The Effect of Accounting Regulation on Second-tier Audit Firms and Their Clients PDF Download

Author: Magdy Farag
Publisher:
ISBN:
Category : Accounting
Languages : en
Pages : 142

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Book Description
The accounting profession has recently been affected by major financial reporting scandals and regulatory changes. The Sarbanes-Oxley Act of 2002 made changes to several engagement-specific characteristics with the ultimate aim of improving auditor independence. Accounting research is currently investigating these recent regulatory changes and how they affect the accounting profession. Although the entire accounting profession has been affected by these regulations, most accounting research focuses only on Big-audit firms. This study examines the effect of recent regulatory changes on Second-Tier audit firms. Agency theory focuses on the relationship between the principal and the agent. The agent has certain obligations, which he fulfills for the principal by virtue of the economic contract. The important concept in the agency relationship is the selection of the appropriate governance mechanism between the principal and the agent that will ensure an efficient alignment of the principal's and the agent's interests. Therefore, agency theory is an appropriate framework to demonstrate and explain the effect of recent regulations on audit firms. Audit firms are expected to assist the principal (stockholders) in monitoring the agent (management) of the firm. I address four research questions that are motivated by agency theory. First, I examine whether clients of Second-Tier audit firms incur higher audit fees subsequent to the recent accounting regulation. My second research question is whether quality of audits provided by Second-Tier audit firms is expected to improve due to recent regulations and rulings, especially in the post-SOX period. Third, I investigate whether clients of Second-Tier audit firms experience a higher cost of capital compared to clients of Big-audit firms. Finally, I address the question of whether there is a relationship between clients of Second-Tier audit firms and the backdating of executive stock options (ESOs). I expect a positive relationship between concentration and audit prices of Second-Tier audit firms. Additionally, audit quality is expected to increase due to recent regulations, but it is possible that Second-Tier audit firms may not be able to provide high quality audits in their efforts to increase their market share. I further predict that firms that are audited by Second-Tier audit firms are subject to larger financing costs measured by cost of debt and equity. I also expect that Second-Tier audit firms' clients exercise backdating of ESOs more often than Big audit firms' clients. The findings of this dissertation will contribute to our understanding of previous audit and financial accounting research from the perspective of Second-Tier audit firms. The investigation of Second-Tier audit firms and their clients will provide us a better understanding of why some firms are more likely to hire a Big-audit firm versus a Second-Tier audit firm. We will also have a better insight on issues raised by backdating of ESOs, and whether the quality of the audit provided can mitigate such irregular behavior.