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Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

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Advances in Accounting, incorporating Advances in


International Accounting
j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / a d i a c

Audit firm, corporate governance, and audit quality: Evidence from Bahrain
Jasim Al-Ajmi ⁎
Department of Economics and Finance, College of Business Administration, University of Bahrain, P. O. Box 32038, Bahrain

a r t i c l e i n f o a b s t r a c t

The aim of this research is to document the perceptions of credit and financial analysts with regard to the
relationship between the effectiveness of audit committee, size of the auditing firm and audit quality in the
context of Bahrain, which is characterized by a developed financial sector, low-liquidity stock market, low
turnover in board of directors of listed firms, an inactive merger and acquisitions market and almost non-extent
litigation. A survey of 300 credit and financial analysts shows that analysts considered auditors' opinion useful.
Both credit and financial analysts see the credibility of financial statements to be a function of the size of the
auditing firm. Both groups assume that the characteristics of Big-Four firms allow them to produce better-quality
reports than non-Big firms. Non-audit services were found to affect auditor's independence and hence impair
audit quality. Both the groups of analysts believe that effective audit committee enhances the quality of audit
reports. Financial analysts perceive financial statements to be more credible than do credit analysts.
© 2009 Elsevier Ltd. All rights reserved.

1. Introduction audit quality as the ability of the auditor to detect and eliminate material
misstatements and manipulations in the net income reported.
Audit service is perceived to play an important role in reducing Users of financial statements perceived audit reports to provide
information asymmetry (Beatty, 1989; Willenborg, 1999) as well as in absolute assurance that company financial statements have no material
mitigating agency problems between managers and shareholders and misstatements and do not perpetrate fraud (Epstein & Geiger, 1994).
between shareholders and creditors (Jensen & Meckling, 1976). However, auditors perceive audit quality in terms of strict adherence to
Therefore, owners hire auditors to produce information used in GAAS/ISA requirements. Auditors working with a company also strive to
contracting with managers (Antle, 1982; Watts & Zimmerman, 1986). reduce their business risk by minimizing auditees' dissatisfaction,
Meeting these two roles depend on audit quality. While audit quality avoiding litigation, and limiting the damage to their reputation, which
is considered an important element of corporate governance, it is could result from audit failure. The demise of Arthur Andersen in 2002 is
unclear whether audit quality and other aspects of corporate governance an example of the ultimate results of audit failure.
(such as director knowledge and independence) are fundamentally Regardless of any differences in the definition of audit quality, and
complements or substitutes, according to Defond and Francis (2005). even when users and providers of audit services question the quality of
Audit quality is a concept that has different definitions for different audit service, they agree on its importance. I acknowledge that measuring
people. DeAngelo (1981a) hypothesizes a two-dimensional definition of audit quality is problematic. The quality of an audit is not directly or
audit quality that has set the standard for addressing the issue. First, a immediately obvious, especially to creditors and investors. Audit quality-
material misstatement must be detected, and second, the material control procedures are intended to maintain high standards of control
misstatement must be reported. Audit quality as such is the increasing over the process of an audit, but an audit failure usually becomes known
function of the ability of an auditor to detect accounting misstatements only in the case of a business failure; witness Enron.
and is related to the degree of auditor independence. Titman and An auditor's role is to assuage agency problems resulting from the
Trueman (1986) propose that a good auditor provides precise informa- separation of ownership and control (management). This role can be
tion regarding the firm's value. Because the purpose of an audit is to successful only if an audit opinion reflects the true findings of the audit
provide assurance as regards the financial statements, audit quality is engagement.
defined by Palmrose (1988) as the probability that financial statements According to the Statement of Financial Accounting Concepts No. 1
contain no material misstatements. Davidson and Neu (1993) define (SFAC No. 1, Paragraph No. 8, p. 9), “financial statements are often
audited by independent accountants for the purpose of enhancing
confidence in their reliability.”
American Institute of Certified Public Accountants (AICPA) (1994) also
⁎ Tel.: +973 39444284; fax: +973 17449776. acknowledges the importance of considering perceptions of investors on
E-mail address: jasimalajmi@yahoo.com. auditor independence. A former chairman of the AICPA, Elliott (2000)

0882-6110/$ – see front matter © 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.adiac.2009.02.005
J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74 65

says “[The AICPA] believe[s] that appearances are very important and As of the end of February 2008, audit services in Bahrain are
capital markets require confidence in financial statements and audit provided by 24 accounting firms. Five of these are considered local;
reports, and the member firms of the AICPA are basing their business of four are operating as foreign branches; and the remaining are linked to
auditing on their reputations, and that is heavily affected by appearance.” international firms. The Big Four; i.e., Ernst & Young (E&Y), Deloitte &
Despite considerable research on audit quality, studies on audit quality Touche (D&T), KPMG, and PricewaterhouseCoopers (PWC) have a
in Bahrain are scarce. This might be due to the relatively low number of strong presence in Bahrain. D&T and KPMG operate as a joint venture,
audit failures. Since the establishment of the first shareholding companies whereas the other two operate as branches of international firms. BDO
until 2008, there were only three reported cases of audit failure. These Jawad Habib and E&Y are the only two firms registered with the United
cases involve the General Trading and Food Processing Company (1994), States (US) Public Company Accounting Oversight Board (PCAOB).
the Bahrain Islamic Investment Company (2002), and the Bahrain Saudi The Bahrain Stock Exchange (BSE) was established in June 1989. As of
Bank (2002). The fraud involved in the first case was carried out by the July 2007, there were 41 listed Bahraini incorporated firms (two of these
company's accountant, and the court ruled against the accountant. As for have been de-listed and did not issue their reports of 2006). The
the second company, the case was settled out-of-court, and the partner majority of the companies are retail banks, wholesale banks, and
involved in the case was asked to leave the firm, whereas the third investment companies.
instance resulted in replacement of the auditors without the auditors The Central Bank of Bahrain (CBB) requires financial institutions to
being taken to court. The low number of reported cases of audit failures be audited by one of the big audit firms. Audit services are regulated
does not ensure that audits of Bahraini listed firms are of good quality and by the Amiri Decree Number 26 of 1996, which requires auditors to
should not mean that users of company reports should be complacent as obtain a license to practice and set the minimum requirements for a
to the quality of an audit. Therefore, this study investigates the way users license. In effect, audit firms got two licenses, one to practice auditing
of financial statements determine the quality of audit reports. Accordingly, and the second specifically to offer auditing services to financial
a survey of the major users of financial statements (investors and lenders) institutions.
with respect to their perceptions of the factors that determine audit Appointments of auditors, as per article (205) paragraph (e) of the
quality, particularly with respect to the impact of corporate governance Bahrain Commercial Companies Law Number 21 of 2001, should be
and size of audit firms on the quality of an audit report, is carried out. made on a yearly basis at firm annual stockholder meetings. However
This research makes three contributions to the literature. First, in practice, boards of directors are empowered by annual meetings to
although most of the research in the area uses different methodologies appoint auditors and to determine their remuneration. This practice is
to investigate the determinants and the role of audit quality on integrity subject to criticism on the grounds that an auditor's role is to miti-
and quality of accounting information, studies on markets such as gate agency problems that might exist between the board and the
Bahrain, which is characterized by dominance of few accounting firms; shareholders.
largely uncommon cases of switching audit firms; weak enforcement of The CBB's authority is based on article, (61) paragraph (a), of The
regulation reverent to audit industry, with exception of those related to Central Bank of Bahrain and Financial Institutions Law Number 64 of
financial institutions; low-liquidity stock market; and considerably less 2006, which states: “Every Licensee shall appoint one or more
number of different institutional setup. Hence, this research provides qualified and experienced external auditors for its accounts for every
additional insights to audit quality. Second, it responds to calls for financial year. Prior written approval by the Central Bank will be
empirical testing of the relationship between corporate governance and required before appointing an auditor.” This approval is needed
audit quality, according to Defond and Francis (2005). Third, Defond and annually. In cases wherein a decision has been taken to replace the
Francis (2005) argue that research on the effectiveness of audit external auditors before the end of the year, the respective financial
committee suffer from a number of problems such as weak statistical institutions are also required to inform the CBB about the reasons for
explanatory power and multi-colinearity problem. A survey method this decision.
that asks respondents to state their perception of the effect of effective Since 2002, only three of the Big Four have been approved to audit
audit committee on audit quality overcomes these problems. the financial statements of the locally incorporated banks. Exclusion
The remaining part of the article is organized into four sections. The firm of the Fourth came after its audit failure of the financial
following section provides brief accounts of the audit market in Bahrain. statements of locally incorporated retail banks. CBB guidelines specify
Section 3 offers brief literature review on the relationship between experience of the auditors, experience of the firm, and number of
effectiveness of audit committee, firm's size, and audit quality. Section 4 partners, among other requirements. Currently, only Big Four firms
describes the data collection and research methodology. Section 5 audit small financial institutions.
presents the research findings of questionnaire survey. The final section The internal guidelines of the CBB allow non-big firms to audit
provides conclusions of the study, its implications, and suggestions for small investment companies. As of September 2007, Bahraini incorpo-
future research. rated financial and non-financial firms listed on the Bahrain Stock
exchange are audited by five companies, the Big Four and one other
2. Audit market in Bahrain1 company, which is connected with an international firm. The other two
companies are a joint venture between a local audit firm and regional
Some important features of the audit market in Bahrain must be or international companies. Unlike some other countries in the region
understood to perceive the context in which this study was undertaken. where listed firms are audited by two audit firms, all companies in
Bahrain are audited by only one audit firm.
1
Most of the contents of this section are based on interviews with the following Audit services industry is dominated by the Big Four. A total of
persons: Adnan Yusuf, Chief Executive Officer of Albarka Banking Group; Ibrahim 82.5% of the 41 listed companies on the BSE that published their
Zainal, Chairman of TRAFCO; Jamal Fakhro, CPA (US), Managing Partner of KPMG annual reports in 2007 are audited by one of the Big Four, and the
Fakhro and Ex-Chairman of the Bahrain Accountants Association (BAA); Elham Hasan,
other 17.5% are audited by a non-Big Firm company.
CPA (US), Managing partner of PWC-Bahrain; Abbas Radhi, CPA (US), a partner from
BDO Jawad Habib, and Chairman of the BAA; Hameed Rahma, Assistant Undersecretary In Bahrain, it is not mandatory to switch audit firms. In fact, in 2006,
for domestic trade at the Ministry of Industry and Commerce; Jassim Abdulaal, CA the CBB took a position against a motion in the parliament to mandate
(UK), Senior Partner, Grand Thornton-Gulf Audi-Bahrain; Yusuf Hassan, director of such a requirement on the ground that small markets are distorted by
bank supervision at the Central Bank of Bahrain (CBB); Khalil Noor Eldeen, CFA, Ex- such decisions. Experience has shown that switching of audit firms
investment banker, Ex-director of BIBF, and a member of the audit committee of
Ethmar Bank Group; and Waleed Bangash, CA (UK), Director, Financial Control
takes place in very rare cases and generally occurs only after an audit
(Strategic Planning), Unicorn Investment bank. The interviews took place between the failure. The CBB does require auditors of financial institutions to switch
5th of January and the 4th of March, 2008. auditing partners at least every five years. Auditing firms claim that
66 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

they follow such a practice for other firms in accordance with their own announced out-of-court settlements between the auditors and their
internal policies. Auditors are not prevented from joining a client firm clients nor court judgments against erring auditors. However, there is
at any time, even immediately after formulating an audit opinion. one case pending against the auditors belonging to one of the non-Big
The presence of multinational firms and international financial Four firms. No decision has yet been arrived at, even though it dates back
institutions in Bahrain, the government's long-standing policy of to the mid-1990s. Another case involving E&Y was settled out-of-court,
attracting foreign investment, the effect of globalization, and the size and the partner involved in the case was asked to leave the firm.
of the Bahrain economy are possible reasons for the nondevelopment However, the low number of litigation cases should not be seen as an
of local accounting and auditing standards. As a result, companies in indicator of high audit quality in Bahrain. The fewer cases of litigation
Bahrain are required to comply with international financial reporting might be due to the high cost, weak regulation, less efficient court
standards (IFRS), whereas accounting firms must comply with the system, the difficulties of bringing such cases to the court, and passive
international standards on auditing (ISA). These requirements apply investors. However, this situation changed after the audit failure of the
to all companies, including financial institutions. The latter are Bahrain Saudi Bank. The role of the CBB in maintaining the stability of
required to comply with the financial accounting standards issued the financial system ensures the maintenance of a certain level of audit
by the Accounting and Auditing Organization for Islamic Financial quality during the auditing of financial institutions. Furthermore, as the
Institutions (AAOIFI). However, in accordance with the requirements number of foreign investors increase, raising the awareness of investors,
of AAOIFI, for matters on which AAOIFI standards do not exist, the enhancing the efficiency of the judiciary system, increasing the
respective institutions are required to comply with the relevant IFRS. probability of materialization of risk, increased government privatiza-
This is also applicable to conventional bank licensee units. Require- tion programs, and reduction of government ownership in listed firms
ment to comply with the IFRS and ISA are perceived by both the are likely to increase the probability of materialization of litigation risk.
government and the accounting firms as the basis for the competitive Restatements of earnings are uncommon in Bahrain. The only
advantage that Bahrain enjoys. restatement between 1957 and 2007 in the financial statements of listed
As in many other countries, the practice in Bahrain is that companies was in 1994 when the newly appointed auditors restated the
accounting firms should sign the audit reports and not the partners profit figures of the General Trading and Food Processing Company.
who supervise the audit engagements. This is due to the lack of legal In Bahrain, it is common to outsource internal audit services to
sanction for the auditors of companies operating in Bahrain to sign the audit firms. Firms thus avoid the cost of creating an internal audit
audit report in their own names. Article (19) of the Amiri Decree No. department with expertise that is not used during the year. The CBB
26 of 1996 gives auditors the choice to sign the audit reports using prohibits external auditors from providing routine internal audit
either their names or the name of the company. Chairmen and chief services to their clients. OM2.7.2 of the Operational Risk Management
executive officers sign the company(ies)'s reports as representatives guidelines states that “The [CBB] will generally not permit licensees to
of the respective board(s) of directors. As such, they assume no more outsource their internal audit function to the same firm that acts as
personal responsibility than other members on the boards. their external auditors. However, the [CBB] may allow short-term
All listed and unlisted financial institutions are required to form outsourcing of internal audit operations to a licensee's external
independent audit committees. Listed non-financial firms are not auditor, to meet unexpected urgent or short-term needs (for instance,
required by law to form such committees. Members of the audit on account of staff resignation or illness). Any such arrangement will
committees of financial institutions are nominated by the boards; normally be limited to a maximum of one year.”
however, they need to be approved by the CBB. However, whether the Universities in Bahrain use American textbooks in their business
criteria that the CBB uses for its approval include an assurance of programs, including textbooks on accounting. Bahrain University, the
independence and knowledge or merely an affirmation of the latter is biggest and the only public university, has a policy that dictates
not clear. professors teaching at the college of business to have been educated in
The principles of Auditor Oversight issued by the International western universities. Furthermore, auditors and analysts are expected
Organization of Securities Commissions (IOSCO) in 2002 state that audit to seek professional qualifications from the US and the United
quality is an important requirement for the integrity of financial Kingdom (UK). Advertisements on the websites of financial institu-
statements. However, Bahrain lacks a formal independent audit over- tions and in newspapers seeking new staff state that applicants need to
sight regulating authority, similar to the PCAOB in the US. The possess professional qualifications obtained from the US and the UK;
establishment of such an institution is considered the best practice this policy seems to be followed by both the government and the
internationally, as it provides one of the mechanisms that increase private sector. For example, the Labor Fund of Bahrain (www.lf.com),
confidence in the quality of an audit (International Audit Networks which is the government arm for training, awarded two contracts to
(IANs), 2006). IANs recognize that the establishment of independent BDO Jawad Habib and Earnest & Yong in 2007, worth 14.1 million
audit oversight regimes have reinforced the independence of auditors, Bahraini Dinars (US$37.4 million), to train 7200 Bahrainis for obtaining
and in their view, improved the governance and regulation of the American and British accounting qualifications. The human resources
auditing profession. They state that independent audit oversight regimes development fund (HRD Fund) (www.hrdfund.org) and the Bahrain
have led to audit firms emphasizing on the quality of the audit. The need Institute of Banking and Finance (BIBF), the banks' arms for training
for having an audit oversight in Bahrain is a view that is shared by most of their staff, offer funding for and provide training for their staff only for
those interviewed for the purpose of writing this section. Furthermore, acquiring professional qualifications from the US and UK. This policy is
peer review for other companies is uncommon in Bahrain. also followed by audit firms that require their local staff to seek their
The Ministry of Industry and Commerce (MIC) as per article (27) professional qualifications from these two countries.
establishes a disciplinary committee composed of the Chairman, who Unlike in the US, there is no professional body in Bahrain to play a
should be a judge from the Civil High Court, appointed by the Minster role similar to that of AICPA. The Bahrain Accountants Association (BAA),
for Justice, and two other members, who are specialists in auditing, which was established in 1972 as a nongovernmental organization, has a
appointed by the MIC. The disciplinary committee investigates the very minimal role in the further development of the profession. Its
cases referred by the MIC for misconduct, violations of professional activities are limited to workshops, seminars, and public lectures.
requirements, serious negligence, or violations of the Amiri Decree No. Membership in the BAA is voluntary. Despite thousands of accountants
26 of 1996. However, there are no public records available regarding qualifying for membership into the BAA, including all holders of an
the referred cases. undergraduate degree in Accounting, the number of members at the end
Previous experience shows that litigation risk is very low in of January 2007 was only around 250, among whom, the active
Bahrain. In the corporate history of Bahrain, there are neither publicly members were very few.
J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74 67

3. Brief literature review determine audit quality. These are auditee size, audit team and firm
experience with the client, industry expertise, responsiveness to client
Watkins, Hillison, and Morecroft (2004) summarize both theore- needs, compliance with GAAS, firm executive involvement, firm commit-
tical and empirical work on audit quality from DeAngelo (1981b) ment to quality, involvement of audit committee, degree of personal
through 2002. Francis (2004) offers an excellent review of published responsibility, conduct of fieldwork, auditor's skeptical attitude and firm
empirical attempts over a quarter century beginning in 1981. Defond personnel maintain freshness of perspective.
and Francis (2005) offer a critical review of audit quality literature Corporate governance is defined as the system by which firms are
after 2002. Besides these three studies, a brief review that presents the directed and controlled (Cadbury, 1992). The principles of corporate
salient feature of the relationship between firm size, corporate governance formulated by the Organization for Economic Cooperation
governance, and audit quality is imperative to set the ground for the and Development (OECD) state that “An annual audit should be
stage for the author's survey results. conducted by an independent, competent and qualified, auditor to
The relationship between the audit-firm size and the quality of audit- provide an external and objective assurance to the board and share-
reporting decisions has been widely investigated; however, the results holders that the financial statements fairly represent the financial
are not conclusive. Although extensive empirical evidence suggests that position and performance of the company in all material respects,”
the Big Four firms provide higher quality audits (DeAngelo (1981b), (OECD, 2004)). KPMG (2006, p. 2) states that audit committees are
Palmrose (1988), Deis and Giroux (1992), Mutchler, Hopwood, and responsible for oversight of the company's financial reporting process,
McKeown (1997), Krishnan and Schauer (2000), Fuerman (2004), there including related risks and controls as well as the company's internal
is other evidence to suggest that no differences in quality exist between and external auditors. U.S. SEC (2003) states that the primary role of the
the Big and non-Big audit firms (Jeong and Rho (2004) and Khurana and audit committee is to oversee the financial reporting process with the
Raman (2004). Krishnan (2005) comments that audit quality differs ultimate objective of ensuring high-quality financial reporting.
between and within the various audit firms. These results might have an KPMG (2006) outlines five guiding principles for audit committee
important implication for the perception of investors and lenders about for playing an effective role. These are: 1) recognize that one size does
the quality of audit reports. not fit all, 2) have the “right” people in the committee, 3) monitor and
A number of reasons are used to explain the positive effect of audit- insist on the right “tone at the top,” 4) ensure that the oversight
firm size on audit quality. Audit quality is a function of how well an process facilitates the committee's understanding and monitoring of
audit team functions, and presumably firms perform best based on the key roles, responsibilities, and risks within the financial reporting
following criteria: environment, and 5) articulate and exercise the committee's direct
responsibility for the external auditor.
1. availability of adequate resources (human and technology) (DeAngelo,
An effective independent audit Committee is seen as one of the
1981b; Frantz, 1999);
determinants of audit quality, see for example Dhaliwal, Naiker, and
2. control systems of high standard;
Navissi (2006). Such a committee recommends external auditors and
3. larger firms are more independent of their clients (DeAngelo,
manages the relationship between them and the company, according
1981b);
to AICPA (2004) and OECD (2004). Zhang, Zhou, and Zhou (2007)
4. large firms have a considerable business at stake if they lose their
report that firms with an ineffective audit committee are more likely
reputations (DeAngelo, 1981b);
to be identified with an internal control weakness. Krishnan (2005)
5. charging higher audit fees that allow them to spend more time and
finds that there is a positive relationship between audit committee
effort in each audit engagement (Francis, 2004; Goodwin-Stewart
independence and the quality of internal control prior to the enact-
& Kent, 2006); and
ment of SOX. However, others report that the role of audit committees
6. high significant economic costs imposed on the auditor in the event
in overseeing and strengthening the audit process is not significant,
of audit failure (DeAngelo, 1981b).
Carcello, Hermanson, Neal, and Riley (2002); Abbott, Parker, Peters,
Auditor independence from the client's management is considered and Raghunandan (2003).
as one of the prerequisites for a good-quality audit. Several definitions Piot and Missonier-Piera (2007) report that audit quality, unlike
can be found for the independence of the auditor. Among them are the quality of corporate governance, measured by firm size (Big and non-Big)
following: “the conditional probability of reporting a discovered breach” does not have a significant influence on the cost of debt of non-financial
(DeAngelo, 1981a, p. 186); “the ability to resist client pressure” (Knapp, French listed firms. These results are robust even after controlling for a
1985); “a function of character—with characteristics of integrity and set of auditees' characteristics such as firm size, profitability, asset
trustworthiness being essential” (Magill & Previts, 1991); and “an structure, and interest coverage ratio. However, others report that one of
absence of interests that creates an unacceptable risk of bias” (Beattie, the most important functions corporate governance can play is ensuring
Fearnley, & Brandt, 2001). Several factors are found to have potential quality of financial reporting process (see for example, Blue Ribbon
influence over the independence of the auditor. Among them are size of Commission, 1999)). Dechow, Sloan, and Sweeney (1996); Beasley
the auditing firm (Shockley, 1981); non-audit service (Shockley, 1981; (1996); Beasley, Carcello, and Hermanson (1999); Beasley, Carcello,
Knapp, 1985); the client's financial conditions (Knapp, 1985); the nature Hermanson, and Lapides (2000); Carcello and Neal (2000); and Klein
of conflict of interest (Knapp, 1985); the tenure of the audit firm, (2002) report an association between weaknesses in governance and
(Shockley,1981); the degree of competition in the audit-service markets poor financial reporting quality, earnings manipulation, financial
(Knapp, 1985); and the audit committee (Teoh & Lim, 1996). statement fraud, and weaker internal controls.
Eichenseher and Shields (1983) show that chief financial officers Audit quality might be impaired by a number of factors especially
believe that audit quality is a function of 11 items. These are ethical by the pressure on the accounting firms to increase profit, reduce
standards, reputation, industry expertise, audit-team expertise, geogra- costs, and increase fees. Otley and Pierce (1996) and Willett and Page
phical coverage, audit fees, working relationships, meeting deadlines, (1996) report that it is not unusual for accounting firms to trim their
technical qualifications, accessibility of the audit firm, and range of time budgets and increase control over their staff so as to increase
services offered. Shockley and Holt (1983) argue that bank chief financial profits, which thus leads to the response of the audit staff to these
officers rank the Big Firms in terms of 10 attributes. These are prestige, pressures by resorting to dysfunctional behavior such as falsifying
professionalism, expensiveness, competence, aggressiveness, conserva- audit work. Otley and Pierce (1996) also argue that a performance-
tiveness, impendence, reliability, helpfulness, and bureaucratic behavior. evaluation system might represent a threat to audit quality.
Carcello, Hermanson, and Mcgrath (1992) report 12 items that are Furthermore, the pressure to meet the time budget is found to lead
perceived by auditors, preparers, and users of financial statements to to a reduction of audit quality (Kelley, Margheim, & Pattison, 1999).
68 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

Additionally, the low probability of bringing in litigation cases against involves analysis of financial statements for credit and investment
auditors and imposition of a limit for liabilities affect the economic decisions; and their qualifications, age, and length of experience in
incentives that deliver good audits. decisions on investing and lending. Table 1 describes the respondents.
Section II asks of a number of questions found in the accounting and
4. Research methodology and sample characteristics corporate governance literature to determine audit quality; Section III
asks respondents to state their perceptions on the important compe-
This study was undertaken in two stages. The first stage involved tencies of auditors that might affect the credibility of an audit firm; and
the use of a mail-in questionnaire to seek the views of loan officers and Section IV asks two questions soliciting respondents' perceptions of the
investment analysts on the issues of the auditing firm's size and the credibility of audit reports issued by Big Four and non-Big Four auditors.
attributes of audit quality. The second stage entailed a series of Finally, Section V requires participants to state their perceptions of the
interviews with senior auditors of audit firms, banks, and investment effect of effectiveness of audit committee on quality of audit.
companies on the issues of size of the auditing firms and audit quality, The respondents work for retail banks (38.4%), wholesale banks
with the aim of more detailed analysis. (42.1%), and investment companies (19.5%). Although the respondents
The use of the questionnaire is motivated by an argument in hold a variety of positions in their organizations, the author wanted to
Beattie and Fearnley (1998, p. 264) that “the questionnaire approach reach those who analyze company reports for the purpose of obtaining
provides richer insights than is possible using secondary data analysis, decisions on investment and lending, and respondents were asked to
which focuses on economic factors, because the questionnaire indicate the purpose for which they analyze reports. Around 54.9% are
instrument includes both economic and behavioural factors.” They investment analysts, whereas 45.1% are credit analysts. The majority of
also point out that a behavioral or qualitative technique is important the respondents (74.4%) held graduate degrees or qualifications with
to clarify theories in accounting research because it can provide “new respect to accounting or investment analysis. A majority of the
insights into buyers' behavior is offered by the ‘relationships respondents also had more than five years of experience, whereas
approach’ to professional services developed in the service marketing around 60% of those with experience of less than five years had
literature, which classifies relationships (in the present case, auditor– professional accounting qualifications. Hence, the information gathered
client relationships) based on buyer type.” They note further that an ought to be reliable and could be generalized to the whole population.
“economic-based framework can be expected to provide only a partial
explanation of auditor choice.” 5. Results and analysis
The corporate debt secondary market in Bahrain is thin, with only
two issues, which means that companies seeking credit must rely on The first question the respondents were asked to answer is about
bank loans. There are also limited numbers of listed companies, so their confidence in the independence of the auditors performing their
considerable equity investment in local companies is directed to non- audit engagements. Auditor independence is seen by many as an
listed companies or to companies whose financial statements are not important prerequisite for audit quality (DeAngelo, 1981b). Lack of
publicly available. auditors' independence indicates that clients may be exerting influence
Thus, a survey approach to examine the role of firm size in over the results of their audit. If this is the case, an auditor will be unable
determining audit quality from the users' perception is the best approach to carry out the necessary duties to reduce agency problems and ensure
in Bahrain. Moreover, some of the factors the author tests in the study credible financial statements.
(non-audit services and outsourcing internal audit services) are not The majority of the respondents seem to be confident (but not
disclosed even by listed companies, which are required by law to publish extremely confident) that the auditors are independent when they
annual and quarterly reports. This makes a survey approach the only express their opinion. Table 2 shows the means and standard deviations
viable methodology.
The survey instrument was developed upon review of literature
and after consultation with five analysts with appropriate experience. Table 1
It was comprehensively tested to improve its quality and to make sure Sample characteristics.

it was applicable to current practices in Bahrain to generate the Institutions Frequency Percent Cumulative percent
highest response rate. The questionnaire was then pretested on a Retail bank 63 38.4 38.4
sample of 20 credit and financial analysts whose comments were Wholesale bank 69 42.1 80.5
incorporated in the final version. Investment company (Bank) 32 19.5 100.0
Total 164 100.0
The survey was administered during January and February 2007 to
Position
150 credit analysts and to 150 financial analysts working in Bahrain for Financial analysts 90 54.9 54.9
retail banks, wholesale banks, and investment companies. Out of the Credit analysts 74 45.1 100.0
300 questionnaires distributed, 175 questionnaires were returned, of Total 164 100.0
which 164 questionnaires were useful for the analysis, resulting in a Highest qualification
B.Sc. 50 30.5 30.5
54.7% response rate. Sixty percent response was obtained from
Graduate degree 67 40.8 71.3
financial analysts and 49.3% from credit analysts. CPA/CA/ACCA/CFA 47 28.7 100.0
One of the most common problems cited in a survey methodology is Total 164 100.0
of non-response bias, when data from survey respondents may turn out Age of the respondents
Less than 25 years 8 4.9 4.9
to be invalid. To ensure the reliability and validity of the data, it is
25 to 29 years 34 20.7 25.6
essential to examine the sample for the possibility of a non-response 30 to 34 years 36 22.0 47.6
bias (see Bartlett & Chandler, 1997; Mallin & Ow-Yong, 1998). The author 35 to 39 years 54 32.9 80.5
follows Oppenheim (1999) and Wallace and Mellor (1988), and the first 40 years and older 32 19.5 100.0
15 questionnaires were compared with the last 15 questionnaires, using Total 164 100.0
Length of experience
t-test to investigate the differences. The results show that there is no
Less than 5 years 52 31.7 31.7
significant difference between the 15 early and the 15 late responses, 5 to 9 years 28 17.1 48.8
implying the absence of non-response bias. 10 to 14 years 46 28.0 76.8
The questionnaire is divided into five sections. Section I requires 15 to 19 years 14 8.5 85.3
20 years and longer 24 14.6 100.0
respondents to provide information about the type of their institu-
Total 164 100.0
tions; the positions they occupy to determine whether their work
J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74 69

of the responses. The mean responses show that respondents perceive access to their clients facilitating the process of obtaining more
auditors in Bahrain as independent but not highly independent. This information from clients whenever the need arises.
observation came from credit analysts as well as financial analysts, Whether auditor reports influence credit and investment decisions is
although financial analysts thought that auditors were more indepen- the third question in the questionnaire. The mean of the responses
dent than credit analysts. indicates that those reports do influence analyst decisions. The majority
To test whether this difference is significantly different from zero, of respondents appeared to take auditors' reports into consideration to
the author applies a Levene test and t-test. The homogeneity of the different degrees; only 8.5% of the respondents answered that the
variances of the responses of two groups is confirmed by the results reports do not influence their decisions at all. Mean responses indicate
obtained from the Levene test, so a t-test is performed to test the financial analysts (3.49) appear to be influenced more by auditors'
differences in the mean of the responses between credit and financial reports than credit analysts' reports (3.38).
analysts. The results show that the mean difference is not significantly The results of Levene's test for the equality of variances indicate no
different from zero, indicating that both groups seem to agree that significant difference between the variances of the responses of both
auditors in Bahrain are independent of their clients. groups, but the results of the t-test indicate the mean responses of the
Another measure of audit quality is that financial statements are free groups differ significantly from each other.
from unintentional misstatements or omissions of material information. These results might be explained by two reasons: 1) credit analysts
Respondents were asked to indicate their confidence level with regard can obtain additional information from clients who are seeking
to whether the financial statements of Bahraini companies meet a financing, and 2) bank–client relationships give creditors more leverage
standard using such a definition of audit quality. The mean rank of the to know their clients, their financial positions, and their probability of
responses shows that the majority of respondents (86.6%) are at least defaults. Investors and financial analysts do not generally have these
confident, and only 2.4% do not have any confidence at all in the financial advantages. Financial analysts would be expected to rely more on
statements. financial statements and auditors' reports as one way to determine the
The results also show that, on average, financial analysts are more credibility of a financial statement.
confident in financial statements than credit analysts (mean of response The effect of non-audit services (NAS) by firms' external auditors is
of 3.49, 5.00 being extremely confident compared with the mean of one factor cited in the literature as having an impact on auditor
3.38). The t-test results indicate that the mean difference is significantly independence and audit quality. Such services tend to be regarded by
different from zero, indicating that the two groups are homogeneous in regulators in the UK, the US, Australia, and various other countries as a
their perceptions of the quality of audits. This can also be seen from the threat to auditor independence (Craswell, 1999, p. 29). In fact,
results of the Levene test, which shows that variances of the responses of research findings on a connection between the joint provision of
the two groups do not differ significantly. The relatively high confidence audit and NAS and auditor independence have been inconclusive and
of financial analysts in financial statements might be due to 1) their contradictory (Ashbaugh, 2004; Brandon, Crabtree, & Maher, 2004;
reliance on these statements as the main source of information, and Chung & Kallapur, 2003; DeFond, Raghunandan, & Subramanyam,
therefore, they need to believe that such financial statements are more 2002; Frankel, Johnson, & Nelson, 2002; Geiger & Rama, 2003;
reliable than the credit analysts do; 2) financial analysts deal mainly Kleinman, Palmon, & Anandarajan, 1998; Reynolds, Deis, & Francis,
with financial statements of listed firms which are audited by either the 2004).
Big Four or BDO Jawad Habib, whereas credit analysts deal mainly with A review of the literature by Beattie and Fearnley (2002) shows no
the small- and medium-sized firms, the accounts of which are audited evidence to support the hypothesis that the joint provision of audit
mainly by small audit firms. This might imply that “audit quality” has and NAS could threaten auditor independence; it is acknowledged
been socially constructed to fit needs of financial analysts more than the that it might threaten the appearance of independence (but the audit
users of financial statements. Credit analysts, on the contrary, have quality will not be affected).

Table 2
Means and standard deviations of the responses, Levene's F test, and t-test.

Questions Stat. Sample Financial Credit Levene's t-test


analysts analysts F test
1. How confident are you that the Qualified Accountants are independent in performing the audit? Mean 3.440 3.490 3.380 0.111 0.654
Std 1.075 1.008 1.155

5 = Extremely Confident, 0 = No Confidence


2. How confident are you that the financial statements are free of unintentional (alternatively, intentional) misstatements Mean 3.440 3.490 3.380 0.111 0.654
or omissions? Std 1.075 1.008 1.155

5 = Extremely Confident, 0 = No Confidence


3. The influence of the auditor's report on your decision-making process. Mean 3.650 3.780 3.490 0.007 2.139a
Std 0.877 0.897 0.832

5 = Great Influence, 0 = No Influence


4. In your opinion, the provision of non-audit services by the audit firms will impair its independence and Mean 3.730 3.760 3.700 2.219 0.309
therefore its quality of services. Std 1.086 1.042 1.144

5 = Strongly Agree, 0 = Do Not Agree


5. In your opinion, outsourcing internal auditing activities to the external auditors will enhance the audit quality. Mean 1.770 1.870 1.650 0.041 1.401
Std 0.928 0.927 0.911

5 = Strongly Agree, 0 = Do Not Agree


6. In your opinion, long association of the relationship between auditors and their clients will enhance the Mean 2.680 2.640 2.730 0.635 − 0.467
credibility of financial statements Std 1.160 1.202 1.114

5 = Strongly Agree, 0 = Do Not Agree

Std: Standard Deviation.


a
Significant at less than 5% significance level.
70 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

Antle, Griffin, Teece, and Williamson (1997) contended that Auditor tenure is one among the factors that affect audit quality,
auditor independence would not be affected by NAS because this although the relationship is complex. Auditors auditing a client for the
client association would improve audit quality. The reasons are that an first time generally need more time to understand the client's
auditor's knowledge of the client company can be improved by the business, which increases the risk of missing material and misstate-
provision of NAS, resulting in increased objectivity (knowledge ments. Yet, although a very long association may lead to a better
spillover); independence (Goldman & Barlev, 1974; Wallman, 1996); understanding of the client's business and make it more likely that the
and economies of scope (Arrunada, 1999). auditor will detect misstatements and earnings management, it might
Others, including Brandon et al. (2004), Frankel et al. (2002), also produce a poorer quality audit.
Glezen and Millar (1985), Jenkins and Krawczyk (2002), Lowe and Shockley (1981) and Deis and Giroux (1992) argue that long
Pany (1995, 1996), Raghunandan (2003), and Wines (1994) argue that tenure has the potential to cause complacency, more relaxed audit
performing non-audit and audit services will pressurize auditors not procedures, too much dependence on management representations,
to conduct the audit function objectively, impairing their indepen- and less skepticism and less diligence in gathering evidence. Myers,
dence. Auditors will end up auditing their own work, according to Myers, and Omer (2003) and Ghosh and Moon (2005) contend that
“Revision of the Commission's Auditor Independence Requirement,” long relationship improves audit quality and that mandatory limits on
2001. Auditors will be weakened if they rely on NAS (Canning & an auditor's term might put on unnecessary cost burden on investors.
Gwilliam, 1999). This will ultimately impair the quality of an audit. More recently, Knechel and Vanstraelen (2007) find that long
Elstein (2001) contends that high consulting fees negatively affect associations between auditors and clients do not impair auditor
auditor independence and worsen audit quality; having provided NAS, independence; they do not find evidence to support the contention
auditors become more likely to give the client the benefit of the doubt, that long-term relationships will make auditors better at predicting
including more flexibility in recording and adjusting discretionary bankruptcy.
reserves that could lead to manipulation of earnings figures. The author's survey results show that opinions of the respondents
The respondents of the survey conducted by the author were asked vary, although the largest group perceives tenure to have little effect
to determine how much they agree with the statement that “the on the quality of an audit. Levene's test for equality of variances shows
provision of non-audit services by audit firms will impair auditor that variances of the responses of the groups are homogeneous. The t-
independence and therefore its quality of services.” The results show test shows no significant difference between the means of the
that the majority agreed that auditors offering non-audit along with responses of the two groups.
audit services might compromise their independence, leading to a Fourteen competencies (attributes) have been found in the literature
poorer quality of their audit. The Levene test and t-test results show to contribute to the quality of the audit service and ultimately the audit
that the perceptions of the two groups were similar. report: specialization; independence; industry expertise; technical
Abbott, Parker, Peters, and Rama (2007) argue that the effect of competence in applying GAAP & GAAS/IFRS & ISA, a wide range of skills
outsourcing internal audit services to external auditors will lead to such as analytical skills; provision of real value for the audit fees paid by
economic bounding only if companies outsource routine internal clients; proactiveness, taking initiative; due care; commitment to
audit tasks and also will result in a loss of internal auditors' providing and maintaining quality service; professional audit expertise;
independence, although outsourcing non-recurring internal audit reputation; high ethical standards; and possessing strong accounting and
tasks will not lead to economic bonding. In Bahrain, although some auditing knowledge.
non-financial non-listed companies outsource their internal audit to Survey respondents were asked to state their perceptions with
non-external auditors, some companies do outsource such services to regard to the level of importance of each of those competencies for the
their external auditors. quality of audit, using a 6-point Likert scale, where zero indicates that
To test how credit and financial analysts perceive the effect on audit the competency is not important in determining audit quality and 5
quality of outsourcing internal audit tasks to external auditors, indicates that it is extremely important. Table 3 presents the summary
respondents were asked to express their opinion of the role of statistics.
outsourcing in the credibility of financial statements. The results show Accounting and auditing knowledge is ranked first, followed by
that the majority (more than 76%) do not look favorably on outsourcing professional audit expertise (with a mean of 4.52). Auditor indepen-
internal audit tasks to a firm's external auditors. Levene's test on the dence is ranked third with a mean of 4.49. Real value for the audit
variances of the responses shows that the variances are homogeneous. fees is ranked last by both groups of analysts with a mean of 3.46.
The mean difference is not significantly different from zero, indicating The low ranking of this factor should come as no surprise because
that credit analysts and financial analysts share similar opinion. users of financial statement would be more concerned about the

Table 3
Descriptive statistics of competencies/factors, Levene's F test, and t-test.

Competencies/Factors Whole sample Financial analysts Credit analysts Levene's t-test


Mean Std. Deviation Mean Std. Deviation Mean Std. Deviation F test

Specialization 4.140 1.021 4.210 0.977 4.050 1.071 0.089 0.981


Independence 4.490 0.883 4.610 0.730 4.350 1.026 11.358a 1.830
Industry Expertise 4.050 1.064 4.100 1.039 4.000 1.098 0.000 −0.655
Technical competence in applying 4.080 1.203 4.170 1.144 3.970 1.271 0.057 1.026
Wide range of skills (GAAP & GAAS/IFRS & ISA) 3.750 1.076 3.700 1.126 3.810 1.016 0.000 − 0.655
Real value for fees 3.400 1.237 3.340 1.300 3.460 1.161 0.903 − 0.592
Proactive 3.630 1.203 3.610 1.287 3.660 1.101 4.220a − 0.274
Takes initiative 3.730 0.999 3.770 1.092 3.680 0.878 0.873 0.579
Due care 4.120 1.090 4.270 1.003 3.950 1.169 0.689 1.890
Quality commitment 4.300 0.999 4.310 1.098 4.300 0.872 1.986 0.088
Professional audit expertise 4.520 0.917 4.520 0.939 4.510 0.895 0.388 0.060
Reputation 4.150 1.152 4.240 0.878 4.030 1.414 7.717a 1.153
Ethical standards 4.410 1.129 4.530 1.173 4.270 1.064 0.108 1.490
Accounting & auditing Knowledge 4.610 0.937 4.620 0.801 4.590 1.084 0.603 0.187
a
Significant at less than 0.05 level.
J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74 71

Table 4
Respondents' perceptions of the credibility of audit reports.

Credibility of audit reports Whole sample Financial analysts Credit analysts Levene's t-test
Mean Std. Deviation Mean Std. Deviation Mean Std. Deviation F test

The credibility of a report audited by one of the Big Four 4.34 0.722 4.49 0.066 4.16 0.092 0.132 2.953a
The credibility of a report audited by Non-Big Four 2.57 1.016 2.58 0.104 2.57 0.123 0.468 0.064
a
Significant at less than 0.05 level.

quality of the reports than the value of money; reduced auditor fees because they can access the expertise needed even if it is not available
might lead to a compromise on the quality of an audit. The four factors in the auditor's local offices, providing assurance of a quality that meets
most important to financial analysts (mean is higher than 4.5) were the expectations of investors and creditors.
accounting and auditing knowledge; independence; ethical stan- Two regression models are used to test the effect of the 14 attributes
dards; and professional audit expertise. Credit analysts rank only on the perception of the credibility of financial statements. The
accounting and auditing knowledge and professional audit expertise dependent variable in the first model is the perception of the
as extremely important and rank auditor independence in third place. respondents of the credibility of reports audited by Big Four firms. The
The Levene test and t-tests of the mean difference show no significant dependent variable in the second is the perception of the respondents of
difference between the variances of the responses of all factors, except the credibility of statements audited by non-Big Four firms. In both
for independence, proactiveness, and reputation. The test results also models, the independent variable is the sum of the ratings of the 14
indicate that the mean responses of the credit analysts and of the competency factors as perceived by respondents. Each model is run
financial analysts do not differ significantly, indicating that the two three times. The first assumes that the dependent variable is the
groups perceive the importance of the factors similarly. perception of all the respondents; the second is the perception of the
To test respondents' perceptions of the effect of firm size on audit credit analysts; and the third is the perceptions of the financial analysts.
quality, they were requested to answer two questions on how they Table 5 shows the regression results.
perceived the quality of audits performed by Big Four firms and the The adjusted R2 in the first model is 17.9% and significant at less
quality of audits by non-Big Four firms. The means of the responses than 5%, and the coefficient of the competencies is 0.031 and
show that both groups of analysts think financial statements audited significant at less than 5%, indicating that the total rating of the
by one of the Big Four as being more credible than those of firms that competencies is one of the determinants of the audit quality. When
are not classified as Big Four. Financial analysts rank the credibility of the dependent variable is replaced with the perceptions of credit
financial statements audited by Big Four significantly higher than the analysts and then with those of financial analysts, the R2 changed to
rank of financial analysts. This difference should not be interpreted as 9.40% and 51.90%, respectively. In both regressions, the coefficients of
that credit analysts favor statements audited by non-Big four firms, as independent variable remain significant with a priori expected sign.
both credit and financial analysts consider the quality of financial The adjusted R2 in the second model is 0.8% and insignificant at the
statements audited by non-Big firms as average. conventional level, and the coefficient of the competencies is 0.09 and
These results should be interpreted along with the respondents' insignificant. Similar regression results are obtained when the model
perception of the importance of 14 factors that are likely to determine is tested using the two subsamples (credit analysts and financial
the quality of the audit service. These factors are shown in Table 4. analysts). The outcomes of the six regression runs also indicate that
Because these factors are likely to be characteristic of Big Four firms, both credit analysts and financial analysts perceived that the Big Four
these firms are more likely to be perceived as providing better-quality firms, unlike non-Big Four, are more likely to have the needed
audit reports. These results would be consistent with those of many of competencies to ensure audit quality from a user's perspective. These
the studies that find that Big Four firms produce better quality reports results lend further support to those reported by Carcello et al. (1992),
because they have better resources. This is also additional evidence Eichenseher and Shields (1983), Shockley and Holt (1983), and Frantz
supporting the current CBB policy that non-Big Four firms are not (1999).
allowed to audit retail and wholesale banks and large investment Subsequently, step-wise regression is carried out after replacing
companies. The results also justify the decisions of listed companies to the independent variable with the individual values of the 14
demand audit services from companies with an international presence competencies in the mode. For the entire sample, the dependent

Table 5
Regression results (Creditability of audit reporti = α + β competenciesi + εi).

Dependent variable Sample Constant Independent variable Adjusted R2 F- value


(Competencies/Factors)
Coefficient Standardized beta
Credibility of a report audited by one of the Big Four Whole sample 2.566a 0.031a 0.423 17.90% 35.232a
(0.303) (0.005)
Financial analysts 1.068a 0.055a 0.720 51.80% 77.280a
(0.006) (0.006)
Credit analysts 0.807a 0.031a 0.307 9.40% 7.467a
(0.655) (0.011)
Credibility of a report audited by Non-Big Four Whole sample 0.2040 0.009 0.09 0.80% 1.331
(0.469) (0.008)
Financial analysts 4.224a 0.005 0.069 0.50% 0.415
(0.416) (0.007)
Credit analysts 3.335a − 0.015 − 0.124 0.015% 1.379
(0.653) (0.011)

Standard errors are in parentheses.


a
Significant at less than 0.05 level.
72 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

variable is the credibility of a report audited by one of the Big Four; in markets, the bigger auditing firms are perceived to provide better
addition to the constant, only professional audit expertise, reputation, quality audits and to be more independent of the management of
and wide range of skills are included in the final model, with an R2 of companies they audit compared with smaller firms. Findings are
24%. The coefficients of the three variables are positive and significant similar in both the questionnaires and personal interviews. The
at less than 2.8%. When the dependent variable is replaced with the conclusion is that the Big Four auditing firms have characteristics that
perceptions of the credit analysts, the final model has an R2 of 62.7% place them in a better position to produce better quality audits than
and includes professional audit expertise, wide range of skills, smaller firms.
reputation, and accounting-and-auditing knowledge. When the A review of the 2007 annual reports of 41 companies listed on the
dependent variable is replaced with the perceptions of financial Bahrain Stock Exchange shows that 82.5% of the companies are
analysts, the final model has an R2 of 70% and includes professional audited by one of the Big Four. The author's interviews indicate that
audit expertise, real value for fees, wide range of skills, ethical the Big Four auditors are better able to resist management pressure in
standards, and accounting-and-auditing knowledge. When the cases of conflict. Their greater resources, technical knowledge, and
dependent variable is replaced with the credibility of a report audited global reach allow them to deal with clients more objectively without
by one of the non-Big Four, for the entire sample, only two variables a fear of termination.
(proactive and takes initiative) remain in the final model, with a Financial analysts rely more on the audited financial statements
significant R2 of 8.9%. When the sample is limited to the credit than credit analysts. This is likely because a bank–client relationship
analysts, the final model includes only one variable, “due care”, with a allows credit analysts to obtain more information from their clients;
significant R2 of 5.1%. The final step-wise regression is carried out for they are also in a better position to evaluate the financial position of
the sample that is limited to financial analysts. The final model has a their borrowers than financial analysts. Both groups of analysts think
significant R2 of 34.9% and includes the following variables: due care, that provision of non-audit services will negatively affect auditor's
expertise in the industry, and commitment to quality. independence and ultimately impair the quality of an audit. An
The audit committee is considered an important board committee effective audit committee is seen as one factor that should improve
that plays a role in implementing corporate governance guidelines. the credibility of financial statements.
One of the most important functions of the committee is to oversee Regression results indicate that both groups of analysts perceive
internal and external audit performance and to advise the board on financial statements audited by Big-Four firms to be of better quality
audit matters. Therefore, an effective audit committee should enhance than those audited by non-Big firms. This is because of the
audit quality. Corporate governance principles (OECD, 2004) outline characteristic of Big Four firms, which are not matched by other
the importance of audit committee in enhancing audit quality. Abbott, audit firms. This is an evidence supporting CBB's current policy that
Parker, and Peters (2004), Yang and Krishnan (2005), DeZoort and audit of retail and wholesale banks and large investment companies
Salterio (2001), and Lin, Li, and Yang (2006) find a positive relation should be performed by Big-Four firms. Furthermore, credit analysts
between audit quality and the effectiveness of audit committee. have found that the creditability of an audit report by one of the Big
Banks and investment companies are required by law to have audit Four is determined by professional audit expertise, wide range of
committees, but not non-financial companies listed on the Bahrain skills, reputation, and accounting-and-auditing knowledge. However,
Stock Exchange. To measure the impact of an audit committee on for financial analysts, the credibility of these reports is a function of
perceived audit quality, respondents were asked about their reactions professional audit expertise, real value for fees, wide range of skills,
with regard to the role of an effective audit committee in audit quality. ethical standards, and accounting-and-auditing knowledge.
To test the effect of the role of the committee in improving audit Future research may be directed toward determining the effect of
quality, respondents were asked to state their perception of the the actual role of an audit committee on audit quality. This can be
importance of effectiveness of audit committee on the quality of audit, carried out when companies start establishing such committees and
using a 6-point Likert scale, where 0 indicates not important in ensure that they act in an independent and effective manner. This is
determining audit quality and 5 indicates that it is extremely likely to take place when Bahrain issues its corporate governance
important. The survey does not elaborate on the requirements for code.
audit committee to be effective. This is attributed to the fact that
practices “that work best for one organization may not be ideal for
another—especially in a corporate governance environment where Acknowledgements
corporate culture, financial reporting risks, and governance needs can
vary dramatically from company to company.” The mean of the I am grateful to the two anonymous reviewers for their time and
responses of the whole sample is 4.15 and 0.82 standard deviation. efforts. I would like also to thank the Journal co-editor, Professor J.
The mean and the mode of the responses clearly show that these users Timothy Sale, for his support and editorial assistance. The usual
of financial statements perceive that an audit committee affects the caveats apply.
audit quality.
Splitting the responses into the groups, the mean responses of the References
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