AUDIT QUALITY AND PERFORMANCE OF BANKS LISTED ON THE NIGERIAN STOCK EXCHANGE (2005-2016)

AUDIT QUALITY AND PERFORMANCE OF BANKS LISTED ON THE NIGERIAN STOCK EXCHANGE (2005-2016)

ABSTRACT

The study ascertained the relationship between audit quality and return on asset of commercial banks in Nigeria; determined the effect of audit quality and return on asset of commercial banks in Nigeria; the relationship between audit committee effectiveness and organizational performance of commercial banks in Nigeria, in order to examine the impact of audit quality on organizational performance. The study employed secondary data which were obtained from the annual reports of selected quoted companies on the Nigeria stock exchange. A sample of sixteen (16) commercial banks were purposively selected based on the availability of information. Model was formed to test the data obtained using correlation research design with the aid of E-view econometrics package. The result showed that the F-statistic of 1.614771 is significant at 5 percent level as the probability value estimate of 0.036862 has indicated. The F-statistics shows that Audit committee, Audit committee expertise, Audit committee frequent meeting, Audit committee Size, Audit fee, Audit period, and firm size are jointly significant in explaining returns on assets (dependent variable). The coefficient of the independent variables, that is Audit committee, Audit committee expertise, Audit committee frequent meeting, Audit committee Size, Audit fee, Audit period, and firm size for instance are all positive except for Audit fee and Audit period, these positive values show that a unit increase in these variables for instance will increase returns on assets by 11.79%, 2.24%, 0.22%,72.50% and 17.13% respectively in the short run, Audit fee and Audit period which has negative coefficients imply that a unit increase in these variables for instance will reduce return on assets by 3.18 % and 4.68% respectively. The study concluded that adequate audit quality is essential as it has a direct impact on the performance of commercial banks in Nigeria, quality audit reduces the agency cost and it enhances the credibility of financial statement which has a positive impact on the performance of commercial banks in Nigeria.

 CHAPTER ONE

INTRODUCTION

1.1              Background to the Study

Increased concerns regarding corporate accountability in various developed nations have been associated with the need for appropriate audit which involves risk management and internal control systems (Beekes & Brown, 2006). The impact of audit quality on organizational performance has recently received attention from various researches like Chang, Dasgupta and Hilary, (2009), Bhatia, Ali, Balachandran and Jurdi(2015), Ilaboya & Ohiokha (2014). Bhatia (2015) examined the relationship between audit quality and firm’s financial decisions using audit fees as proxy and found out that there is a positive relationship between audit fees and corporate financial decisions. Chang (2009) also examined the effect of auditor choice on financial decision that firms take and found out there exist a negative relationship between the size of the audit company and debt financial choices the firms make.(Ilaboya, 2014) indicates that there’s a positive relationship between firm size, audit tenure and audit quality. According to them, those firms audited, use equity issue more than they use debt to finance their project. This is because potential and existing investors have confidence in the audited financial statements and this makes them invest more in the company. Other studies have however yielded mixed results.

Audit quality plays an important role in maintaining an efficient working environment, and independent quality audit underpins confidence in the credibility and integrity of organizational performance which is essential for well-functioning organizations and enhance organizational performance (Musa & Shehu 2014). The societal role of auditors should be a key contribution to organizational performance, in terms of reducing the risks of significant misstatements and by ensuring that the financial statements are elaborated according to preset rules and regulations (Heil, 2012). Internal financial statement users such as management, audit committees and board of directors have an interest in quality audits, for example; to help reduce the cost of capital (ISB, 2000; Miettinen, 2011).Lower risks on misstatements increase confidence in capital markets, which in turn lowers the cost of capital for firms (Heil, 2012). Audit quality is subject to many direct and indirect influences. In cycle with the stakeholder theory (Khan, 2006), perceptions of audit quality vary amongst stakeholders depending on their level of direct involvement in audits and on the perspective through which they assess audit quality. Audit quality is recognized to influence financial reporting and strongly impact on investors’ confidence (Levitt, 2008). Conventionally, external auditors lay critical and highly challenging roles in assuring the credibility of organizations performance. Audit quality will be measured using: audit committee, audit period, audit fees, and firm size. Financial performance of organizations may be calculated from return on investment perspective, and measured by several indicators which include return on asset (ROA), return on equity (ROE), and return on investment (ROI). (Mohd, 2013; Omar2013; Sim Chia Hua2016).Accordingto contracting theory the relationship between management control systems and firm performance depends on the costs of writing and enforcing contracts which may vary depending on firm characteristics (Watts &Zimmerman 1986).The societal role of auditors should be a key contribution to financial performance, in terms of reducing the risks of significant misstatements and by ensuring that the financial statements are elaborated according to preset rules and regulations. Lower risks on misstatements increase confidence in capital markets, which in turn lowers the cost of capital for firms (Heil, 2012; Watts and Zimmerman, 1986).For the purpose of this study, return on asset will be adopted to measure organizational performance.

Audit quality shows positively effect of both performance indicators, this provides that external audit provides the monitoring device to reduce information asymmetry between the managers and shareholders and also a positive relationship between firm size, audit tenure and audit quality. Audit quality has a significant positive impact on business financial success, and to also determine whether corporate financial performance may be influenced by firm practices in financial reporting standards (FRS), audit quality as well as transparency and disclosure requirements in their annual reports (Sim&Daw, 2016; Ilaboya& Ohioka, 2014). This study is conducted to examine the impact of audit quality on organizational performance.

1.2       Statement of the Problem

Some studies indicate that high-quality audit services improve the confidence of investors in financial statements and increases investment possibilities (Lin and Liu, 2009). Thus, high-quality auditing is particularly important for companies that are frequently involved in raising funds, such as financial institutions. accordingly, other studies have also found that a firms’ demand for high-quality audit services is related to its financing needs (Knechel, 2008). While some studies are of the opinion that high quality audit is associated with lower cost of capital (Pittman and Fortin, 2004; Hartarska, 2009)

Some studies showed that audit quality impact positively on firms’ performance (Mohd,2013; Heil,2012; Miettinen,2011; Zureigat,2010; Musa and Shehu,2014; Sim,2014; Tarak,2016; Malai,2015). Mohd,2013 examined the effect of audit quality on company performance of companies in Malaysia, and showed a positive impact of audit quality on companies’ performance in Malaysia. (Heil, 2012; Miettinen,2007) examined the impact of audit quality on financial performance of firms, they found out that audit quality has a positive impact on financial performance of organization.Zureigat (2010), tried to examine the effect of financial performance among Jordanian listed firms on audit quality, and found out that there’sa significant positive relationship between audit quality and financial structure.Musa and Shehu (2014) studied the impact of audit quality and financial performance on quoted cement firms in Nigeria, and they found out that audit. quality has a positive influence on the financial performance of quoted cement firms in Nigeria. Sim (2014), examined howfinancial performance of construction firms listed on Bursa Malaysia stock exchange may be influenced by a good audit quality, and they confirmed that a good audit quality has a positive influence on construction firms in Malaysia.Tarak (2016), examined the impact of audit quality on the accounting profits on firms in Tunisia, and found out that audit quality has a significant positive influence on accounting profit of firms in Tunisia.Malai (2015), observed the effectiveness of audit quality on financial reporting quality of listed companies in Thailand, and found out that audit quality has a positive impact on financial reporting quality of companies in Thailand.  However, some studies opposed the above proposition, showing that audit quality has a negative impact on financial performanceof firms.(Obal and Bassarial,2015; Watts and Zimmerman,1986; Violet and Jane,2011; Morteza,2014;Copley and Doucet,1993;Carcello and Nagy,2004).Obal and Bassarial (2015), carried out a study on the dimensions of audit quality and their influence on the performance of local governments in Nigeria, and found out that audit quality has a negative impact on the performance of local governments in Nigeria.Watts and Zimmerman (1983) found that the longer the auditor tenure, the more dependence on clients. Auditor’s objectivity and independence will be destroyed and hence, audit quality reduces.(Violet& Jane, 2011), examined the relationship between audit fees as a proxy for auditor independence and audit quality of firms in New Zealand, their study discovered that the performance of firms is negatively associated with audit quality. Morteza (2014), asserted the relationship between audit quality and financial performance of companies in Iran, and found out that audit quality has a negative impact on financial performance. Copley and Doucet (1993) discoursed that the longer the period of engagement, the higher the risk of lower audit quality. Carcello and Nagy (2004) explored the association of changing the auditor and audit quality from the point of view of fraudulent reporting.

From clear examination, it can be observed that most studies conducted on the impact of audit quality on performance of firms had been done within the concentrated numbers of five years. Therefore, for the purpose of this study,information will be gathered from commercial banks quoted on the Nigeria Stock Exchange with available information for the period of 13 years ranging from 2005 to 2016.

1.3 Research Questions

Against this backdrop, the following research questions are raised

        i.            What is the relationship between audit quality and return on asset of commercial banks in Nigeria?

      ii.            What is the effect of audit quality on return on asset of commercial banks in Nigeria?

    iii.            What is the relationship between audit committee effectiveness and performance of banks in Nigeria?

1.4Objectives of the Study

The broad objective of this study is impact of audit quality on organizational performance to examine the impact of audit quality on organization performance. Specifically, the objectives of the study are to;

i.                    ascertain the relationship between audit quality and return on asset commercial of banks in Nigeria.

ii.                  determine the effect of audit quality on return n asset of commercial banks in Nigeria.

iii.                examine the relationship between audit committee effectiveness and performance of banks in Nigeria.

1.5    Significance of the Study

                Research has been carried out on impact of audit quality on organizational performance both in and outside Nigeria. It has been observed that audit quality showed both positive and negative impact on the performance of organizations. This study will therefore be of great importance to commercial banks in Nigeria it will help them in knowing the impact of audit quality on their performance, to what extent is its effect and it impact on Return of Asset. It will also be of great importance to existing and potential shareholders to enable them understand that a good organization performance can be achieved through quality audits and its influence on decisions taken by firms.

            It will also be beneficial to managers to understand the importance of credible financial statements in financial decisions taken by the firms. It would also improve the confidence of investors in financing reporting and increase fund raising possibilities.

1.6       Scope of the Study

This study covers commercial banks listed on the Nigerian stock exchange (NSE). As at 2017, 22 commercial banks were listed on the Nigerian stock exchange, out of which 15 commercial banks will be selected for this study. This study will consider commercial banks which have available data from the year 2005-2016. The annual report of the selected companies will be analyzed to derive the needed information for the purpose of this research.

CHAPTER TWO

LITERATURE REVIEW

2.1 CONCEPTUAL FRAMEWORK

2.1.1 CONCEPT OF AUDIT QUALITY

According to De Angelo (1981), audit quality is market-assessed joint probability that a given auditor will both discover a breach in the client accounting system and report the breach. Jackson, Moldrich & Roebuck (2008) view the quality of audits from actual and perceived quality. Titman and Trueman (1986) see audit quality as the accuracy of the information reported by auditors. A large body of accounting research investigates the drivers and consequences of audit quality. In other words, audit quality is a function of technical capability of the auditor and ability to uphold standards. PCAOB re-emphasizes a classic academic definition of audit quality as the market assessed joint probability that a given auditor will both discover a breach in the client’s accounting system, and report the breach. According to Memi and Çetenak the technical capability of auditors or the probability to uncover errors and going concern breaches is invariant across auditors. Prior researches have argued that the size of the firm or brand name of audit firms is proportional to audit quality. Several other variables such as economic dependence, auditor’s term, industry expertise, audit fees, reputation and cost of capital have also been used as measures audit quality. Arising from the afore-mentioned definition, an audit failure happens (lack of audit quality) when an auditor fails to uncover material errors and fraud that led a client’s financial statements not to reflect a true and fair view. PCAOB further identified more indicators or determinants of audit quality. These include competence and experience of audit personnel, whether or not the audit is conducted in accordance with Generally Accepted Auditing Standards (GAAS), audit resources, the strength of the clients internal control system, compliance with independence requirements, investment in infrastructure supporting audit quality, audit firm’s internal quality review and industry expertise.

Audit quality minimizes risks, improves control issues, reduces monitoring cost, reduces earnings management, mitigates fraud risks and minimizes other opportunistic behaviours within an organization (Ege, 2015; Prawitt, 2009). However, Davidson, Goodwin-Stewart, and Kent (2005) found no evidence that the presence of audit could be associated with lower earnings management. Also, Ege (2015) suggest that if managers have control over audit quality, opportunistic behaviours can go on unabated. This implies that an organization may have an audit function, yet opportunistic behaviours may not be curtailed especially where aspects of the function can be contained by management. Onatuyeh and Aniefor (2013) examined the role of effective audit in the management and accountability of the public sector using 245 respondents from audit departments of ministries and government agencies in Edo state in Nigeria. Although their study found some evidence that effective audit promotes accountability, their measure of effective audit leaves much to be desired as no reliability or previous test of their instrument was reported. Also, the analysis was merely descriptive as no relationship was tested. Similarly, a study by Ebimobowei and Kereotu (2011) in two southern states of Nigeria using 96 auditors in state ministries found widespread governance failures resulting from audit not performing its role. Their study ignored the quality of audit in arriving at their conclusion as the quality of audit is important both for role performance and contribution to organizational performance. Baltaci and Yilmaz (2006) acknowledged the limited number of studies on audit quality in the public sector especially at the local government level and called for more research. Furthermore, a close look at audit quality shows the similarity of the concept with that of audit effectiveness.

2.1.2   AUDIT QUALITY IN THE NIGERIAN PERSPECTIVE

Nigeria being a British colony, its accounting and auditing characteristics can be linked to the traditional British Bookkeeping. The most significant feature of the traditional British bookkeeping audit is that it was closely bound up with also doing the client's accounting. According to Jones (1981), accounting researchers have been aware of the extent of the practice and its longevity. However, its full implications have been largely overlooked by historians, perhaps because the Nigeria Companies Acts (CAMA, 1990, as amended). The Companies and Allied Matters Act (1990 – CAMA) was not a major influence of Audit in Nigeria. The CAMA laid down the duties of the auditor but never made any stipulation as to how the audit should be conducted. Anlin (2006) identified that as social demand for audit quality was growing strong, split of social division of labor made audit quality function independent and considerable expertise and experience were accumulated in the course of development of audit profession, experience and knowledge were created in their wake.A quality audit involves a comprehensive understanding of the key risks that could impact the financial statements, and astutely translating that understanding into an effective audit plan to address those risks. These risks go well beyond the numbers—they include risks specific to each company's business, industry, management team, IT system, and control structure. The quality of the audit is a result of the performance of the audit team in planning and executing the audit and the system of quality control of the audit firm as a whole.

Perception of audit quality can depend very much on whose eyes one looks through. Users, auditors, regulators and other stakeholders in the financial reporting process may have very different views as to what constitutes audit quality, which will influence the type of indicators one might use to assess audit quality. The production of a quality audit report is perceived to prompt confidence in financial reports by the users of those reports. Investors in particular tend to place better trust in financial statements that are audited; as the expected independence of the auditor boosts the assurance that important investment decisions can be made on the thrust of those statements. The increased confidence of these set of financial users tend to attract the inflow of capital which has the long-run effect of creating growth and development in the business environment (Adeyemi & Fagbemi, 2010). These financial statements ordinarily do not show the true state of affairs and financial position of the organization and hence, could jeopardize the decisions of prospective investors. The quality of audits and audit opinions expressed on financial reports are crucial to achieving a sustained investor’s confidence. Independent auditors play a vital role in enhancing the reliability of financial information by attesting to the trustworthiness of the financial statements. However, the study of Ghosh & Moon (2005) noted that a number of accounting and reporting irregularities and frauds in the last one decade have led to intense scrutiny of corporate governance frameworks and drove intense debate about issues such as financial statement audit, audit approach and audit quality.

2.1.3   RELEVANCE OF AUDIT QUALITY TO ORGANIZATIONAL PERFORMANCE

One of the relevance of external financial reporting is to reduce information asymmetries and agency conflicts between the firm and its various stakeholders (Healy and Palepu, 2001; Hope, 2008). The degree to which information asymmetries are reduced by financial reports is crucially dependent on the quality of these financial reports; the purpose of an audit is to improve financial reporting quality (Boone, 2010). DeAngelo (1981) defines audit quality as the joint probability that an auditor will detect and report a material misstatement. However, in addition to the direct effects of audit quality on accounting trustworthiness, indirect effects of audit quality are also observed; these effects are mediated by the associations between audit quality and other mechanisms of corporate governance (O‟Sullivan, 2000; Carcello et al., 2002; Abbott et al., 2003; Knechel and Willekens, 2006).