P ROBLEM STATEMENT
From the agency theory perspective, the separation of ownership and management in corporations creates information asymmetry and conflicts of interest between managers and shareholders In this context, the role of third-party auditors in providing opinions on financial information disclosure is crucial, as audit quality serves as an external monitoring factor that significantly influences firm performance While previous studies have explored the relationship between audit quality and firm performance, they have employed varying measures of audit quality and focused on different markets, leading to inconsistent empirical results Some research indicates a positive impact of audit quality on firm performance, while other studies report negative or insignificant effects.
The significance of audit quality as a crucial factor influencing firm performance has not garnered adequate focus from researchers and policymakers in Vietnam This oversight may lead to investors underestimating the importance of audit quality, potentially compromising financial disclosures and the availability of vital information necessary for informed decision-making.
As Vietnam integrates into global organizations like the WTO and TPP, it faces challenges in ensuring the reliability and transparency of financial information to attract foreign investment and foster fair competition The collapse of Arthur Andersen in 2002 and recent audit quality scandals have heightened investor concerns regarding the integrity of financial statements, emphasizing the need for improved audit quality In Vietnam, this issue has gained prominence following scandals involving listed companies, such as the evaporated inventories of Truong Thanh Corp (TTF), NTACO Corp (ATA), and the bad debt crisis at Ocean Group (OGC), which severely impacted the stock market and eroded investor confidence.
Audit quality remains a contentious topic among legislators and is a crucial consideration for auditors The UK Financial Reporting Council (UKFRC) established an audit quality framework in 2008, outlining key determinants such as the audit firm's culture, the skills and quality of auditors, the effectiveness of the audit process, and the reliability of audit reporting, along with external factors DeAngelo (1981) and PCAOB (2011) define audit quality as the likelihood of identifying material errors or omissions in financial statements The International Federation of Accountants (IFAC) emphasizes that audit quality is essential to international auditing standards, requiring consistent interpretation and enforceability to ensure high-quality audits According to Vietnamese Standards Auditing 220 (VSA 220), audit quality is measured by user satisfaction regarding the objectivity and reliability of the audit opinion, as well as the auditor's recommendations aimed at enhancing the entity's business efficiency within a reasonable timeframe and cost.
There is no agreement among researchers on how to measure audit quality, with previous studies utilizing indirect methods such as audit rotation, audit fees, audit firm size, litigation, auditor tenure, non-audit services, industry experience, and peer reviews Sori et al (2006) suggest that audit firm size is a strong indicator of audit quality, as larger firms typically possess a better reputation, experienced professionals, advanced technology, and greater financial resources, which enhance the reliability of their audit opinions Additionally, larger audit firms may be less susceptible to revenue pressures from significant clients, thereby maintaining their independence and objectivity in evaluating the financial status of audited companies.
The Institute of Internal Auditors was established in the United States in 1942, marking the beginning of formal auditing institutions In Vietnam, independent auditing firms emerged in 1991, and to ensure high audit quality, these firms and their auditors must adhere to standards set by the Ministry of Finance and the Vietnam Association of Certified Public Accountants (VACPA) Additionally, auditors are required to follow Ethical Standards that emphasize integrity, independence, prudence, and professional competence The core motivation behind these principles is to uphold both the independence of mind and appearance, with audit rotation serving as a key indicator of audit independence.
In an attempt to enforce and improve audit quality in Vietnam, on 6 th December
In 2012, the Ministry of Finance introduced 37 new auditing standards, which became effective on January 1, 2014 Among these, VSA 220 specifically addresses "Quality Control of Financial Statements Audit Activities." This standard is designed to establish additional requirements and strengthen audit control measures, ultimately enhancing the quality of independent audit activities in Vietnam.
R ESEARCH OBJECTIVES AND RESEARCH QUESTIONS
This study aims to investigate the influence of audit quality on the performance of listed companies in Vietnam It focuses on three key proxies for audit quality: audit rotation, audit reputation, and audit firm experience, assessing their effects on firm performance indicators such as profitability, market value, and bankruptcy risk Additionally, the research will evaluate the impact of the implementation of VSA 220, a crucial legal framework designed to enhance audit quality in Vietnam, on overall firm performance.
In order to achieve those objectives, we conduct an empirical analysis on the firm level data in Vietnam to seek convincing answers for the following two research questions:
This article investigates the impact of audit quality, as measured by audit rotation, audit reputation, and audit firm experience, on the profitability (ROA), market value (Tobin’s Q), and bankruptcy risk (Z-Score) of publicly listed companies in Vietnam It aims to determine whether these factors exert a positive or negative influence on firm performance and the underlying reasons for these effects.
- Does the promulgation of VSA 220 in 2014 have any effect on firm profitability, market value and risk of bankruptcy of listed companies in Vietnam?
R ESEARCH METHODOLOGY AND DATA
This study analyzes panel data from 268 listed companies on the Ho Chi Minh Stock Exchange between 2010 and 2015, excluding financial institutions and insurance companies due to their distinct financial structures Utilizing the Generalized Method of Moments (GMM) estimation, the research investigates the relationship between audit quality and firm performance Additionally, it assesses correlation, heteroskedasticity, and the validity of instrumental variables through Hansen and Sargan tests The impact of three different proxies for audit quality on firm performance is evaluated both individually and collectively.
R ESEARCH C ONTRIBUTION
This study addresses the limited empirical evidence regarding the impact of audit quality on the performance of listed companies in Vietnam, contrasting with inconsistent findings from previous international research It uniquely analyzes various measurements of firm performance, including Return on Assets (ROA), Tobin’s Q, and Z-Score, providing a comprehensive perspective Additionally, the research evaluates the influence of Vietnam's auditing legal framework, particularly the implementation of VSA 220, on audit quality The findings aim to offer significant policy implications for investors' decision-making and assist policymakers in enhancing the transparency of Vietnam's business environment.
T HESIS STRUCTURE
This thesis is structured into several key sections: the second section reviews the theoretical framework and empirical evidence regarding the impact of audit quality on firm performance The third section outlines the research methodology and data utilized in the study The fourth section presents the empirical results, while the final section concludes with insights and policy implications.
FRAMEWORK AND EMPIRICAL EVIDENCE OF
T HEORETICAL LITERATURE OF AUDIT QUALITY AND FIRM PERFORMANCE
2.1.1 Audit quality definition and relevant theoretical framework
Audit quality is a multifaceted concept defined as the likelihood of identifying material misstatements and errors in audited financial statements through appropriate audit procedures (DeAngelo, 1981; PCAOB, 2011) Eilifsen and Wilekens (2008) emphasize that it encompasses the independence and competence of auditors in detecting these misstatements and forming accurate audit opinions based on evidence The International Federation of Accountants (IFAC) asserts that audit quality is a core characteristic of international auditing standards, requiring consistent interpretation and enforceability to achieve high-quality outcomes In Vietnam, Standards Auditing 220 (VSA 220) defines audit quality in terms of user satisfaction regarding the objectivity and reliability of audit opinions and recommendations, aimed at enhancing the audited entity's efficiency within a reasonable timeframe and cost.
The involvement of third parties in providing opinions on financial information disclosure is crucial, as audit quality serves as an external monitoring mechanism that significantly impacts firm performance This relationship is supported by various theories, including agency theory, stakeholder theory, and the theory of information asymmetry.
Agency theory, introduced by Jensen and Meckling in 1976, examines the dynamics between shareholders and managers, who act as agents responsible for optimizing returns for investors This theory addresses challenges arising from agency relationships, including conflicting interests, differing strategic approaches, and varying risk tolerance levels.
The separation of ownership and management in large corporations, initially addressed by Adam Smith (1776) and Berle and Means (1932), is further explored by Jensen and Meckling (1976), who highlight the moral hazard issue This problem arises when managers prioritize personal gains over the interests of the owners, potentially obscuring inefficient operations Additionally, managers may manipulate financial statements through accounting tricks to present a misleadingly favorable financial position Soltani (2007) illustrates the conflict of interest between directors and shareholders, emphasizing the need for transparency and accountability in corporate governance.
Source: Jensen (1983), Zahra and Pearce (1989)
Profitability Market Value Corporate Bankruptcy
To mitigate agency problems, Jensen (1983) emphasizes the importance of independent monitoring systems free from conflicts of interest between owners and managers Additionally, Kim and Nofsinger (2014) advocate for the establishment of effective mechanisms to oversee managerial behavior An independent auditor serves as a crucial third party, providing objective oversight of financial information disclosure, thereby enhancing accountability and transparency.
The audit function, whether internal or external, aims to mitigate agency problems Internal auditors primarily serve the interests of the board of directors by overseeing their actions and ensuring compliance with company policies As a result, the focus of internal auditors is not primarily on outside shareholders.
External auditors play a crucial role in providing valuable information and oversight of directors' activities for both internal and external stakeholders As a result, the reach and influence of the financial information produced by external auditors extend far beyond that of internal auditors (Colbert and Jahera, 1988).
Dang and Fang (2011) empirically examined the relationship between audit quality and owner-manager agency costs using data from listed companies in China, finding that higher audit quality significantly reduces agency costs, particularly in emerging markets Krishnan (2003) supports this by stating that high external audit quality diminishes managers' ability to manipulate financial information Additionally, Habbash and Murya (2010) explored the effectiveness of external audits in curbing earnings management in the UK, demonstrating that auditor independence and audit quality play crucial roles in moderating agency costs.
The stakeholder theory, as proposed by Freeman (1984), highlights the impact of relationships between organizations and their internal and external stakeholders, including employees, customers, suppliers, government, shareholders, and the local community, on the achievement of organizational strategies Effective financial decisions consider the interests of these diverse parties, fostering strong relationships that contribute to long-term sustainable development and positive public goodwill Conversely, organizations that perform poorly risk losing stakeholder trust and support.
Figure 2.2 The stakeholder model of the corporation
Agency theory primarily emphasizes shareholders, while stakeholder theory encompasses a wider range of interests In today's landscape, organizations must address economic, social, and environmental factors, making their public image, information disclosure, and creditworthiness crucial Managers are tasked with balancing the interests and welfare of various stakeholder groups (Brusseau, 2012) Conflicts of interest may arise, highlighting the need for transparency in corporate information Additionally, stakeholder theory articulates the importance of business ethics within the framework of social responsibility.
Audited financial statements play a crucial role in bridging the gap between ownership and management, as highlighted by Paydarmansh et al (2014) in their discussion of stakeholder theory Independent audit firms, equipped with expertise in accounting and finance, are adept at identifying material risks and errors in financial reports This independent scrutiny enhances the reliability of financial information for stakeholders, fostering greater trust and transparency in the reporting process.
Stakeholder Theory highlights a dual impact in the relationship between objectives and stakeholders When stakeholders prioritize the quality of audited financial statements, it restricts managers from manipulating the company's financial position (James and Izien, 2014) Additionally, Chiu and Wang (2014) examine the quality of social disclosure in Taiwan, providing insights into the effectiveness of transparency in corporate reporting.
Asymmetric information is one of the key factors contributing to market failure, alongside externalities and public goods, as introduced by Akerlof in 1970 This concept refers to a situation where certain parties in a market transaction possess information that others do not Akerlof argues that buyers typically gather market information and use statistical methods to estimate the average value of goods, while sellers have detailed knowledge about the specific items they are offering.
Figure 2.3: The asymmetric information theory
Effective communication between buyers and sellers is essential for successful transactions However, asymmetric information can lead to increased agency costs and negative outcomes (Anderson and Lyall, 2013).
Stiglitz (2000) highlights that inefficient markets arise from asymmetric information, leading to issues like adverse selection, moral hazard, and monitoring costs Keat, Young, and Erfle (2013) reinforce these concerns and outline potential market responses to asymmetric information, including acquiring information from third parties, relying on seller reputation, and utilizing market signaling.
E MPIRICAL EVIDENCE ABOUT THE IMPACT OF AUDIT QUALITY ON FIRM PERFORMANCE
Investors, creditors, and suppliers are keenly interested in the financial status of listed companies To enhance confidence in a firm's financial reporting, external auditors serve as impartial third parties Consequently, improving audit quality remains a top priority for both regulators and researchers.
Audit quality can be assessed through two main approaches: direct and indirect The direct approach relies on a clear definition of audit quality for measurement, whereas the indirect approach utilizes surrogates and selects appropriate variables to represent audit quality effectively.
Previous studies have explored various proxies for audit quality, highlighting the complexity of its definition Balsam et al (2003) argue that auditor characteristics serve as the most effective surrogates for measuring audit quality Similarly, Hussein and MohdHanefah (2013) advocate for the indirect method in assessing audit quality In Vietnam, Nguyen and Ha (2014) identify audit rotation as a crucial factor influencing auditor independence and overall audit quality Sayyar et al (2015) measure audit quality through audit fees and rotation, while Al-Khaddash, Nawas, and Ramadan (2013) consider variables such as internal control, audit firm size, and auditor independence Ziaee (2014) focuses on audit tenure, reputation, and firm experience, and James and Izien (2014) examine audit tenure, firm size, and independence as key proxies Finally, Dadashi et al (2014) evaluate audit quality using audit reputation, independence, and specialty as their primary indicators.
Lu and Ma (2016) measure audit quality by audit opinion, audit reputation and audit fee
This study utilizes audit rotation, audit reputation, and audit firm experience as indicators of audit quality due to their strong representativeness and data availability Audit rotation serves as an independent characteristic of audit quality, while audit reputation and firm experience reflect the brand and expertise within the auditing field.
2.2.1 The impact of audit rotation on firm performance
Mandatory audit firm rotation, as outlined in Section 207 of the Sarbanes-Oxley (SOX) Act, establishes a time limit on auditor tenure, preventing the re-appointment of audit firms after their term expires This regulation has sparked debate regarding its impact on audit quality, with opinions divided on whether rotating auditors improves or undermines the effectiveness of auditing procedures.
The primary purpose of an audit is to provide shareholders with an independent opinion on the accuracy and fairness of financial statements, ensuring compliance with the Companies Act and accounting standards This process benefits various stakeholders, including shareholders, potential investors, and the broader business community (ICAEW, 2006) Efforts by policymakers, regulators, and academics aim to improve audit quality by enhancing auditor independence Research by Coyle & Deirdre (2010) on 20 accounting firms and interviews with Irish accounting bodies and audit regulators suggest that implementing audit firm rotation is an effective strategy to enhance perceptions of auditor independence.
Research by Ouyang and Wan (2013), Anis (2014), Arel et al (2005), and Chi et al (2009) provides empirical evidence that the duration of audit tenure influences perceptions of auditor independence and overall audit quality.
Ouyang and Wan (2013) discovered that extending the audit period beyond ten years may elevate the risk of accounting fraud in companies Their analysis of listed firms in the USA from 1996 to 2005 revealed that the negative impact of prolonged audit tenures is more pronounced in large companies compared to small ones These empirical findings underscore the significance of audit rotation in enhancing audit quality and improving firm performance.
In a study by Okolie (2014), the influence of audit quality on earnings management through discretionary accruals and economic operation manipulation was analyzed for listed companies on the Nigerian Stock Exchange (NSE) from 2006 to 2011 The findings reveal that audit quality, indicated by audit rotation and audit fees, has a significant negative effect on earnings management This suggests that audit rotation positively impacts firm performance by reducing managerial manipulation.
According to Rahmina and Agoes (2014), business failures are often linked to inadequate auditing, highlighting the importance of audit quality for the reliability of financial statements They advocate for the establishment of an Institute of Public Accountants and recommend that Indonesia adopt international standards for mandatory auditor and audit firm rotation, suggesting a seven-year rotation period for listed companies on the Indonesian stock market.
Ardiana (2014) investigates the role of external audit via audit rotation in enhancing the firm performance in Indonesia Firm performance is measured by P/E, P/B and Tobin’s
Q By using 2,240 firm-year observations during the period from 2007 to 2013, the study concludes that the longer audit tenure decreases the firm performance
Khatab (2013) investigates the impact of audit rotation on firm value, as indicated by Tobin’s Q, within the Egyptian stock market from 2005 to 2009 Utilizing both Fixed effects and random effects models, the study demonstrates that audit rotation positively influences firm performance.
Mostafa and Hussien (2010) conducted a self-questionnaire survey involving 50 randomly selected auditors, advocating for mandatory audit rotation at the firm level in Egypt instead of at the auditor level They argue that by aligning auditors' expertise with the client's industry specialization, audit firms can appoint experienced auditors, ultimately benefiting both the clients and the firms involved.
Sayyar et al (2015) investigate the influence of audit quality, indicated by audit rotation, on the performance of publicly listed companies in Malaysia between 2003 and 2012 Their findings reveal that audit rotation does not significantly correlate with firm performance as measured by Return on Assets (ROA) and Tobin’s Q In contrast, Myers et al (2003) suggest that extended auditing periods can help reduce extreme management decisions, positively impacting firm performance.
The literature review presents two primary perspectives on audit rotation One viewpoint suggests that extended audit tenure fosters a closer relationship between auditors and clients, potentially compromising auditor independence and the quality of financial statements Conversely, studies by Anderson and Verma (2012), Crabtree et al (2004), and Lu & Sivaramakrishnan (2009) argue that audit rotation is an effective strategy to ensure auditor independence and objectivity, highlighting its importance in maintaining the integrity of financial audits.
(2015) examine the audit firm rotation and audit quality data in Florida government audit market and suggest that rotation policies have positive relation to audit quality via audit firm selection
Maintaining strong client relationships can lead auditors to overlook critical accounting information, potentially compromising their skepticism Research indicates that rotating auditors after a specified period can enhance audit quality by introducing new perspectives and insights into the auditing process.
It also increases the probability of detection of misstatements (Siregar el at, 2012)
T HE CONCEPTUAL FRAMEWORK
In general framework for audit quality and firm performance has been applied in this study
METHODOLOGY AND DATA
D ATA COLLECTION
This study analyzes data from 268 listed companies on the Ho Chi Minh Stock Exchange (HOSE), Vietnam's second-largest stock exchange, covering the period from 2010 to 2015 The data, sourced from annual audited financial statements and Board of Director reports available on platforms such as Cophieu68, Vietstock, Stockbiz, and CafeF, excludes financial institutions, insurance companies, banks, and investment funds to ensure information homogeneity, as these entities operate under different mechanisms and capital structures For consistency in financial reporting, the accounting period is standardized to end on December 31st.
M ETHODOLOGY
This study utilizes the dynamic panel data approach as proposed by Okolie (2014) and Sayyar et al (2015) to address the endogeneity issue related to audit quality and firm performance Audit quality may be influenced by prior firm performance through the selection of audit firms, prompting the use of one-year lagged dependent variables to mitigate this endogeneity When a firm demonstrates strong past performance, it is likely to retain its current audit firm or engage a more reputable one to enhance the credibility of its financial statements in the subsequent year Conversely, firms with poor previous performance may opt for higher-quality audit firms to improve their financial reporting and market value To effectively tackle the potential endogeneity problem, this study employs the Generalized Method of Moments (GMM) estimation technique, which is preferred over Instrumental Variable (IV) estimation due to the presence of heteroskedasticity.
Following the work of Sayyar et al.,(2015) and Okolie (2014), the empirical models are written as:
ROA i,t = β 0 +β 1 ROA i,t-1 + β 2 AuditQi,t + β 3 LEV i,t + β 4 LNASSET i,t + β 5 SG i,t + ε i,t (1)
Tobin’Qi,t = α 0 + α 1 TQ t-1 +α 2 AuditQ i,t + α 3 LEV i,t + α 4 LNASSET i,t + α 5 SG i,t + ε i,t (2)
Z-Score i,t = γ0+γ1 Z-Score i,t-1+ γ2 AuditQ i,t +γ 3 LEV i,t γ 4 LNASSET i,t +γ 5 SG i,t + ε i,t (3) Whereas i: firm, t: time, from 2010 to 2015
In order to assess the impact of audit quality on firm performance comprehensively, this study measures firm performance from three approaches: market value, accounting profit and risk of bankruptcy
Dependent Variables: Firm performance is measured by
ROA measures firm earnings as a proportion of net income to totalassets ROA illustrates how much profit the firms can generate from their assets
Tobin's Q, initially developed by Brainard and Tobin in 1968, was later recalculated by Tobin in 1969 He defined it as the ratio of the total stock market values and liabilities to the replacement costs of assets.
Measuring the market value of liabilities poses significant challenges, and estimating the replacement costs of a company's diverse assets is equally complex Previous research has typically relied on book value rather than market value for calculating liabilities and assets This thesis adopts the same approach to evaluate Tobin's Q.
Tobin's Q is a financial metric that evaluates a company's value by comparing its market capitalization and total liabilities to its total assets When Tobin's Q is below 1, it indicates that the firm is undervalued, as its market value is less than the value of its assets Conversely, a Tobin's Q above 1 suggests that the firm's market value exceeds the value of its assets, indicating a higher valuation in the market.
A high Tobin’s Q indicates that companies are more likely to invest, as it signals easier capital mobilization in the stock market Conversely, when Tobin’s Q is low, companies tend to decrease their investment activities.
3 Z-Score (firm’s risk of bankruptcy)
Z-score is developed by Altman (1968) to calculate the risk of corporate bankruptcy This ratio is also used to evaluate the firm’s financial health status Z-Score is made up from five financial ratios:
- X3: Earning before interest and taxes / Total assets
- X4: Market value equity / Book value of total debt
- X5: Sales / Total Assets The higher value of Z-Score means the lower risk of bankruptcy The credit of bankruptcy rating is divided into three benchmarks
2.99< Z-Score Safety level The company will not likely go bankruptcy with the presented accounting figures
1.81< Z-Score < 2.99 Dangerous level The investors need to consider about the ability of bankruptcy
Z-Score