ABSTRACT

The objective of this study is to ascertain the effect of audit market concentration and auditor‘s attributes on audit quality in the Nigerian manufacturing sector. Specificallyit aimed at finding out the impacton relative audit market concentration (RAMC), absolute audit market concentration (AAMC), auditors‘ independence (AUIND), auditors‘ tenure (AUTEN) and audit risk (AUDRISK) on audit quality (AQ) in the Nigerian manufacturing sector. The study employed anex post factoresearch design because the data for the study was extracted from archived of past events. The study was restricted to Nigerian manufacturing firms.Simple random sampling technique was employed to select 52 firms quotedon the Nigerian Stock Exchange as at 31^st December, 2015. The study covered a period of 15 years from 2001 – 2015, forming an observation of 780 firm-year observation in the Nigerian audit market. Data on relative audit market concentration, absolute audit market concentration, auditor‘s independence, audit tenure and audit firm size were obtained from secondary sources (annual reports and accounts) and subjected to the regression analysis using the pooled OLS and Panel EGLS. Theresult shows that there is a negative relationship between audit quality and relative audit market concentration, absolute audit market concentration, auditor tenure, audit firm size and rendering of non-audit services while auditor independence and audit fee have a positive relationship with audit quality.The study recommended that professional bodies, management and auditors should introduce alternative appointment processes for auditors.Again, regulators and standards setters should come up with early warning systems of significant threats to the operations of a ‗Big 4‘ firm; while investors should find a way of ensuring that the largest institutional investors act together to influence large companies to consider ‗Mid-Tier‘ audit firms, as they usually get the changes they are looking for in the interest of all and sundry.

CHAPTER ONE

INTRODUCTION

1.1              Background to the Study

The word ―audit‖ was derived from the Latin word ―audire‖ which means ―to hear‖. In the early days, an auditor used to listen to the accounts read over by an Accountant in order to check them. Gray and Manson (2002) documents that an audit is an examination or a search for facts to enable an judgment to be made on the truth and fairness of financial reports prepared by management with the intention of increasing its credibility and therefore its usefulness‖.Hayes, Dassen, Schilder and Wallage(2005) elucidates that the major purposefor performing an audit is to show credibility to financial statements hence, the crucial role of auditin the operation of capital markets cannot be over emphasized. The engagement of the services of an external auditor for quality assurance is inevitable because it is a statutory requirement for all quoted companies to file audited report (OECD Policy Roundtables Report, 2009).

Jensen and Meckling (1976) opine that in line with agency theory, audit exercise is a sort of scrutinizing toolthat guarantees stakeholders that agents are carrying on business activities in the interest of owners. Therefore, the decision to choose auditors is to resolve the agency problem that may arise as a result of separation of ownership and control. Companies are expected to have a high quality of financial reporting. Management is saddled with the responsibility of preparing financial statements and ensuring that the statements meet reporting requirements like the General Accepted Accounting Principles (GAAP) or the International Financial Reporting Standards (IFRS) (Arens, Elder & Beasley, 2010). Stakeholders and other users should be able to rely on the financial statements for making informed investment decisions. Auditors are also saddled with the responsibility of plummeting information hazardthat may arise from published financial reports which is the principalrationale behind the engagement of the services of an auditor (Suyono, Yi & Riswan, 2013).

It is interesting to know that audit quality is anunfamiliar concept in accounting research yet till date, there is no consensus on the definition of the subject matter by accounting researchers. A conventionalmeaning of audit quality is that of the market–gauged combinedlikelihood that a given auditor will both: (i) spotout issues of violation of GAAP in the auditee accounting system and (ii) report that breach, that is that the auditor has both the technical competence to detect any material errors during the audit process, and the independence to ensure that material errors and omissions are corrected or disclosed in the auditor‘s report (DeAngelo, 1981). Kilgore (2007) defines auditquality as the likelihood that an auditor will mutuallyspotout a violation of GAAP in client‘s domain and thereafter,give account of the violation at the end of the audit exercise. The detection of a misstatement reflects qualitywith regardsto the auditor‘s sagacity and aptitude, while the disclosure on a misstatement is a upon the auditor‘s inducement to divulge.

The Cadbury Report (1992) confirmed that the yearly audit is one of the cornerstones of corporate governance. Esteemedaudit quality makes financial report dependable for the viability of the capital. Some scholars (Kilgore, 2007 Skinner & Srinivasen, 2009) are of the view that audit quality as an essential ingredient is needed for the efficient functioning of the capital markets.Zureigat (2011) further stresses that audit quality has taken the front burner in accounting research because of the role it plays in enhancing reliability of financial statements.In the absence of audit quality the worth of financial information presentedby managers to users of financial report is likely to decline.

High quality financial reporting is important toboth investors and the firm because itguides the investors‘investment decisions and helps to evaluate managers‘ true performance. Other stakeholders, like- employees, government and researchers rely on informationgenerated from financial statements to guidethem in decision making.Abysmal financial report will mislead the aforementionedcategories of interest groups(Scott, 2009). Flanagan, Muse and O‘Shaughnessy (2008) asserts that auditis a device that enhances quality assurance and gives credibility to financialreports. It boosts the confidence of the potential investors on the financial reports.The author further stresses that when an auditor issuesan unqualified opinion instead of a qualified audit opinion on a financial report, such a report will eventually mislead the users of such financial report.

Velte  and  Stinglbaecer  (2012)  opine  thatthe  concept  ―concentration‖  describes  the agglomeration of economic power, that is present in several industrial sectors, having varied causes. Extant literature examines the use of market share as a proxy for market concentration (Dubaere, 2008; Miguel, 2010). Market concentration is a function of the number of firms in a market and their respective market shares (Wikipedia, 2015). Schaen and Maijoor (1997) assert that concentration is the joint market allocation of foremostcompanies whichconnotes a level of oligopoly. Feldman (2006) further argues that mergers of some prominent auditfirms in the 1ast two decades have raised the concentration of prominent audit firms. Pong (1999) reports that in extremely tight markets, theprobability of conspiring with (high) fee fixing engagements is very highand auditee choice is limitedwhileconflict of interest hasbecomethe order of the day. Dubaere (2008) documents that smaller audit firms and governments apprehensiveof fact that excessive concentration of the large audit firms will result toindiscriminate increasein audit prices, unabated decreasein auditor independence and lowered audit quality. Dubaere(2008) reports that the outstanding method to determine the market allocation is taking the sum of audit fees paid by the auditee.Eshleman (2013)further emphasizes that audit fees received by an audit firm is a function of the audit supplier. Extremely concentrated markets can result to homogeneouspricing and/or abysmal servicedelivery. The author furtherstresses that less competitive market result to extremely high audit fee and a corresponding lowaudit quality.

Auditor remuneration can affect audit quality basically in two ways: abnormal auditor remunerationmay make auditor to exert more efforts on the audit exercise hence leads to quality audit. Alternatively, excess auditor remuneration, especially those that are related to non-audit services creates an economic bonding of theauditor to his clients. This kind of financialdependencecanbring about anassociationthat willmakethe auditor give the client free hands to window dress its reportsin order to retain the client. On the other hand some scholars (DeAngelo, 1981; Simunic, 1984)are of the view that the moral hazard and reputation loss from audit failure outweighs the benefit derived from economic bonding.

The Government Accountability Office (2003) observes that mergers and acquisitions have been used as a means for audit firms to expand their business by achieving greater economies of scale and also industry expertise. According to Newton, Wang & Wilkins (2013), there are at least two concerns with this consolidation of auditors: first, fewer competitors may lead to higher prices; and second, less competition may lead to a lower quality product. In the case of auditing, the higher concentration could lead to complacency, as auditors realize that clients have very few audit firms to choose from. According to these authors, this can lead to a less skeptical approach to auditing.

Current high-profile of dominance of the Big4 in the audit market has become a subject of concern in developed countries like United States, United Kingdom and European Union (General Accounting Office, 2003; Government Accountability Office, 2008; Oxera, 2006; Oxera, 2007).United States Treasury (2008) reports that the domination of the audit market by the Big4 is detrimentalto the growth of the market because it restrictsclient‘ choices of auditor, especially for blue chip firms. Theagency further expressed its fears that if the present trend is not curtailed, it will culminate into excessive audit pricing and low audit quality because of the absence of competition. Despite the above reports, very little is known about the consequences of market concentration on the quality of audit services (Francis, Michas & Seavey, 2010) in Nigeria.

Pound and Francis (1981) assert that the domination of big audit firmshas made some authors to conclude that audit services market exhibits characteristics of an oligopoly. One of the features of an oligopoly as stated by economists is the likelihood to conspire. Sammelson and Nordhous (2001) see conspiracyassynchronization between different firms to unanimously agreeto hike prices, dividing markets or otherwise reducing competition. One of the ways to collude is by merging or forming a cartel. Regulators are concerned about audit market concentration because the market dominance of ―Big4‖ auditors may pose a threat to audit quality (Government Accountability Office in US, 2008).

1.2              Statement ofthe Problem

The results of previousstudies (Pearson & Trompeter, 1994; Willekens & Achmadi, 2003; McMeeking, Peasnell & Pope, 2007; Numan & Willekens, 2012; Ding & Jia, 2012) are inconclusive on the impact of market concentration on audit quality. There are diverging perceptionsof the potential consequences of increased competition in audit marketsby two different schools of thought. The legalistic look at market concentration from the traditional view of legislators and courts. They assert that competition in the market will increase quality and decrease prices.On the contrary the economists suggest that when suppliers compete for market share, competition will lead to poor product quality.

As at 2011, twenty thousand audit firms offer audit services to unquoted and quotedfirms in Nigeria (World Bank, 2011). In spite of the existence of large number of audit service providers, the audit market is controlled by few large audit firms, knownas the ‗Big4‘ (World Bank, 2011). These accounting firms audit about 90 percent of quoted firms in Nigeria. They dominate the practice in Nigeria while the 15 national firms with international affiliation audit the remaining percent. The difference in market share betweenthe Big4 and non-big4 has become wider, eventually plummeting the likelihood for the non-Big4 firms to become momentous service suppliers of audit services in the market (World Bank, 2004).

Extant literature shows that the mode of market allotment that prevalent in the audit market has been on the increase world over. Oxera (2006) opines that the degree of market concentration in the audit industry increased after the Pricewaterhouse/Coopers & Lybrand merger in 1998 and after the demise of Arthur Andersen in 2002, in the United Kingdom. The author furtherstresses that theBig4 audit firms– Deloitte &Touché, Ernst & Young, KPMG and PricewaterhouseCoopers – audit all but one of the Financial Times-Stock Exchange (FTSE) 100 companies, and represent 99% of audit fees in the FTSE 350. The resultsshow that more than 700 UK-listed companies, covering the period 1995-2004 that experienced an increase in audit fees in recent years is as a result of domination of the market by the Big4. Feldman (2006) concludes that the crash of Arthur Andersen has led to the domination of the Big4in the US audit market and also caused hike of audit fees.   Atotal of 94% of the audit share in the EU is dominated by the Big4 (Le Vourc‘h & Morand, 2011).

Toward the end of last decade,the eight largest audit firmscrashed and thisled to mergers that whittled down the number of large multinational auditing firms to five. In 2002 Arthur Andersen also crashed followingthe Enron saga. This invariably ledto the reduction of the number of multinational audit firm to four. In Nigeria, the ‗Big4‖ audit firms are Akintola Williams Deloitte, Ernest and Young (E&Y), PricewaterhouseCoopers (PwC) and KPMG professionals. Rising audit market concentration has been a serious issue in the mind of regulators and market participants. Francis, Michas and Seavey (2013) opine thatdespite that fact the Big4 are the major providers ofaudit services the hike in prices cannot be justified.

Velury (2005) opines that the audit failure that erupted across the globe has put auditing in the accounting spotlight in recent times. Dopuch (1988) argues that if a firm goes underimmediately after it was audited, the auditors should be held liable.He stresses whenever a firm fails, there should be an enquiry to ascertain if the failure was as a result of auditor‘s negligence.Similarly, Okaro and Okafor (2013) reports that the Nigerian Security and Exchange Commission indicted the Akintola Williams Deloitte for its role in the Cadbury Nigeria Plc scandal. It is consequentlyimperative to evaluate the effect of the volume of audit work in relationship withthe size ofthe audit firms onthe audit quality of quoted manufacturing companies in Nigeria.

The emergence of the Big4 in the audit market in the last decade hassubsequentlyculminated into a heavier concentration. The collapse of Arthur Andersen in 2002 led to the decrease in the number of choices for large public clients looking for an auditor to just four. Stressing the importance of effective competition, the increasingly taut oligopoly in the audit service industry raises concerns about non- competitive pricing behaviour. Bain, (1956) suggests that highly concentrated industriesexert a negative effect on quality in the long run. It further asserts that such industries can still be very price competitive. Scholars have not reachedany consensus on the effect of market concentration on audit quality. The mixed results in literature on theeffect of concentration on audit quality, suggests that additional evidence is required to ascertain if audit market concentration will negatively affects audit quality in an emerging economy like Nigeria.

Audit attributes are said to determine audit quality.Following the market framework, early studies (Simunic, 1980; Palmrose, 1986; Butterworth & Houghton, 1995) used the market framework to identify the determinants of audit pricing and hence, the audit quality. However, most of the researches on audit market and audit quality were donein developed countries like, United States of America, United Kingdom, Belgium, New Zealand, Australia and the likes. It will be disingenuous to presumeovertto the resultsand draw conclusion for audit markets of emerging economic. Hence, this study will incorporates some certain audit peculiarities that exist in the supply side of the audit market for emerging economies (like Nigeria), such as the audit independence, auditors‘ tenure, audit fees, audit risk and audit firm size.

1.3              Objectives of the Study

On the basis of the above research problem, the main objective of this study is to empirically ascertain the effect of audit market concentration and auditors‘ attributes on audit quality in the Nigerian manufacturing sector.The specific objectives are:

i.)        To determinewhetherrelative audit market concentration has significant relationship withaudit quality in the Nigerian manufacturing sector.

ii.)       To ascertain whetherabsolute audit market concentration has significant relationship withaudit quality in the Nigerian manufacturing sector.

iii.)      To assess whether auditors‘ independence has significant relationship with audit quality in Nigeria.

iv.)      To empirically ascertain whether auditors‘ tenure has significant relationship with audit quality in Nigeria.

v.)       To determine whether audit firm sizehas significant relationship with audit quality in the Nigerian manufacturing sector.

1.4              Research Questions

This study seeks to provide answers to the following research questions:

i.)        What is the relationship between relative audit market concentration and audit quality in the Nigerian manufacturing sector?

ii.)       What is the relationship between absolute audit market concentration on audit quality in the Nigerian manufacturing sector?

iii.)      What is the relationship between auditors‘ independence and audit quality?

iv.)      What is the relationship between auditors‘ tenure and audit quality?

v.)       What is the relationship between audit firm size and audit quality?

1.5              Statement of the Research Hypotheses

The following research hypotheses, which are stated in their nullform will be tested:

Hypothesis One

Ho₁: There    is   no   significant   relationship   between   Relative   audit   market concentration and audit quality in the Nigerian manufacturing sector.

Hypothesis Two

Ho₂: There    is   no   significant   relationship   between   absolute   audit   market concentration and audit quality in the Nigerian manufacturing sector.

Hypothesis Three

Ho₃: There is no significant relationship between auditors’ independence and audit quality

Hypothesis Four

Ho₄: Auditors’ tenure does not have significant relationship with audit quality.

Hypothesis Five

Ho₅: Auditors’ firm size does not have significant relationship with audit quality.

1.6              Significance of Study

There are a number of reasons why this present study is important. First, most of the studies undertaken on effect of market concentration on audit quality are done in advanced countries. Second, the usage of a panel data of Nigerian quoted manufacturing companies unlike most studies which used cross-sectional data within a period of 15 years (2001-2015), will assist in contributing to the understanding of the structure of audit market. Third, the shareholders and the varying stakeholders,

including senior management, managers, policy makers and regulatory authorities in Nigeria, like Financial Reporting Council of Nigeria (FRCN) who are constantly looking for ways to promote audit quality in the country will find the study useful. Four, researchers who are carrying out studies in the area of market concentration and audit quality will also find the work useful.

Lastly, this study is important because there is paucity of work about the consequences of market concentration on the quality of audit services, in essence, it is necessary to investigate whether audit concentration has a beneficial or detrimental effect on audit quality in developing countries like Nigeria. Therefore, this study will extend and contribute to the body of knowledge by using Nigerian quoted manufacturing companies to investigate the likely effect of market concentration alongside auditors‘ attributes on audit quality.

1.7              Scope and Limitationsof the Study

This study focused on manufacturing companies listed on the Nigerian Stock Exchange as at 31^st December 2015. The study covers a period of 15 years (2001- 2015), with year 2001 as the lagged year and 2002 as the base year. The year 2002 was chosen as the base year because it was the year the number of five large international auditing firms was reduced to four, after the demise of Arthur Andersen in 2002, following the involvement in Enron scandal. The period witnessed different reported scandals involving Accountants, Auditors and regulatory bodies in Nigeria. It also witnessed a sharp drop in the value of stock in the Nigerian capital market. Moreover, the choice of this period is based on the expected availability of data.

The year 2001 was included for the computation of the lagged year for 2002. We will assume also that the accounting construct of reliability is perfectly captured by our model of measurement error, although, other elements of reliability may be missing in our model.

1.8              Operational Definition of Terms

Audit Market: This is a market for the provision of auditing services to companies operating within specific industrial segments. For the purpose of this study, quoted manufacturing companies in Nigeria is the audit market.

Audit Quality: A quality audit is audit conducted in accordance with applicable auditing standards to provide reasonable assurance about whether the audited financial statements are presented in accordance with applicable accounting principles and are free of material misstatements. It is an audit that captures the technical competence of and independence of the auditor as represented in his audit report.

Low balling: A process whereby an audit firms agree with the client upon a non cost- covering audit fee in the first audit period hoping this would lead to future rationalization effects.

Market Concentration: This is the extent or degree to which a relative small number of audit firms (The Big4 Audit Firms) account for a relative large percentage of the audit market.

The Big Four (Big4): For the purpose of this study, the audit markets are segmented into  two  categories,  the  Big4  and  non-Big4.  The  term  ―Big4‖  dates  from  2002  and refers to the remaining four large international accounting firms after the collapse of Arthur Andersen. The Big4 auditing firms represent the dominant group of large providers of auditing services, that is, they dominate the industry in terms of revenues, global reach, infrastructural investments and professional staff. In Nigeria, the Big4 accounting firms are Akintola Williams Deloitte; Ernst & Young; Pricewaterhouse Coopers and KPMG Professional Services.

Non-Big Four: All other firms which have a national or local reputation are termed non-Big4 audit firms. If a firm is not one of the ‗Big4‘ audit firms, then it is referred to as a ‗non-Big4‘.

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