The effect of auditor type on audit quality in emerging markets: evidence from Egypt

• Pages: 43-66
• Published date: 20 August 2020
• DOI: https://doi.org/10.1108/IJAIM-04-2020-0060
• Date: 20 August 2020
• Subject Matter: Accounting & finance,Accounting/accountancy,Accounting methods/systems
• Author: Mohamed M. El-Dyasty,Ahmed A. Elamer

The ef‌fect of auditor type on audit

quality in emerging markets:

evidence from Egypt

Mohamed M. El-Dyasty

Department of Accounting, Faculty of Commerce, Mansoura University,

Mansoura, Egypt, and

Ahmed A. Elamer

Brunel Business School, Brunel University London, London, UK and

Department of Accounting, Faculty of Commerce, Mansoura University,

Mansoura, Egypt

Abstract

Purpose –Although a number of studies suggestthat big audit f‌irms provide higher auditquality in strict

legal environments, empirical evidence remains inconclusive. As little is known about the effect of auditor

type on audit quality in less strictly legalenvironments, this study aims to investigate the impact of auditor

type on audit qualityin the Egyptian market.

Design/methodology/approach –Data of Egyptian-listedcompanies during the period 2011–2018 are

used. To examine the impact of auditor type on audit quality, ordinary least square regression and robust

standard errors clustered at year and industry level are used. This study uses discretionary accruals as a

proxy for auditquality. Several additional analyzes are conducted to assess the robustnessof the main results,

includingalternative measures of audit quality andauditor type.

Findings –The results show that audit f‌irmstend to provide higher audit quality when they are aff‌iliated

with a foreign audit f‌irm. However, Big 4 auditors do not provide higher audit quality compare to their

counterparts. Additionally, the governmental agency, accountability state authority, that monopolize audit

function in state-owned companies do not appear to be associated with higher audit quality. Finally, local

audit f‌irms have a negativeassociation with audit quality. This may be their strategy to securefuture clients

that seek low-qualityaudits.

Research limitations/implications –This study suggests that aff‌iliation with foreign audit f‌irms

will help the Egyptian f‌irms to develop theirabilities by using advanced technology and techniques and

transfer rare expertize to the Egyptian auditors. This study also shows that the strategy adopted by

many Egyptian audit f‌irms to aff‌iliate with foreign auditors ref‌lects the desire of these f‌irms to be

included in one tier alongsideBig 4 audit f‌irms to increase t heir market share under a claim of providing

a higher audit quality.

Originality/value –This study adds to the rare but growing body of literature by investigating how

auditor type affectsaudit quality in the context of less strictly legalenvironments. The results are important,

as investors, standards-setters and regulators have growing concerns over audit quality since the Enron

scandal. The f‌indings suggest that audit quality depends on auditor type. These f‌indings have important

implications for investors, standards-setters and auditors interested in auditor oversight, audit quality and

auditor choice.

Keywords Audit quality, Big 4, Second-tier auditors, Third tier auditors, Local audit f‌irms,

Accountability state authority

Paper type Research paper

JEL classif‌ication –M42

Audit quality

in emerging

markets

43

Received26 April 2020

Revised17 July 2020

Accepted1 August 2020

InternationalJournal of

Accounting& Information

Management

Vol.29 No. 1, 2021

pp. 43-66

© Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-04-2020-0060

The current issue and full text archive of this journal is available on Emerald Insight at:

https://www.emerald.com/insight/1834-7649.htm

1. Introduction

Traditionally, audit f‌irms are classif‌ied into two broadtypes based on size, big audit f‌irms

and non-big audit f‌irms. A frequent debate exists between levels of audit quality delivered

by audit f‌irms. It is argued by DeAngelo (1981) that big audit f‌irms provide higher audit

quality. Since then, many studies assert that this notion is logical (Berglund et al., 2018;

Dechow and Schrand, 2004;Eshleman and Guo, 2014;Geiger and Rama, 2006;Lennox,

1999). Because big audit f‌irms possess distinguished human resources and higher technical

and technological abilities,they are able to differentiate their services from other audit f‌irms

to provide higher audit quality(Sirois, 2009).

On the contrary to this long-standing notion, the collapse of a big audit f‌irm, Arthur

Andersen, provides irrefutable evidence of poor audit quality. Arthur Andersen was, until

the Enron scandal, one of the f‌ive largest audit and accountancy partnerships in the world.

Before its bankruptcy in 2001, Enron was one of the leading companies in the USA and the

world in f‌ields of electricity, natural gas, communications and pulp and paper. The

accounting irregularitiesrevealed at Enron and not detected by Arthur Andersen represents

one of the biggest audit failures in history (Li, 2010;Nelson et al.,2008). Consequently, the

f‌inancial press and the public criticizethe auditing profession and question the level of audit

quality provided big audit f‌irms. Based on this criticism,the self-regulation of the auditing

profession is terminated and Sarbanes-Oxley enacted. The Public Company Accounting

Oversight Board was establishedto oversee the auditing profession (Francis, 2004).

Besides what is documented in the real-world, prior research is not indicating a pieceof

conclusive evidence regarding audit quality provided by the big audit f‌irms. For example,

Lawrence et al. (2011) reported basedon three proxies of audit quality that Big 4 audit f‌irms

are insignif‌icantly different from non-big audit f‌irms. Likewise, Berglund et al. (2018)

conclude that empirical evidenceon the association between auditor size and going concern

frequency is quite mixed. It is not quite evident that mixed results were reached because of

the poor performance of big audit f‌irmsor methods used in designing research. Accordingly,

Fuerman (2004) assumed that the notion suggested by DeAngelo (1981) might not be

completely valid and called for developing a more complex theory of audit quality. He

indicates that audit qualityis merely a function of auditor size and other paradigms, such as

behavioural, ethicaland cultural aspects, must be considered to understand auditquality.

In addition, auditing literature considers a change in classifying audit f‌irms. The

traditional classif‌icationof big audit f‌irms versus non-big audit f‌irms is not valid to describe

the audit market precisely. The conceptof second-tier emerged to divide non-big audit f‌irms

into additional two types of audit f‌irms. Therefore, the Big 4 audit f‌irms represent the top

tier. The next four audit f‌irms are placed into a new tier; second-tier. Finally, other audit

f‌irms will be placed in small f‌irms tier. Accordingly,second-tier include BDO, Crowe Chizek

and Company, Grant Thornton and McGladrey and Pullen (Dey and Robin, 2011;Herda

et al.,2014).

Egypt has a unique and complex audit market. Egypt is one of a few countries that

permits mandatory audit alongsidevoluntary audit (Mohamed and Habib, 2013). On the one

hand, each publicly held company might choose, upon discretion, to hire one audit f‌irm or

more [Article 103 of Law 159/1981].Only public accounting f‌irms are considered to perform

the audit in publicly held companies. Accordingly, if a company decides to appoint more

than one audit f‌irm, a joint audit is applied. Audit f‌irms in Egypt are classif‌ied into two

broad categories, f‌irms aff‌iliated with foreign audit f‌irms and local audit f‌irms. The f‌irst

category involves alltiers of audit f‌irms, including big auditors. The other category contains

small f‌irms that are not aff‌iliated with foreignf‌irms. What is interesting about the Egyptian

market is the fact that many audit f‌irmsare seeking to distinguish themselves by aff‌iliating

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