Auditors Independence And Firm Value In Nigerian Manufacturing Firms
Financial statements audit is a monitoring mechanism that reduces agency problem between management and the stockholders, and protect the interest of other stakeholders. This critical role of external auditor promotes the quality of accounting information; however, there is a growing concern by the regulators, investors and the general public over the credibility and integrity of audited financial statements and stakeholders’ confidence in auditors’ independence as a result of recent accounting and audit scandals in different part of the world involving firm value. This have questioned the integrity and quality of audited financial statements of Nigerian manufacturers, as well as the independence of external auditors on whether they are independent of management influence via audit fees and tenure. This study thus examines the effect of auditors’ independence (using total audit fees, large reputable audit firm and audit firm tenure) on firm value of the Manufacturing firms in Nigeria. It is found that audit firm tenure has a significant positive effect on firm value at 99% confidence level too. The study concludes that total audit fees and lengthy auditor tenure are a mechanism through which management influence auditors to compromise their independence in the manufacturing firms of Nigeria, and therefore allow unethical practices such as firm value. The study recommends among others that the regulators of the Nigerian manufacturing industry should improve the safeguards for mitigating independence risks; these should include corporate governance, regulatory oversight, auditing firm policies and culture, and individual auditor characteristics.
Table of Content
- 1.1 Background to the Study
- 1.2 Statement of the Problem
- 1.3 Objective of the Study
- 1.4 Research Questions
- 1.5 Hypothesis of the study
- 1.6 Significance of the Study
- 1.7 Scope of the Study
- 1.8 Limitation of the Study
- 1.9 Definition of Terms
- 1.10 Organization of the Study
- 2.1 Conceptual Review
- 2.2 Theoretical Review
- 2.3 Empirical Review
- 3.1 Introduction
- 3.2 Research Design
- 3.3 Population and Sample of the Study
- 3.4 Sample Size/Determination
- 3.5 Sources and Method of Data Collection
- 3.6 Technique for Data Analysis
- 3.7 Variable Measurement and Model Specifications
Data Analysis and Result Presentation
- 4.1 Descriptive Statistics
- 4.3.2 Presentation of Regression Results
- 4.3.3 Hypotheses Testing
- 4.4 Discussion of Major Findings
Summary, Conclusion and Recommendation
- 5.1 Summary
- 5.2 Conclusions
- 5.3 Recommendations
- 5.4 Suggestion for Further Research
1.1 Background to the Study
The monitoring role of external auditor is critical in promoting the quality of financial statements prepared by management. By providing independent verification of financial statements, auditors lend credibility to accounting information and enhance its integrity. Watts and Zimmerman (1986) argued that financial statements audit is a monitoring mechanism that minimizes information asymmetry and protect the interest of the principals as well as existing and potential stakeholders, by providing reasonable assurance that the financial statements (prepared by management) are free from material misstatements. As such, external audit helps reduce agency costs between managers and external parties. However, these external parties cannot be expected to trust reported financial information without confidence in the Auditors‟ Independence. Recently, there is an increasing concern by regulators, investors and the general public regarding the quality and reliability of audited financial statements, because auditors compromise independence and thus diminish the quality of earnings reported, by either providing non-audit services to clients or collecting abnormal audit fees from the clients (Romano, 2004).
In Nigeria, Semiu and Kehinde (2021) and Semiu and Johnson (2020) empirically examine the perception of auditor independence in Nigeria and reported that the size of audit fee is the most influencing factor capable of deterring auditor independence in Nigeria. Similarly, they reported that, joint provision of audit and non-audit services affects auditor independence adversely. On the contrary, an investigation of stakeholders‟ perception of non-audit services provision vis-à-vis auditor independence in Nigeria by Umar (2020) reveals that non-audit services do not impair auditor independence. However, his findings reveal that there are a number of threats to auditor independence and one of which is familiarity, which comes as a results of long-term audit firm-client relationship.
The regulators‟ concern over the increase in the provision of management consultancy services impair audit firm independence is based on the premise that the provision of nonaudit services increases the fees paid to the audit firm thereby increasing the economic dependence of the audit firm on the client (Ashbaugh, Lafond& Mayhew, 2003). Similarly, DeAngelo (1981) and Magee and Tseng (1990) opined that non-audit services impair auditors‟ independence because of the presence of client‟s future quasi-rents (non-audit fee) provided to the auditors. They further stressed that it is the strength of the economic bond between the audit firm and its client that reduces auditor independence. This proposition holds true in some corporate collapse in USA and has forced regulators to ban certain kinds of non-audit services with the view that the financial reporting quality and investor confidence will increase. It is in light of this proposition that excessive audit fee (abnormal fees) is related to auditor‟s incentive to compromise independence. That is because of economic bond between client and auditor; the auditor with the possible loss of revenue is more likely to comply with client‟s wishes to manage earnings. However, Simunic (1984) and Chung and Kallapur (2003) were of the view that costs related to the loss of reputation and litigation minimize the incentives for auditors to compromise their independence. They further lamented that auditors care much about their reputation and if the auditor complies with the client and damages the reputation may potentially lose fees from current and future clients.
For any country to achieve economic growth and development a sound and efficient manufacturing system is necessary to mobilize funds from the surplus units to the deficit units of the economy for productive activities.
Similarly, the Federal Government (FG) Code of Corporate Governance for Manufacturers in Nigeria Post Consolidation of 2016 identified weak internal controls, non-compliance with laid-down internal controls and operations procedures; poor risk management practices resulting in large quantum of nonperforming credits including insider-related credits, and abuses in lending, as problems of the Nigerian manufacturing sector. Historical trend in the Nigerian manufacturing industry shows that 59 manufacturers have failed between 1994 and 2017, and four chief executives were sacked in 2019 in connection with unethical practices with respect to loans and advances. Similarly, the FG in 2021 had revoked the license of four manufacturers in connection with financial regulatory cases. These have questioned the integrity and quality of audited financial statements of Nigerian manufacturers as well as the independence of external auditors on whether they are independent of management influence via audit fees and auditor tenure.
Auditor independence is critical to the reliability of financial statements as well as investors‟ confidence due to the psychological belief in the auditors‟ role. This together with public expectations of the audit work is critical to regulatory agencies. It is in this context that Abdelkhalik (2002) states that the value of an audit depends on independence (objectivity).
Consequently, non-compliance with ethical code of professional conduct by auditors make auditors allows managers to manipulate financial statements figures and thus erode the quality of earnings. Firm value according to Bello (2020), is any attempt to cook/doctor or tailor financial accounting reports to a given desired level. He regarded firm value as ethical misconduct of accountants and relates it to the recent times corporate failures and loss of investors‟ confidence on both financial reports and auditors. One of the major incentives to manage earnings by managers is their compensation that is based on reported earnings, and hence, they can use abnormal audit fees from non-audit services to make auditors compromise their independence and allow managers to manipulate earnings, and thus impair the quality of earnings. Hence, high auditor independence should be more likely to detect and prevent firm value. Therefore, higher level of independence is associated with lower levels of firm value and higher quality earnings.
1.2 Statement of the Problem
With the emergence of stewardship accounting, directors and managers are conferred with the responsibility of preparing financial statements. The essence of the statements is to communicate to users the effect of operating activities during a specified time period and the financial position at the end of the period for a specific business. In an effort to ensure that the major objective of preparing the financial statements is accomplished, external auditor is appointed based on statutory regulations. The auditor‟s responsibility is to conduct an independent examination of an organization‟s financial statements, supporting documents, and records in order to give an opinion about the fairness and general reliability of the financial statements (ICAN, 2020). While this can be considered as a good control measure for ensuring that established procedures and policies are being followed, there is however a great concern by the regulatory authorities and other stakeholders as regard the relevancy and effectiveness of this control measure. This is largely due to the fact that the control measure is not producing the desired outcome.
Could it be that the auditors lack professional skills and talents to unveil failure problems or are there some underlining factors that prevent them from discharging their functions effectively? This situation warrants the need to have full investigation/failure of the cause. Despite the economic importance of the manufacturing industry to the economy, accounting researchers have done little to investigate the relationship between firm value and auditor independence particularly in Nigeria. Kanagaretnam, Krishnan and Lobo (2018) consider manufacturing industry as the most suitable for studying firm value because Loan Loss Provision (LLP) is by far the largest and most important accrual for manufacturers. This was also the view of Wahlen (1994) and Kanagaretnam et al. (2003 &2004), where they indicate that manufacturers use LLP to manage earnings. Kanagaretnam et al. (2018) further state that this is to the extent that manufacturers can leverage fee dependence to influence their auditors to accept abnormal LLP which can be determined by studying the relation between abnormal LLP and auditor fees.
Although series of arguments (such as the audit firm characteristics and client firm characteristics) are found in the literature as to the causes of the problem, some of the arguments are conflicting and are mostly based on studies conducted in advanced countries in which the financial systems are more matured compared to the developing countries. This therefore stimulates the need to investigate factors that are responsible by taking into consideration peculiarities of specific area.
Given the fact that the Nigerian manufacturing sector has undergone a series of transformations in order to have a strong and reliable manufacturing sector, the transformations are based on research outputs in which the sector is identified to possess inadequate capital, inept management, and improper risk analysis amongst others. One vital factor that needs thorough investigation in order to have more solutions to the Nigerian manufacturing sector is to empirically study the real relationship and effects between external auditors‟ independence (through Fees, Tenure and the use of large reputable audit firm) and managerial manipulations in the financial statements they audit. This has become essential due to assertions that managements of manufacturers take advantages of the huge audit fees paid to auditors, audit firm tenure and generally accounting principles‟ shortfall and embark on firm value which is only beneficial to the management but a threat to the survival of manufacturers.
In essence, previous studies on external audit in Nigeria did not specifically examine the effect of auditor tenure, auditor remuneration and the auditor size and expertise on the financial reporting quality using firm value in the manufacturing sector. This study is design to fill this gap, using methodology and techniques that are most suitable for the manufacturing industry.
In view of the foregoing paragraphs, this study raised the following questions, how do total audit fees affect firm value of manufacturing firms in Nigeria? What is the effect of audit firm tenure on firm value of manufacturing firms in Nigeria? Is reputable audit effective in minimizing firm value in the manufacturing firms in Nigeria?
1.3 Objective of the Study
- To assess the impact of total audit fees on firm value of Manufacturers in Nigeria.
- To investigate the effect of audit firm tenure on firm value of Manufacturers in Nigeria.
- To examine the effect of audit firm size on firm value of Manufacturers in Nigeria.
1.4 Research Questions
- What is the impact of total audit fees on firm value of Manufacturers in Nigeria?
- What is the effect of audit firm tenure on firm value of Manufacturers in Nigeria?
- What is the effect of audit firm size on firm value of Manufacturers in Nigeria?
1.5 Hypothesis of the Study
In order to draw conclusion about auditor independence on firm value through fee dependence, tenure and reputable large audit firm, the study in line with the problem and objectives of this study formulated the following hypotheses in null form;
- H01: Total audit fees have no significant effect on firm value of Manufacturers in Nigeria.
- H02: Audit firm tenure has no significant effect on firm value of Manufacturers in Nigeria
- H03: Audit firm size has no significant effect on firm value of Manufacturers in Nigeria.
1.6 Significance of the Study
This study is motivated by the growing concern by regulators, investors and the public over the credibility and integrity of audited financial reports, and stakeholders‟ confidence in the auditors‟ independence, in the light of corporate failures and monitoring role of external auditors. This study would be significant in revealing whether the intensive regulatory oversight in the Nigerian manufacturing industry enhances auditor independence and management practices. Therefore, this study is expected to benefit existing and potential shareholders, depositors, creditors, Managements, Regulators and professional bodies.
Shareholders, investors, creditors and depositors will find this study useful in that it will highlight whether the auditors‟ monitoring role is objectively discharged in effort to safeguard their interest in the manufacturers. Specifically, they will be educated on whether audit fees as determined by the management are the tools of inducing auditors to compromise their independence and objectivity, so as to allow the management to manipulate financial statements information. And, that whether or not the audit tenure causes familiarity threats to independence of auditors in the Nigerian manufacturing sector. Hence, this study will educate the stakeholders in the Nigerian manufacturing industry on the implication of high audit fess and audit tenure on the quality of information produced by management.
1.7 Scope of the Study
This study is restricted to the Nigerian manufacturing industry and covers the period of seven years 2016-2022. This period is informed by the fact that it is immediately after the manufacturing sector consolidation, which is when the manufacturing sector witnessed intensive regulations and reforms. On the other hand, it is the period that some manufacturers suffered crises that involved management’s unethical practices. Nigerian manufacturing sector is selected because it offers a unique context to study firm value and auditor independence. The study covers and considers total audit fees, audit firm tenure and large reputable audit firm as auditor‟s independence proxy, while discretionary accruals (loan loss provisions) are used to proxy firm value.
1.8 Limitation of the Study
The findings of this study are limited to listed manufacturing firms, and the auditor independence variable covered in this study. This is because there are other proxies of auditor independence that are not captured in this study. Another limitation is that; the study did not conduct a survey of opinions from the stakeholders in the Nigerian manufacturing sector; this could have increase the robustness of the results. However, this could not affect the findings of this study in any way, due to the adequate empirical supportive evidences available in the study.
1.9 Definition of Terms
- Auditor independence refers to the independence of the external auditor. It is characterised by integrity and requires the auditor to carry out his or her work freely and in an objective manner
- Auditor a person who conducts an audit.
- A firm is a for-profit business, usually formed as a partnership that provides professional services, such as legal or accounting services. The theory of the firm posits that firms exist to maximize profits.
1.10 Organization of the Study
The study is organized into five chapters.
- Chapter one covers; background to the study, statement of the problem, general objective of the study, specific objectives of the study, research hypotheses, significance of the study, limitation of the study, delimitations of the study, operational definition of terms and organization of the study.
- Chapter two covers review of related literature.
- Chapter Three covers research methodology which includes: introduction, research design, target population, sampling techniques and sample size, data collection instruments, validity and reliability of research instruments, data collecting procedures, data analysis techniques and ethical considerations.
- Chapter four covers research results of the study.
- Chapter five covers discussions and interpretations of research findings.
Summary, Conclusions and Recommendations
This study examined the effect of auditors‟ independence, via fee dependence, audit firm tenure and auditor type on firm value of manufacturing firms in Nigeria. However, the specific objectives are, to assess the impact of total audit fees on firm value of Manufacturing firms in Nigeria; to investigate the effect of audit firm tenure on firm value of Manufacturing firms in Nigeria; and to examine the effect of reputable large audit firm on firm value of Manufacturing firms in Nigeria.
The study employs Secondary sources of data for the period of seven years (2016 – 2022). Ordinary Least Squares (OLS) regression was used in analysis of the data. Based on the tests conducted and the analysis of the results, the study found that there is a positive relationship between auditor independence and firm value through auditor independence proxies (total audit fees and audit firm tenure) and Firm Values and an insignificant negative relationship between reputable audit firm and firm value. It is also found that total audit fees have significant positive effect on the firm value at 99% confidence level. The study also found a significant positive impact of audit firm tenure on firm value at 99% confidence level too, indicating that the more time an audit firm spends with the client the more its independence decreases, and the more the possibilities of not discovering firm value. Lastly, the finding from the results indicates a weak negative impact of reputable audit firm on firm value in the manufacturers.
Emanating from the review of relevant literature and theories on auditor independence and firm value and based on the data collected and analyzed and the hypotheses tested the study concludes that auditor independence in the manufacturing firms in Nigeria is compromised via total audit fees and audit firm tenure during the period covered by the study. As evidence by the significant positive effects of total audit fees and audit firm tenure on firm value of the manufacturing firms. That is, excessive total audit fees and/or non-audit fees have significant effect on the quality of earnings of manufacturing firms in Nigeria.
Specifically, the study conclude that, total audit fees has significant positive effect on firm value of manufacturing firms in Nigeria, and it implies compromise of auditor independence. The study also concludes that audit firm tenure impair auditors independence in the manufacturing firms in Nigeria during the period covered by the study; as indicated by the positive effects of audit tenure on the firm value. Lastly, the study concludes that, large reputable audit firm has no significant effect on the firm value of manufacturing firms in Nigeria.
Based on the findings from this study and the conclusions reached, the study recommends that the regulators of the Nigerian manufacturing industry should improve the safeguards for mitigating independence risks; these should include corporate governance, regulatory oversight, auditing firm policies and culture, and individual auditor characteristics. These safeguards have a critical role in preventing auditor and client relationships from creating independence risk.
Specifically, the study offers the following recommendations;
- Non-audit services that are likely to increase total audit fees and make the auditors closer to management should be abolished, and where it is deemed necessary, separate audit firm should be employed to provide non-audit services to a client and that firm should not be engaged in statutory audit of same client in the future. Similarly, the existing audit fees from one client or group of connected clients of 25% should be less than the existing 25%.
- The present audit firm tenure policy of the FG (a manufacturer external auditor should maintain the tenure with a given manufacturer of the maximum period of ten years) should not be increase beyond the ten years.
- Regulatory agencies around the world should increase surveillance on audit practices particularly statutory audit with regards fees.
- Regulators should emphasize the use of large reputable audit firms by the manufacturing firms, so as to avoid possible instances of low audit quality and poor financial reporting.
- Standard setters should make a standard limiting managerial discretion in respect of judgements and estimations in financial reporting; this could narrow the wide opportunity of financial information manipulations. While Professional accounting bodies should be updating their ethical code of conduct for their members and make severe penalties for defaulting members.
- Managements of manufacturing firms in Nigeria should subscribe to acceptable ethical standards in discharging their duties and responsibilities.
5.4 Suggestion for Further Research
In typical research, some silent areas are bound to be left out for further investigation. In the light of the findings and conclusions of the study, it is recommended that research on the following areas should or can be carried out:
- Access and Use of Information Resources for firm performance and audit quality in Nigeria.
- Auditors independence and ownership structure.
- Utilization of accounting information for productivity
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