure 4.3: The prediction of relationship between audit firm experience and Z-Score 32

However, the role of audit quality as a key driver of firm performance has not yet attracted sufficient attention from researchers and policy makers in Vietnam This may result in the fact that investors lack the proper consideration about audit quality which might affect the financial disclosure and useful information for investors’ decision-making

In the process of integration and development, Vietnam has more opportunities to approach and take part in the global organization such as WTO, TPP etc One of the difficulties in the foreseen future isto guarantee the reliance and the transparency of declared financial information to attract foreign investment and create the fair competitive environment The collapse of Arthur Andersen, one of the five biggest audit firms (Big 5)

in 2002, the scandal and infringement related to audit quality recently and the integrity of firms’ financial statements force to enhance the investors’ perception about the audit quality and even the pressure to improve the audit quality of external parties In Vietnam, there is also a rising concern about this issue after a serial of scandal of listed companies in the stock exchange such as the evaporated inventories of Truong Thanh Corp (TTF), NTACO Corp (ATA) and bad debt from Ocean Group (OGC) which led to sharp deterioration in stock market and investor’s belief

Audit quality is a controversial issue between the legislators and a key consideration for auditors The audit quality framework of United Kingdom Financial Reporting Council (UKFRC) public in 2008 identifies key determinants of audit quality including culture within audit firm, skills and quality of auditors, the effectiveness of audit process, reliability and usefulness of audit reporting and outside factors According to DeAngelo(1981) and PCAOB (2011), audit quality is identified as the probability of detecting errors or omissions which affect the financial statements in material aspects IFAC (International Federation of Accountants) states that audit quality is the most fundamental characteristic of international auditing standards, it should be capable of consistent interpretation, unambiguous translation, enforceable and designed to achieve a high quality of audit In Vietnamese Standards Auditing 220 (VSA 220) about Quality of auditing activities, audit quality refers to the degree of satisfaction of users of the audit results as the objectivity and reliability of the opinion expressed, and of the entity under audit as to the auditor’s recommendations with the view to improve the business efficiency

of the entity within a time limit and at a reasonable price

There is no consensus among researchers about the method to measure audit quality Previous studies use indirect measurement such as audit rotation and audit fees (Sayyar et al., 2015),audit firm size, litigation, auditor tenure, non-audit services, industry experience and peer review (Hussein & Hanefah, 2013) According to Sori et al., (2006), size of audit firm is a good proxy for audit quality because the large audit firm with better reputation, experienced practitioners, superior technology and abundant financial resources will give assurance of audit opinion about the financial status of audited companies Moreover, the large audit firm size might not be pressured by revenue from big clients that affect its independence and objectivity when expressing audit opinion

The initial auditing institution appeared early in 1942, which is the institute of Internal Auditors in the United States of America In Vietnam, the independent auditing firms started later in 1991 To maintain the audit quality, the audit firms and auditors have

to comply with the audit standards that have been set by Ministry of Finance and Vietnam Association of Certified Public Accountants (VACPA) Moreover, auditors also conform

to the Ethical Standards including the basic principles: integrity, independence, prudence and professional competence The main motivation of principles is to maintain both

independence of mind and independence of appearance (ISA 200, 2009) and audit rotation

is considered a representative variable for audit independence

In an attempt to enforce and improve audit quality in Vietnam, on 6th December

2012, Ministry of Finance announced the composition of 37 new auditing standards These standards are applied and effective from January 1st, 2014 One of which specially focuses

on “Quality control of financial statements audit activities” – VSA 220 This standard aims

to give more requirements and increase the audit control activities to enhance the quality of independent audit activities in Vietnam

1.2 Research objectives and research questions

The main objective of this study is to examine the impact of audit quality on firm performance of listed companies in Vietnam Specifically, it aims to give the deep insight into the impact of three proxies for audit quality (audit rotation, audit reputation and audit firm experience) on firm performance measured by firm profitability, market value and risk of bankruptcy Moreover, this thesis will also test the effect of the promulgation of VSA 220 which is considered as an important legal framework to improve audit quality in Vietnam on firm performance

In order to achieve those objectives, we conduct an empirical analysis on the firm level data in Vietnam to seek convincing answers for the following two research questions:

- Does audit quality proxied by audit rotation, audit reputation and audit firm experience have any effect on firm profitability (ROA), market value (Tobin’s Q) and risk of bankruptcy (Z-Score) of listed companies in Vietnam? If so, the effects are positive or negative and why?

- Does the promulgation of VSA 220 in 2014 have any effect on firm profitability, market value and risk of bankruptcy of listed companies in Vietnam?

1.3 Research methodology and data

This study uses the panel data of 268 listed companies on Ho Chi Minh Stock Exchange from 2010 to 2015 Financial institutions and insurance companies are excluded from this dataset given their different financial structure and performance measurement Generalized method of moments (GMM) estimation is applied to examine the impact of

audit quality on firm performance This study is also to examine the correlation, heteroskedasticity and the fit of instrumental variable by Hansen and Sargan test The impact of three proxies of audit quality on firm performance have been tested individually and simultaneously

1.4 Research Contribution

Until now, there is limited empirical evidence about the impact of audit quality on firm performance of listed companies in Vietnam whereas previous studies across countries provide inconsistent results about this effect Therefore, this study is the modest attempt Moreover, what makes this work different from the contemporary literature is that different measurements of firm performance were analyzed, from accounting perspective (ROA) to market value (Tobin’s Q) and risk of bankruptcy (Z-Score) Testing the effect of auditing legal framework in Vietnam via the promulgation of VSA 220 on the audit quality

is another contribution that this thesis provides from the empirical evidence Therefore, the findings from this research will suggest important policy implication for investors in their investment decision – making and for policy makers to improve the transparency of business environment in Vietnam

1.5 Thesis structure

The remainder of this thesis is organized as follows: the second section is the review of theoretical framework and empirical evidence about the effect of audit quality on firm performance The third section will discuss the research methodology and data The empirical results will presented in the fourth section and the last section will conclude and suggest policy implication

CHAPTER 2:

THEORETICAL FRAMEWORK AND EMPIRICAL

EVIDENCE OF AUDIT QUALITY AND FRIM

PERFORMANCE

Some theories have been presented in this section relative to the role of audit quality as the external monitoring factor in firm financial performance including Agency theory, stakeholder theory and Information Asymmetric theory In addition, evidence of the impact of audit quality on firm performance from previous empirical studies will also

be reviewed From the theoretical framework and empirical evidence, the research hypotheses and empirical strategy will be developed

2.1 Theoretical literature of audit quality and firm performance

2.1.1 Audit quality definition and relevant theoretical framework

Audit quality is a vague term According to DeAngelo (1981) and PCAOB (2011), audit quality is the probability of misstatements and errors of annual audited financial statements in material aspects which are detected by using the appropriate audit procedures Eilifsen and Wilekens (2008) identify that audit quality is an aggregation of independence and competence of auditors to find out the material misstatements and express the appropriate audit opinion based on the audit evidence and applied audit procedures International Federation of Accountants (IFAC) argues that audit quality is the most fundamental characteristic of international auditing standards and it should be consistent interpretation, unambiguous translation, enforceable and designed to achieve a high audit quality In Vietnam Standards Auditing 220 (VSA 220) the concept of the quality of audit activities refers to the level of satisfaction of users about the auditing results as the objectivity and reliability of the opinion expressed, and of the entity under audit as to the auditor’s recommendations with the view to improve the business efficiency

of the entity within a time limit and at a reasonable price

The role of third party who gives the opinion related to financial information disclosure is very important Audit quality is considered as an external monitoring factor

which has a significant effect on firm performance This was explained from many relevant theories such as agency theory, stakeholder theory and theory of information asymmetric

2.1.1.1 Agency Theory

The agency theory is developed by Jensen and Meckling (1976) This theory investigates the relationship between the shareholders and the managers as the agents who are hired for running the firm’s operation to maximize the return for investors Agency theory is also concerned about solving problems which exist in agency relationships because of inconsistent benefits, the disparity of approached strategies and level of risk

The problem relating to the separation between the ownership and management in large corporations is initially discussed by Adam Smith (1776), Berle and Means (1932) However, Jensen and Meckling (1976) restate this problem and emphasize the moral hazard problem Managers may ignore the interests of the owners and hide the inefficient operation in order to get the personal benefits The managers also can use the accounting tricks while preparing financial statements to show the good financial status for self-

interest purposes The conflict of interest between directors and shareholders is also demonstrated by the diagram in Soltani (2007)’s research

Figure 2.1 The Agency theory

Source: Jensen (1983), Zahra and Pearce (1989)

Performance

Profitability Market Value Corporate Bankruptcy

Agency Theory

Conflict of interest

To minimize the consequences of agency problems, Jensen (1983) suggests some solutions, in which he identifies the monitoring systems These systems have to be independent and there are no interests relative to either owners or managers Kim and Nofsinger (2014) also mention about setting up effective mechanisms for monitoring the manager’s behavior to reduce agency problem Auditor is considered a third party to independently and objectively monitor the financial information disclosure (ICAEW, 2005)

The audit function, either internal or external attempts to address the agency problems The role of internal auditor typically ensures the benefits of the board of directors and monitors the director’s behavior and decisions in accordance with company’s policies Therefore, the outside shareholders are not the main objective of internal auditor

In contrast, the existence of external auditors also provides information and monitors the director’s activities for inside parties and outside stakeholders So the influential level and the scope of users of external auditors’ financial information are broader than that of internal auditors (Colbert and Jahera, 1988)

Dang and Fang (2011) provide an empirical test the relationship between the audit quality and owner-manager agency costs using the dataset of listed companies in China Audit quality is considered the monitoring factor that provides an independent supervision and checks the accounting information to reduce the agency costs The results show that higher audit quality reduces the owner-managers agency costs effectively, especially in emerging market Krishnan (2003) argues that high external audit quality declines the manipulation of manager’s ability Habbash and Murya (2010) investigate the effectiveness of external audit on constraining earning managements in UK In their study, the external audit variable is proxied by auditor independence and audit quality The result illustrates that audit can moderate agency costs

2.1.1.2 The stakeholder theory

The stakeholder theory explains how the relationship between the organization with the outside and inside group affect or be affected by the achievement of the organization’s strategies (Freeman, 1984) The external and internal stakeholders include employees, customers, suppliers, government, shareholders, local community, etc When a company’s

financial decision is made, there are many parties to be affected If the company has a good and effective relationship with the stakeholder, they will have a sustainable development in long-term and favorable good-will in public In contrast, the company with the bad performance will not receive the trust from stakeholder

Figure 2.2 The stakeholder model of the corporation

Source: Freeman(2012)

Agency theory mainly focuses on the shareholders whereas the stakeholder theory’s scope is broader In recent years, the organization has to concern about the economics, society and environment aspects The image, information disclosure and the creditworthiness of company in public are really important Managers have to balance the interests and welfare between groups of stakeholders (Brusseau, 2012).The conflict of interest might exist and the demand of transparency in corporation’s information is necessary The stakeholder theory also defines the business ethics in social responsibility

According to Paydarmansh, et al., (2014) audited financial statements are essential for dealing with the disparity between the ownership from management that has been discussed in stakeholder theory The given reason is that independent audit firms with expertise in accounting and finance have full ability to identify the material risks and errors

in the financial reports Therefore, it could increase the reliability from the stakeholders

The relationship of objectives in Stakeholder Theory is a double-side effect Once stakeholders properly consider about the quality of audited financial statements, the managers could not manipulate the company’s financial status (James and Izien, 2014) Chiu and Wang (2014) investigate the social disclosure quality in Taiwan by applying the stakeholder theory They remind the disclosure information quality in stock market

2.1.1.3 Theory of Asymmetric Information

Asymmetric information is mentioned as one of the three factors of market’s failure including externalities, public goods and asymmetric information This term was first introduced by Akerlof (1970) The asymmetric information is the situation in which some parties possess the information about the transaction in market while other parties involved

in this transaction do not obtain the same information Akerlof (1970) argues that the buyers collect the information in market and apply the statistic technique to measure the average value of this class of goods So, the buyers just estimate the length of goods value while the sellers have knowledge about the specific goods

Figure 2.3: The asymmetric information theory

Source: Anderson and Lyall (2013)

The smooth exchange of information between the seller and buyer is prompting the successful and efficient transactions The presence of asymmetric information could increase the agency cost and an adverse outcome (Anderson and Lyall, 2013)

Stiglitz (2000) identifies the inefficient market with the existence of asymmetric information problem and its consequences including (1) Adverse selection, (2) Moral hazard and (3) Monitoring cost Keat, Young and Erfle (2013) also restate the problems with asymmetric information and give the response of market with asymmetric information problem such as obtaining the information from third parties, depending on the seller’s reputation, market signaling

Healy and Palepu (2001) conclude that information asymmetric problem and conflict of interests between the owners and managers lead to an increase in demand of financial statements and control of disclosure information by third party Ittonen (2010) affirms the role of auditing in the channel of dealing with the asymmetric information problems and increasing the credibility of financial information disclosure

To summarize, the theoretical framework explains the role of the third party in monitoring the firm performance and ensuring the credibility of the financial information disclosure The external auditing is considered as the essential mechanism to reduce the problems of market failure and protect the rights of outside and inside parties

2.1.2 Definition and measure of firm performance

Firm performance is one of the most important definitions of business activities It

is also a complex term which includes many aspects Based on the stakeholder theory, a firm is considered as an efficient entity when it satisfies the requirements of stakeholder These requirements are divided into two main groups in seven different aspects including financial performance (profitability, growth and market value) and social performance (employee satisfaction, customer satisfaction, environmental performance and social performance) (Santos and Brito, 2009).The term of firm performance is also identified in paper of Venkatraman and Ramanujan (1986) who categorize corporate performance into three different aspects: financial performance, business performance and organizational effectiveness This study focuses on the financial aspect of firm performance which influences profitability, market value and growth

There are many different methods to measure firm performance One of the most popular methods is that using the financial ratios to represent for firm performance The widely used indicator is Return on Assets (ROA) which reflects the effectiveness of assets management to generate the profits The disadvantages when using ROA to measure firm performance is the historical figures because ROA represents for firm’s accounting measurement In order to reflect the market value on firm performance, the researcher develops the market measurement indicator which is Tobin’s Q (Brainard and Tobin, 1968) Previous studies use two indicators in their studies to proxy for firm performance, such as the paper of Sayyar et al., (2014), Dadashi et al., (2014), Richard et al., (2009), etc

Besides that, Altman (1968) initially introduces Z-Score which uses to measure firm performance and assesses the financial health of companies Z-Score presents the probability of risk of bankruptcy The higher value of Z-Score indicates good firm performance, this firm is in the safety area and harder to bankrupt It is a comprehensive combination between the accounting value and market value By overcoming the disadvantage of Tobin’s Q and ROA, Z-Score is the good proxy to assess firm performance (Vo H.D and Nguyen T.M, 2014) The previous studies use Z-Score to measure firm performance in aspect of financial distress including Altman (2000), Aasen (2011), Shahwan (2015), Vo H.D and Nguyen T.M (2014) etc

To sum up, this study aims to combine three indicators to proxy for firm performance including ROA represents for accounting measurement, Tobin’s Q presents for Market measurement and Z-Score determines the risk of bankruptcy

2.2 Empirical evidence about the impact of audit quality on firm performance

The information of listed company’s financial status receives interests from the investors, creditors, suppliers, etc… The external auditor is considered as third party which ensures and reinforces the confidence of users of firm’s financial reporting Therefore, audit quality improvement is always the preoccupation of regulators and researchers

Audit quality can be measured using direct or indirect approach The direct approach uses the definition of audit quality to address the measurement of audit quality, while indirect approach bases on the surrogates of audit quality and select the suitable variables to represent audit quality

Regarding to the feasibility of the indirect approach, previous studies use different proxies for audit quality Balsam et al (2003) show that audit quality is the unobservable and ambiguous definition, so the best measurement is to use auditor characteristics to surrogate audit quality Hussein and MohdHanefah (2013) also suggest that it is better to use the indirect method to assess audit quality Nguyen and Ha (2014) provide empirical evidence in Vietnam regarding to the factors affect independence characteristic of audit, and conclude that audit rotation is one of the key drivers of auditor’s independence and audit quality Sayyar, et al., (2015) measure audit quality by using audit fees and audit rotation Al-Khaddash, Nawas and Ramadan (2013) use the set of variables such as

internal control, audit firm size, audit fees, auditor independence, industrial specialization and auditor competences Ziaee (2014) examines audit tenure, audit reputation and audit firm experience James and Izien (2014) consider audit tenure, audit firm size, auditor independence as the proxies of audit quality Dadashi et al (2014) assess the audit quality

by three proxies which are audit reputation, auditor independence and auditor’s specialty

Lu and Ma (2016) measure audit quality by audit opinion, audit reputation and audit fee

This study uses audit rotation, audit reputation and audit firm experience to proxy for audit quality because of the highly representative and the availability of data sources Audit rotation presents for independent characteristic of audit quality, audit reputation and audit firm experience presents for the brand and specialty in auditing field

2.2.1 The impact of audit rotation on firm performance

Mandatory audit firm rotation is identified in section 207 of the Sarbanes – Oxley (SOX) Act as the principle of a limit time of auditor tenure has conducted and implemented the auditing procedures of one company After the expiration of audit period, the current audit firms will not be re-appointed during a specific period There are many arguments surrounding the audit rotation problem They consider that whether audit rotation will enhance or deteriorate the audit quality

The primary purpose of audit is to give independent opinion to shareholders about the true and fair view of financial statements in material aspects, whether they have prepared in accordance with the Companies Act and Accounting standards The benefits of the users of financial statements (shareholders, potential investors, employers and other sectors in business community are guaranteed (ICAEW, 2006)).The policy makers, regulators and professors have effort to improve the audit quality through enhancing the auditor independence Coyle & Deirdre (2010) investigate 20 accounting firms and interview Irish Accounting bodies, audit regulators, they find that one of the most efficient way to improve and enhance an auditor’s independence perceptions is audit firm rotation

Ouyang and Wan (2013), Anis (2014), Arel et al., (2005), Chi et al., (2009) also give the empirical evidence which shows that the length of audit tenure affects to likelihood perception of auditor independence and audit quality

Ouyang and Wan (2013) find that if the length of audit period is longer than ten years, the probability of accounting fraud in company might increases Moreover, by utilizing the sample of listed firms in USA from 1996 to 2005, they also find that the drawback of long audit tenure in the large companies is more serious than that of small companies The empirical results confirm the effect of audit rotation on audit quality and firm performance

Okolie (2014) examines the impact of audit quality on earning management from discretionary accruals and economic operation manipulation of listed companies on Nigerian Stock Exchange (NSE) during the period from 2006 to 2011 The result shows that audit quality represented by audit rotation and audit fee has significantly negative impact on earning management It means that audit rotation is positively affects firm performance through mitigating the manipulation of managers

Rahmina and Agoes (2014) state that the failure of business is attributed to auditing failure So, they emphasize the role of audit quality on the credibility of users of financial statements Rahmina and Agoes (2014) suggest that an Institute of Public Accountants should be established and the current mandatory auditor rotation and audit firm rotation should follow the international regulations which require audit rotation every seven years for listed companies in Indonesian stock market

Ardiana (2014) investigates the role of external audit via audit rotation in enhancing the firm performance in Indonesia Firm performance is measured by P/E, P/B and Tobin’s

Q By using 2,240 firm-year observations during the period from 2007 to 2013, the study concludes that the longer audit tenure decreases the firm performance

Khatab (2013) examines the effect of audit rotation on the firm value proxied by Tobin’s Q in Egyptian stock market from 2005 to 2009 Using the Fixed effects model and random effects model, the study gives evidence that audit rotation has a positive effect on enhancing firm performance

Mostafa and Hussien (2010) implement the self-questionnaire survey from 50 auditors who are randomly selected They suggest that mandatory audit rotation at firm level should be applied in Egypt rather than rotation at auditor level Based on the client’s

specialization industry, the audit firm will appoint auditors with extensive experience in this field to audit the client, which will generate more benefits for both sides

Sayyar et al., (2015) examine the impact of audit quality proxied by audit rotation

on firm performance of listed companies in Malaysia from 2003 to 2012 The empirical evidences show that audit rotation is insignificantly correlated with firm performance measured by ROA and Tobin’s Q Myers et al., (2003) find that the longer auditing periods can mitigate more extreme management decisions on firm performance

In general, there are two primary points of view about the role of audit rotation from the literature review On one hand, audit rotation is considered as the long length of audit tenure which leads to closer auditor-client relationship and reduces the auditor independence and quality of audited financial statements Anderson and Verma (2012), Crabtree et al., (2004), Lu & Sivaramakrishnan (2009) find that the audit rotation is the useful and feasible method to guarantee auditor independence and objectivity Elder et al., (2015) examine the audit firm rotation and audit quality data in Florida government audit market and suggest that rotation policies have positive relation to audit quality via audit firm selection

On the other hand, it is argued that the pressure of maintaining the clients and improving the relationship with clients could cause the auditor to ignore and being unskeptical about the accounting information of clients Some researchers investigate the relationship between audit rotation and audit quality and conclude that the change of auditors after certain period could bring the fresh look and perspective to the audit process

It also increases the probability of detection of misstatements (Siregar el at, 2012)

There are many reasons the clients have to deal with because of changing current auditor From the companies perspectives, the cost of audit switching and the process of selecting new auditor is really an instrumental problem under the global competition and the pressure of reducing company’s expense (Myers et al.,2003) Besides, frequent change

of audit firm is not always as efficient as expected, because if the financial disclosure is in low quality, the Board of Directors have intention to change the audit firm to conceal the accounting figures (Johnstone and Bedard, 2004) From the auditors’ aspect, some studies show that current auditors have more experience and familiarity with the client’s business

process, hence are more likely to detect the frauds than new auditors (Ghosh& Moon, 2005; Mansi et al., 2004; GAO, 2003) Lu and Sivaramakrishnan (2009) believe that it is not easy to have deep insight into accounting systems and understanding of the clients’ internal control Therefore, new auditors will get troubles in the first year Moreover, in the final year of appointment, previous auditors will not make more efforts to guarantee the auditing report

Kaklar et al., (2012) examine the relationship between audit quality surrogated by audit firm size, audit rotation and financial reporting quality The authors expect that high audit quality will increase the quality of financial reporting as a tool for preventing financial distress However, with that dataset of 91 firms listed in Tehran Stock Exchange, the study finds no evidence about the relationship between the audit rotation and financial quality reporting It means that changing auditor is not a significant factor affect the financial disclosure and the shareholders’ assessment about firm performance

Mandatory audit rotation can be implemented via the audit firm rotation or auditor rotation compulsorily or voluntarily This study focuses on the audit rotation at firm level and complies with the regulations (except for voluntary rotation at certain times) However, the audit firm rotation has been confronted with many debates International Standard of Auditing (ISA) states that the appointed auditor has been changed every 7 years and come back after 2 years

The Ministry of Finance in Vietnam required that changing the auditors and person responsible for signing audit reports after 3 consecutive years from 2004 (Decree No 105/2004/ND-CP) Regarding to audit firm rotation, Circular No 39/2011/TT-NHNN was promulgated by State Bank of Vietnam which required that financial institutions such as banks, insurance companies have to change the audit firm after 5 continuous years This regulation does not apply for public companies in Vietnam In the workshop of VACPA discussed about the Independent Auditing Act Project, the term of auditing period was mentioned again, but no agreements could be given to unify the appropriate period for audit firm rotation (Auditing Magazines in March, 2011) Based on the actual situation of each country, they require the audit tenure differently In the case of Korea, the time for audit rotation is 3 years and can re-appointment after 3 years The possible acceptance of audit tenure in China, Poland, Singapore, Turkey is every 5 years

Therefore, this study develops the following hypothesis

H1: Audit firm rotation has a significant impact on firm performance measured

by ROA, Tobin’s Q and Z-Score

2.2.2 The impact of audit reputation on firm performance

The audit reputation increases the credibility of the firm’s financial reporting Many parties use the declared financial information but they cannot approach or observe the source documents and assess the audit quality directly to identify the level of information accuracy (Krishnamurthy, 2006) The shareholders have to depend on the independent party who is the expertise in accounting and finance to express their opinion about the true and fair view of annual financial statements DeAngelo (1981) and Dye (1993) believe that the presence of “auditor-reputation effects” causes the larger audit firms to protect their brand by focusing on their audit working and assuring the quality to minimize audit errors than smaller audit firms

According to Jusoh et al., (2013), audit quality and firm performance are positively and significantly related The audit reputation is a proxy of audit quality which is measured

by a dummy variable with Big-Four and Non-Big Four Audit firms They suggest that higher quality of audit might reduce the agency costs and reinforce the trust in financial information disclosure Fooladi and Shukor (2012) consider audit quality as an external corporate governance factor that affects firm performance and find that audit reputation has

a positive correlation with firm’s market capitalization

Lu and Ma (2016) examine the association between audit quality and financial bankruptcy Data is collected from the China Stock Market Accounting Research (CSMAR) database over the period from 2012 to 2013 Lu and Ma (2016) measure audit quality by audit opinion, audit reputation and audit fee, while the financial distress is calculated by Z-Score The empirical evidence confirms that audit quality is negatively and significantly correlated with risk of financial crisis and the findings also suggest that external monitoring auditing is an effective mechanism to deal with risk of bankruptcy

Dadashi et al (2014) find no relationship between the audit reputation and firm performance in Tehran Stock Exchange between 2009 and 2013 The empirical evidence

of this paper also shows that the effect of external regulatory of mechanism on firm performance in Tehran’s listed companies is unobvious

Razafindrambinina and Kwan (2013) show a negative correlation between the reputation of auditors and initial return of share price The reason might come from the fact that owners of IPO firms would like to hire the strong reputable audit firms instead of the audit firms with high quality and under-pricing willingness to pay of investors compared to market price

According to the results of Jusoh et al (2013), Fooladi and Shukor (2012), Lu and

Ma (2016) believe that the reputation is positively correlated with firm performance They argue that the high reputation will increase the credibility of financial information disclosure and they have a tendency to enhance the audit quality to maintain the high standard position Therefore, the listed firms use the assurance service of reputable audit firm such as KPMG, PWC, E&Y and Deloitte (Big4) to get more credibility of shareholder However, some previous studies conclude that audit reputation and firm performance is not statistical correlation (Dadashi et al., 2014) The hypothesis has been developed as follows

H2: There is a significant effect of audit reputation on firm performance

2.2.3 The impact of audit firm experience on firm performance

Audit firm experience is considered as one of the determinants of audit quality Audit firm experience is the length of audit firm joining in community Some opinions noted that the elimination of market is really serious It is not easy for a firm could survive for a long time in specialized field Because they have to capture the demand of market, guarantee the trust and quality of their products Especially, in the high professional field such as accounting and auditing, the assurance of audit expressed opinion has even been assessed more strictly The experience of old institutions is one of factors affecting audit quality

Ziaee (2014) uses the questionnaire in order to examine the effect of audit quality

on firm performance in Tehran and the result shows that audit firm experience has a positive significant association with the firm performance

Kheirollahi et al., (2014) also conclude that the audit firms of higher antiquity have positive correlation with the listed firm performance They use four factors to measure audit quality including firm size, firm reputation, age and experience The results suggest that high quality auditor could affect firm’s profit in the future With the similar findings, Paydarmansh et al., (2014) emphasize that audit firms with high age and experience will assure the quality of opinion about financial information disclosure and maintain the credibility of investors through the high value of firm market capitalization

Consequently, the third hypothesis of this study is as below:

H3: There is a positive significant association between the years of audit institution and firm performance

2.2.4 The effect of Vietnamese Auditing Standards (VSA 220) on “Quality control of financial statements audit activities” on firm performance

VSA 220 on “Quality control of financial statements audit activities” is one of the 37 new auditing standards which is effectiveness from January 1st, 2014 The main objective of this standard is to enhance the role and responsibility of audit activities of auditors and audit firms The researched period from 2010 to 2015, including the transition period of new auditing standards, so this study would like to find out whether the regulation of enhancing audit quality activities has had any effect on firm performance Therefore, fourth hypothesis is developed as follows:

activities” significantly affects firm performance in Vietnam

2.3 The conceptual framework

In general framework for audit quality and firm performance has been applied in

this study

Figure 2.4: TheAnalytical Framework

Source: Author’s analysis

Firm Performance

ROA (Return on Assets)

TOBIN’Q (Market Value)

Z-SCORE (Corporate bankruptcy)

3.2 Methodology

This study applies the dynamic panel data approach suggested by Okolie (2014) and Sayyar et al., (2015) The endogeneity problem might exist in the effect of audit quality on firm performance because audit quality might be affected by the next firm performance via audit firm selection The use of one-year lagged dependent variables is considered to deal with endogeneity problems and mitigate the impact of previous firm performance The past firm performance shows a good financial status, firm intends to continuously use current audit firm or hire a more reputable audit firm to enhance the credibility of financial statements in the next year Nevertheless, if the previous firm performance is not good, some listed firms have a tendency of hiring audit firm with higher audit quality in next year to express opinion about financial statements aimed to increase the quality of financial statements and firm market’s value So, this study uses the estimation technique of Generalized method of moments (GMM) to address the potential endogeneity problem The GMM estimation will be efficient and preferable to IV estimation because of the existence of heteroskedasticity

Following the work of Sayyar et al.,(2015) and Okolie (2014), the empirical models are written as:

ROA i,t = β 0 +β 1 ROA i,t-1 + β 2 AuditQi,t + β 3 LEV i,t + β 4 LNASSET i,t + β 5 SG i,t + ε i,t (1) Tobin’Qi,t = α 0 + α 1 TQ t-1 +α 2 AuditQ i,t + α 3 LEV i,t + α 4 LNASSET i,t + α 5 SG i,t + ε i,t (2)

Z-Scorei,t = γ0+γ1 Z-Score i,t-1+ γ2AuditQ i,t +γ 3 LEV i,t γ 4 LNASSET i,t +γ 5 SG i,t + ε i,t (3) Whereas i: firm, t: time, from 2010 to 2015

In order to assess the impact of audit quality on firm performance comprehensively, this study measures firm performance from three approaches: market value, accounting profit and risk of bankruptcy

Dependent Variables: Firm performance is measured by

1 ROA (Accounting measurement):

re-Tobin’s Q = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑠𝑡𝑜𝑐𝑘+𝑀𝑎𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦

𝑅𝑒𝑝𝑙𝑎𝑐𝑒𝑚𝑒𝑛𝑡 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠

It is not easy to measure the market value of liabilities Similarly, there are various types of assets in company, estimation of the replacement costs of assets are really complicated Previous studies use the book value instead of market value to calculate liabilities and assets This formula is also adopted in this thesis to measure Tobin’s Q

Tobin’s Q = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘+ 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦

𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Tobin’s Q measures firm value as a proportion of both market capitalization and total book of liability to firm totalassets When the Tobin’s Q indicator is lower than 1, the company is undervalued because the market value of the firm is lower than the value of firm’s assets In contrast, once Tobin’s Q is higher than 1, the value of this firm in market

is higher than value of firm’s assets

In another word, if the value of Tobin’s Q is high, company will invest more because it is easy to mobilize capital in the stock market On the contrary, company will reduce investment when Tobin’s Q is low

3 Z-Score (firm’s risk of bankruptcy)

Z-score is developed by Altman (1968) to calculate the risk of corporate

bankruptcy This ratio is also used to evaluate the firm’s financial health status Z-Score is made up from five financial ratios:

Z-Score = 0.012X 1 + 0.014X 2 + 0.033X 3 + 0.006X 4 + 0.999X 5

Where :

- X1 : Working capital /Total assets

- X2: Retained earnings / Total assets

- X3: Earning before interest and taxes / Total assets

- X4: Market value equity / Book value of total debt

- X5: Sales / Total Assets

The higher value of Z-Score means the lower risk of bankruptcy The credit of bankruptcy rating is divided into three benchmarks

Table 2: The Z-Score level

2.99< Z-Score Safety level The company will not likely go bankruptcy with the

presented accounting figures

1.81< Z-Score < 2.99 Dangerous level The investors need to consider about the ability

of bankruptcy

Z-Score <= 1.81 Serious problems relative the financial performance The

company faces with the high risk of bankruptcy

Source: Altman(1968)

Independent Variables:

In this study, audit quality is proxied by three variables as suggested by Ziaee (2014) and Navid, Mehdi, Martina (2014): audit rotation (period ofaudit), audit firm reputation and audit firm experience

 Audit Rotation: (ROTATION): The dummy variable is categorized 0 and 1 In the current year, if the firm has change the audit firm, this variable will be 1 and 0 otherwise

 Audit Reputation (REPUTATION): The dummy variable is measured by using the granted to the quality of audit firms including Big Four (equal 1) and Non-Big Four (equal 0)

 Audit firm experience (EXPERIENCE): Criteria to represent auditing firm antiquity, is the number of year in that audit firm certified public accountants and accepted to join the community

 Audit quality legal framework (VSA 220): VSA 220 on “Quality control of financial statements audit activities” was promulgated and came into effect in 2014

In order to test his legal framework effect, we use a dummy variable which takes the value of 1 for the year 2014 and 2015 and otherwise

Control variables:

There are some potential variables which can affect firm performance Based on the theoretical and previous empirical evidences, four variables have been chosen The explanation of selected variables was noted below

 Leverage (LEV): The proportion of debt to total assets

Leverage is an instrument in the firm’s capital structure The investors usually expect to receive higher return on investment Therefore, managers prefer to use the leverage in order to take advantage of tax shield Based on agency cost theory, leverage is positively related to firm performance (Roden and Lewellen, 1999; Ghosh and Jain, 2000; Hutchinson, 1995) In contrast, Jensen and Meckling (1976), Hutten (2014), Mule (2015) reveal that there is a negative correlation between leverage and firm performance based on free cash flow hypothesis and the monitoring hypothesis

 Firm size (LNASSET): The natural logarithm of total assets

The logarithm of total asset represents the firm size Larger companies receive more benefits than small firms because larger firms can easily approach many different financial sources with better interest rate and discount rate Moreover, larger firms have skilled labors forces and have more market power and might become market leader with huge profits According to Dogan (2013); Pervan and Visic’ (2012) firm size has a positive effect on firm performance

 Sales growth (SG): The difference between the current sales and previous sales/ Current Sale year

This formula indicates the variance between current sales and previous sales which accounts for how many percent in current sales To avoid the sales growth can’t be calculated when the previous sales is equal zero Moreover, this calculation also reflects the sign of sales growth more obvious

Sales growth of a company represents for development periods Company with higher sales growth is in the stage of expanding its market shares or in high development periods and will attract more investors in the future Audretsch (1995) shows that higher sales growth and profitability pushes higher innovation activities

in low technological firms Blundell and Bond (1998) also find that sales growth

and firm profitability has positive and significant correlation, suggesting that firm with higher growth have better performance

To sum up, this thesis uses GMM estimation to deal with the endogeneity problem Regarding to the heteroskedasticity, System GMM is proper method to deal with this problem, whereas 2SLS method is only efficient with homoskedasticity Therefore, by testing the existence of heteroskedasticity problem, this study has an additional reason for choosing the appropriated method Breusch-Pagan or Cook-Weisberg test is applied Sargan or Hansen test uses to test the validity of instrumental variables The null hypothesis of Sargan and Hansen test is the exogenous of instrumental variables So, the higher p-value of Sargan or Hansen test show that it is a good instrumental variable Besides that, the Arellano-Bond estimation is proposed by Arellano-Bond (1991), which examines the autocorrelation

Table 3: Summary of variables and Predicted Sign of Coefficient

Expected Sign

Dummy variable equal 1 for the year of 2014 and 2015 (after the

Control Variable

𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡𝑠 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑆𝑎𝑙𝑒𝑠−𝑃𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑆𝑎𝑙𝑒𝑠

CHAPTER 4:

DATA ANALYSIS AND EMPIRICAL RESULTS

4.1 Descriptive Statistics and basic estimation

4.1.1 Descriptive Statistics

According to the Industry Classification Benchmark of FTSE Group and DownJone, which is the popular criteria of dividing the industry sectors in the world, the business fields of listed companies in dataset are categorized into 10 different sectors including Oil and Gas, Industrials, Consumer Goods, Healthcare, Consumer Services, Utilities, Real Estate, Technology, Basic Materials These are illustrated in Table 4

Table 4: Categorized Business Fields

No Business Field Amount Percentage

Source: Author’s calculation

The majority of business areas of researched companies are Industrials and Consumer Goods which account for28% and 22%, respectively There is fewer companies

in Oil & Gas, Healthcare and Technology industries with around 3% for each as most of the firms in these fields listed in HNX and UpCom stock market

Table 3 shows the descriptive statistics of dependent and independent variables in the model This presents the mean, standard deviation, minimum, maximum values and

gives the overview of characteristic of variables which evidence quite large heterogeneity

in the data sample

Table 5 Descriptive Statistics

Source: Author’s calculation

Mean of audit rotation shows that there are 17.24% companies had changed audit firm at least one time during the tested period This value is much higher than the result in the Sayyar el at., (2015) for Malaysia which is 6.3%, but lower than that of in Indonesia which is 36.75% (Siregarel at., 2012)

There are 30.69% listed companies use the Big-4 firms (including KPMG, E&Y, PWC and Deloitte) to audit their companies and the audit firms is in charge of expressing opinions about financial statements of listed companies Other audit firms in dataset also have extensive experience (more than 19 years old at average)

Average ROA is 6.24% The minimum and maximum values are -0.6455 and 0.7837, respectively ROA indicates the effectiveness of using assets to create more profits

If the ROA indicator is low or negative which means that company suffers loss in management assets and capacity of changing assets into return is inefficient This figure is consistent with the result in developing countries such as Malaysia in Sayyar et al., (2015), Mustapha and Ahmad (2011) and Hashim et al., (2010) who show the results of2.4%, 3%