The Effects of Audit Market Liberalisation and Auditor Type on Audit Opinions: The Iranian Experience

• Author: Mohamat Sabri Hassan,Fakhroddin MohammadRezaei,Norman Mohd‐Saleh,Romlah Jaffar
• Published date: 01 March 2016
• DOI: http://doi.org/10.1111/ijau.12059
• Date: 01 March 2016

The Effects of Audit Market Liberalisation and Auditor Type on Audit

Opinions: The Iranian Experience

Fakhroddin MohammadRezaei, Norman Mohd-Saleh, Romlah Jaffar and Mohamat Sabri Hassan

Audit services were provided exclusively by a state entity in Iran until late 2001, when the audit market was

liberalised. The liberalisation of the audit market resulted in increased competition, as more private auditors

became licensed to operate and provide audit services. The present study examines the effects of audit market

liberalisation and auditor type (i.e., state and private auditors) on audit opinions. It is predicted that increased

competition in the audit market may reduce the relative bargaining power of auditors, which can compromise

auditors’ independence when issuing audit opinions. The present study also investigates whether the process of

issuing audit opinions is influenced by the government, thus resulting in a lower rate of modified audit opinions

issued by state auditors compared to those issued by private auditors. Importantly, this study develops an

explanation based upon a bargaining power view of auditor independence in issuing audit opinions and upon the

limitations of the explanation for the circumstances in which auditorand owner interests are aligned in the case of

government entities. The present study analyses the data of firms listed on the Tehran Stock Exchange between

1999 and 2010. The findings, after controlling for auditor choice, reveal that modified audit opinions have

decreased following the liberalisation of the audit market in Iran, and compared to private auditors, state auditors

have issued fewer modified audit opinions. The findings suggest that increased competition in the audit market is

more likely to decrease the relative bargaining power of auditors and that there is a significant concern regarding

audit opinions when both auditee and auditor are state-controlled entities.

Key words: Audit opinions, audit market liberalisation, state and private auditors, Iran

1. INTRODUCTION

Prior empirical evidence on the determinants of modified

audit opinions (which include qualified, adverse and

disclaimer audit opinions)1(Rittenberg, Johnstone &

Gramling, 2012) has focused on audit variables (such as

audit conduct quality)and auditor-related variables(such

as auditor independence) (Habib, 2013). The results are

mixed. The issuance of a large number of modified audit

opinions under a regulated market in Iran (Banimahd,

Noorifard & Davoudabadi, 2013; MohammadRezaei,

Mohd-Saleh & Ali, 2015) and the drop in the percentage

after audit market liberalisation has motivated us

to investigate this issue further. We found that

approximately 95 per cent (64 per cent) of firms received

modified audit opinions in 1999 (2010). In this paper, we

argue that audit market factors and auditor type

(referring to the classification of auditors into state and

private auditors) could affect the type of audit report

issued by auditors.

This study uses audit market competition and

bargaining power to explain the decrease in modified

audit opinions. An increase in audit market competition

after liberalisation is likely to decrease (increase) the

relative bargaining power of auditors (client firms)

(Casterella et al., 2004). Consequently, a change in relative

bargaining power could affect the audit opinions issued

by auditors (Barnes, 2004; Barnes & Renart, 2013).

Consistent with the foregoing, the liberalisation of the

audit market in Iran, which occurred in 2001, has resulted

in intense competition. Market liberalisation2resulted in

both state and private auditors offering audit services,

and although many private firms switched from the state

to private auditors, state-controlled firms must retain the

state auditors. The prominent feature of audit market

liberalisation in Iran appears to be the lack of

preparedness of the auditmarket, resulting in an increase

in supply thatwas incongruent with the demand for audit

services, particularly among private auditors and firms.

In contrast to other countries that have a relatively stable

audit market condition with large auditfirms dominating

the market, the unique change in the audit market (and,

hence, the level of competition and bargaining power

experienced by audit firms) provides a somewhat unique

research setting in which to study the relation between

changes in the audit market and a modified audit

opinion. In the absence of large audit firms in the Iranian

market (and significant quality differentiationin the audit

services), competitive pressures on the market might

result in adverse effects on auditorindependence and – as

a result – audit opinions.

However, audit market competition and bargaining

power may not be applicable to the state auditors.

Notably, the interest group stasis theory, as one strand of

political theory, suggests that the auditing process can

be viewed as a symbol – as opposed to substance – that

can lead to the impression that problems within the

public sector are being addressed (hereinafter, the

‘symbol-over-substance’ argument) (Moore et al., 2006).

As such, this view might suggest results that contradict

the bargaining power argument for the state auditors.

In particular, while it is predicted that more modified

audit opinions are issued by state auditors (compared

to private auditors) in the post-liberalisation period

due to less competition in the state audit market, i.e.,

audits characterized by greater independence, the

symbol-over-substance argument suggests that the

strong audit–client relationship established between

well-connected interests within the state entities (state

firms and their auditors) could indicate otherwise. As

such, studying the consequences of such a contradictory

theoretical standpoint from the perspective of audit

Correspondence to: Fakhroddin MohammadRezaei, Faculty of Finance,

Kharazmi University, Tehran, Iran. Email: f.mrezaei@khu.ac.ir

International Journal of Auditing doi:10.1111/ijau.12059

Int. J. Audit.

© 2015 John Wiley & Sons Ltd ISSN 1090-6738

20: 87 100 (2016)

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