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

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doi:10.1016/j.adiac.2009.02.005
 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
says “[The AICPA] believe[s] that appearances are very important and
capital markets require confidence in financial statements and audit
reports, and the member firms of the AICPA are basing their business of
auditing on their reputations, and that is heavily affected by appearance.”
Despite considerable research on audit quality, studies on audit quality
in Bahrain are scarce. This might be due to the relatively low number of
audit failures. Since the establishment of the first shareholding companies
until 2008, there were only three reported cases of audit failure. These
cases involve the General Trading and Food Processing Company (1994),
the Bahrain Islamic Investment Company (2002), and the Bahrain Saudi
Bank (2002). The fraud involved in the first case was carried out by the
company's accountant, and the court ruled against the accountant. As for
the second company, the case was settled out-of-court, and the partner
involved in the case was asked to leave the firm, whereas the third
instance resulted in replacement of the auditors without the auditors
being taken to court. The low number of reported cases of audit failures
does not ensure that audits of Bahraini listed firms are of good quality and
should not mean that users of company reports should be complacent as
to the quality of an audit. Therefore, this study investigates the way users
of financial statements determine the quality of audit reports. Accordingly,
a survey of the major users of financial statements (investors and lenders)
with respect to their perceptions of the factors that determine audit
quality, particularly with respect to the impact of corporate governance
and size of audit firms on the quality of an audit report, is carried out.
This research makes three contributions to the literature. First,
although most of the research in the area uses different methodologies
to investigate the determinants and the role of audit quality on integrity
and quality of accounting information, studies on markets such as
Bahrain, which is characterized by dominance of few accounting firms;
largely uncommon cases of switching audit firms; weak enforcement of
regulation reverent to audit industry, with exception of those related to
financial institutions; low-liquidity stock market; and considerably less
number of different institutional setup. Hence, this research provides
additional insights to audit quality. Second, it responds to calls for
empirical testing of the relationship between corporate governance and
audit quality, according to Defond and Francis (2005). Third, Defond and
Francis (2005) argue that research on the effectiveness of audit
committee suffer from a number of problems such as weak statistical
explanatory power and multi-colinearity problem. A survey method
that asks respondents to state their perception of the effect of effective
audit committee on audit quality overcomes these problems.
The remaining part of the article is organized into four sections. The
following section provides brief accounts of the audit market in Bahrain.
Section 3 offers brief literature review on the relationship between
effectiveness of audit committee, firm's size, and audit quality. Section 4
describes the data collection and research methodology. Section 5
presents the research findings of questionnaire survey. The final section
provides conclusions of the study, its implications, and suggestions for
future research.
2. Audit market in Bahrain1
Some important features of the audit market in Bahrain must be
understood to perceive the context in which this study was undertaken.
1
Most of the contents of this section are based on interviews with the following
persons: Adnan Yusuf, Chief Executive Officer of Albarka Banking Group; Ibrahim
Zainal, Chairman of TRAFCO; Jamal Fakhro, CPA (US), Managing Partner of KPMG
Fakhro and Ex-Chairman of the Bahrain Accountants Association (BAA); Elham Hasan,
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
for domestic trade at the Ministry of Industry and Commerce; Jassim Abdulaal, CA
(UK), Senior Partner, Grand Thornton-Gulf Audi-Bahrain; Yusuf Hassan, director of
bank supervision at the Central Bank of Bahrain (CBB); Khalil Noor Eldeen, CFA, Ex-
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
(Strategic Planning), Unicorn Investment bank. The interviews took place between the
5th of January and the 4th of March, 2008.
65
As of the end of February 2008, audit services in Bahrain are
provided by 24 accounting firms. Five of these are considered local;
four are operating as foreign branches; and the remaining are linked to
international firms. The Big Four; i.e., Ernst & Young (E&Y), Deloitte &
Touche (D&T), KPMG, and PricewaterhouseCoopers (PWC) have a
strong presence in Bahrain. D&T and KPMG operate as a joint venture,
whereas the other two operate as branches of international firms. BDO
Jawad Habib and E&Y are the only two firms registered with the United
States (US) Public Company Accounting Oversight Board (PCAOB).
The Bahrain Stock Exchange (BSE) was established in June 1989. As of
July 2007, there were 41 listed Bahraini incorporated firms (two of these
have been de-listed and did not issue their reports of 2006). The
majority of the companies are retail banks, wholesale banks, and
investment companies.
The Central Bank of Bahrain (CBB) requires financial institutions to
be audited by one of the big audit firms. Audit services are regulated
by the Amiri Decree Number 26 of 1996, which requires auditors to
obtain a license to practice and set the minimum requirements for a
license. In effect, audit firms got two licenses, one to practice auditing
and the second specifically to offer auditing services to financial
institutions.
Appointments of auditors, as per article (205) paragraph (e) of the
Bahrain Commercial Companies Law Number 21 of 2001, should be
made on a yearly basis at firm annual stockholder meetings. However
in practice, boards of directors are empowered by annual meetings to
appoint auditors and to determine their remuneration. This practice is
subject to criticism on the grounds that an auditor's role is to miti-
gate agency problems that might exist between the board and the
shareholders.
The CBB's authority is based on article, (61) paragraph (a), of The
Central Bank of Bahrain and Financial Institutions Law Number 64 of
2006, which states: “Every Licensee shall appoint one or more
qualified and experienced external auditors for its accounts for every
financial year. Prior written approval by the Central Bank will be
required before appointing an auditor.” This approval is needed
annually. In cases wherein a decision has been taken to replace the
external auditors before the end of the year, the respective financial
institutions are also required to inform the CBB about the reasons for
this decision.
Since 2002, only three of the Big Four have been approved to audit
the financial statements of the locally incorporated banks. Exclusion
firm of the Fourth came after its audit failure of the financial
statements of locally incorporated retail banks. CBB guidelines specify
experience of the auditors, experience of the firm, and number of
partners, among other requirements. Currently, only Big Four firms
audit small financial institutions.
The internal guidelines of the CBB allow non-big firms to audit
small investment companies. As of September 2007, Bahraini incorpo-
rated financial and non-financial firms listed on the Bahrain Stock
exchange are audited by five companies, the Big Four and one other
company, which is connected with an international firm. The other two
companies are a joint venture between a local audit firm and regional
or international companies. Unlike some other countries in the region
where listed firms are audited by two audit firms, all companies in
Bahrain are audited by only one audit firm.
Audit services industry is dominated by the Big Four. A total of
82.5% of the 41 listed companies on the BSE that published their
annual reports in 2007 are audited by one of the Big Four, and the
other 17.5% are audited by a non-Big Firm company.
In Bahrain, it is not mandatory to switch audit firms. In fact, in 2006,
the CBB took a position against a motion in the parliament to mandate
such a requirement on the ground that small markets are distorted by
such decisions. Experience has shown that switching of audit firms
takes place in very rare cases and generally occurs only after an audit
failure. The CBB does require auditors of financial institutions to switch
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
internal policies. Auditors are not prevented from joining a client firm
at any time, even immediately after formulating an audit opinion.
The presence of multinational firms and international financial
institutions in Bahrain, the government's long-standing policy of
attracting foreign investment, the effect of globalization, and the size
of the Bahrain economy are possible reasons for the nondevelopment
of local accounting and auditing standards. As a result, companies in
Bahrain are required to comply with international financial reporting
standards (IFRS), whereas accounting firms must comply with the
international standards on auditing (ISA). These requirements apply
to all companies, including financial institutions. The latter are
required to comply with the financial accounting standards issued
by the Accounting and Auditing Organization for Islamic Financial
Institutions (AAOIFI). However, in accordance with the requirements
of AAOIFI, for matters on which AAOIFI standards do not exist, the
respective institutions are required to comply with the relevant IFRS.
This is also applicable to conventional bank licensee units. Require-
ment to comply with the IFRS and ISA are perceived by both the
government and the accounting firms as the basis for the competitive
advantage that Bahrain enjoys.
As in many other countries, the practice in Bahrain is that
accounting firms should sign the audit reports and not the partners
who supervise the audit engagements. This is due to the lack of legal
sanction for the auditors of companies operating in Bahrain to sign the
audit report in their own names. Article (19) of the Amiri Decree No.
26 of 1996 gives auditors the choice to sign the audit reports using
either their names or the name of the company. Chairmen and chief
executive officers sign the company(ies)'s reports as representatives
of the respective board(s) of directors. As such, they assume no more
personal responsibility than other members on the boards.
All listed and unlisted financial institutions are required to form
independent audit committees. Listed non-financial firms are not
required by law to form such committees. Members of the audit
committees of financial institutions are nominated by the boards;
however, they need to be approved by the CBB. However, whether the
criteria that the CBB uses for its approval include an assurance of
independence and knowledge or merely an affirmation of the latter is
not clear.
The principles of Auditor Oversight issued by the International
Organization of Securities Commissions (IOSCO) in 2002 state that audit
quality is an important requirement for the integrity of financial
statements. However, Bahrain lacks a formal independent audit over-
sight regulating authority, similar to the PCAOB in the US. The
establishment of such an institution is considered the best practice
internationally, as it provides one of the mechanisms that increase
confidence in the quality of an audit (International Audit Networks
(IANs), 2006). IANs recognize that the establishment of independent
audit oversight regimes have reinforced the independence of auditors,
and in their view, improved the governance and regulation of the
auditing profession. They state that independent audit oversight regimes
have led to audit firms emphasizing on the quality of the audit. The need
for having an audit oversight in Bahrain is a view that is shared by most of
those interviewed for the purpose of writing this section. Furthermore,
peer review for other companies is uncommon in Bahrain.
The Ministry of Industry and Commerce (MIC) as per article (27)
establishes a disciplinary committee composed of the Chairman, who
should be a judge from the Civil High Court, appointed by the Minster
for Justice, and two other members, who are specialists in auditing,
appointed by the MIC. The disciplinary committee investigates the
cases referred by the MIC for misconduct, violations of professional
requirements, serious negligence, or violations of the Amiri Decree No.
26 of 1996. However, there are no public records available regarding
the referred cases.
Previous experience shows that litigation risk is very low in
Bahrain. In the corporate history of Bahrain, there are neither publicly
announced out-of-court settlements between the auditors and their
clients nor court judgments against erring auditors. However, there is
one case pending against the auditors belonging to one of the non-Big
Four firms. No decision has yet been arrived at, even though it dates back
to the mid-1990s. Another case involving E&Y was settled out-of-court,
and the partner involved in the case was asked to leave the firm.
However, the low number of litigation cases should not be seen as an
indicator of high audit quality in Bahrain. The fewer cases of litigation
might be due to the high cost, weak regulation, less efficient court
system, the difficulties of bringing such cases to the court, and passive
investors. However, this situation changed after the audit failure of the
Bahrain Saudi Bank. The role of the CBB in maintaining the stability of
the financial system ensures the maintenance of a certain level of audit
quality during the auditing of financial institutions. Furthermore, as the
number of foreign investors increase, raising the awareness of investors,
enhancing the efficiency of the judiciary system, increasing the
probability of materialization of risk, increased government privatiza-
tion programs, and reduction of government ownership in listed firms
are likely to increase the probability of materialization of litigation risk.
Restatements of earnings are uncommon in Bahrain. The only
restatement between 1957 and 2007 in the financial statements of listed
companies was in 1994 when the newly appointed auditors restated the
profit figures of the General Trading and Food Processing Company.
In Bahrain, it is common to outsource internal audit services to
audit firms. Firms thus avoid the cost of creating an internal audit
department with expertise that is not used during the year. The CBB
prohibits external auditors from providing routine internal audit
services to their clients. OM2.7.2 of the Operational Risk Management
guidelines states that “The [CBB] will generally not permit licensees to
outsource their internal audit function to the same firm that acts as
their external auditors. However, the [CBB] may allow short-term
outsourcing of internal audit operations to a licensee's external
auditor, to meet unexpected urgent or short-term needs (for instance,
on account of staff resignation or illness). Any such arrangement will
normally be limited to a maximum of one year.”
Universities in Bahrain use American textbooks in their business
programs, including textbooks on accounting. Bahrain University, the
biggest and the only public university, has a policy that dictates
professors teaching at the college of business to have been educated in
western universities. Furthermore, auditors and analysts are expected
to seek professional qualifications from the US and the United
Kingdom (UK). Advertisements on the websites of financial institu-
tions and in newspapers seeking new staff state that applicants need to
possess professional qualifications obtained from the US and the UK;
this policy seems to be followed by both the government and the
private sector. For example, the Labor Fund of Bahrain (www.lf.com),
which is the government arm for training, awarded two contracts to
BDO Jawad Habib and Earnest & Yong in 2007, worth 14.1 million
Bahraini Dinars (US$37.4 million), to train 7200 Bahrainis for obtaining
American and British accounting qualifications. The human resources
development fund (HRD Fund) (www.hrdfund.org) and the Bahrain
Institute of Banking and Finance (BIBF), the banks' arms for training
their staff, offer funding for and provide training for their staff only for
acquiring professional qualifications from the US and UK. This policy is
also followed by audit firms that require their local staff to seek their
professional qualifications from these two countries.
Unlike in the US, there is no professional body in Bahrain to play a
role similar to that of AICPA. The Bahrain Accountants Association (BAA),
which was established in 1972 as a nongovernmental organization, has a
very minimal role in the further development of the profession. Its
activities are limited to workshops, seminars, and public lectures.
Membership in the BAA is voluntary. Despite thousands of accountants
qualifying for membership into the BAA, including all holders of an
undergraduate degree in Accounting, the number of members at the end
of January 2007 was only around 250, among whom, the active
members were very few.
 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
3. Brief literature review
Watkins, Hillison, and Morecroft (2004) summarize both theore-
tical and empirical work on audit quality from DeAngelo (1981b)
through 2002. Francis (2004) offers an excellent review of published
empirical attempts over a quarter century beginning in 1981. Defond
and Francis (2005) offer a critical review of audit quality literature
after 2002. Besides these three studies, a brief review that presents the
salient feature of the relationship between firm size, corporate
governance, and audit quality is imperative to set the ground for the
stage for the author's survey results.
The relationship between the audit-firm size and the quality of audit-
reporting decisions has been widely investigated; however, the results
are not conclusive. Although extensive empirical evidence suggests that
the Big Four firms provide higher quality audits (DeAngelo (1981b),
Palmrose (1988), Deis and Giroux (1992), Mutchler, Hopwood, and
McKeown (1997), Krishnan and Schauer (2000), Fuerman (2004), there
is other evidence to suggest that no differences in quality exist between
the Big and non-Big audit firms (Jeong and Rho (2004) and Khurana and
Raman (2004). Krishnan (2005) comments that audit quality differs
between and within the various audit firms. These results might have an
important implication for the perception of investors and lenders about
the quality of audit reports.
A number of reasons are used to explain the positive effect of audit-
firm size on audit quality. Audit quality is a function of how well an
audit team functions, and presumably firms perform best based on the
following criteria:
1. availability of adequate resources (human and technology) (DeAngelo,
1981b; Frantz, 1999);
2. control systems of high standard;
3. larger firms are more independent of their clients (DeAngelo,
1981b);
4. large firms have a considerable business at stake if they lose their
reputations (DeAngelo, 1981b);
5. charging higher audit fees that allow them to spend more time and
effort in each audit engagement (Francis, 2004; Goodwin-Stewart
& Kent, 2006); and
6. high significant economic costs imposed on the auditor in the event
of audit failure (DeAngelo, 1981b).
Auditor independence from the client's management is considered
as one of the prerequisites for a good-quality audit. Several definitions
can be found for the independence of the auditor. Among them are the
following: “the conditional probability of reporting a discovered breach”
(DeAngelo, 1981a, p. 186); “the ability to resist client pressure” (Knapp,
1985); “a function of character—with characteristics of integrity and
trustworthiness being essential” (Magill & Previts, 1991); and “an
absence of interests that creates an unacceptable risk of bias” (Beattie,
Fearnley, & Brandt, 2001). Several factors are found to have potential
influence over the independence of the auditor. Among them are size of
the auditing firm (Shockley, 1981); non-audit service (Shockley, 1981;
Knapp, 1985); the client's financial conditions (Knapp, 1985); the nature
of conflict of interest (Knapp, 1985); the tenure of the audit firm,
(Shockley,1981); the degree of competition in the audit-service markets
(Knapp, 1985); and the audit committee (Teoh & Lim, 1996).
Eichenseher and Shields (1983) show that chief financial officers
believe that audit quality is a function of 11 items. These are ethical
standards, reputation, industry expertise, audit-team expertise, geogra-
phical coverage, audit fees, working relationships, meeting deadlines,
technical qualifications, accessibility of the audit firm, and range of
services offered. Shockley and Holt (1983) argue that bank chief financial
officers rank the Big Firms in terms of 10 attributes. These are prestige,
professionalism, expensiveness, competence, aggressiveness, conserva-
tiveness, impendence, reliability, helpfulness, and bureaucratic behavior.
Carcello, Hermanson, and Mcgrath (1992) report 12 items that are
perceived by auditors, preparers, and users of financial statements to
67
determine audit quality. These are auditee size, audit team and firm
experience with the client, industry expertise, responsiveness to client
needs, compliance with GAAS, firm executive involvement, firm commit-
ment to quality, involvement of audit committee, degree of personal
responsibility, conduct of fieldwork, auditor's skeptical attitude and firm
personnel maintain freshness of perspective.
Corporate governance is defined as the system by which firms are
directed and controlled (Cadbury, 1992). The principles of corporate
governance formulated by the Organization for Economic Cooperation
and Development (OECD) state that “An annual audit should be
conducted by an independent, competent and qualified, auditor to
provide an external and objective assurance to the board and share-
holders that the financial statements fairly represent the financial
position and performance of the company in all material respects,”
(OECD, 2004)). KPMG (2006, p. 2) states that audit committees are
responsible for oversight of the company's financial reporting process,
including related risks and controls as well as the company's internal
and external auditors. U.S. SEC (2003) states that the primary role of the
audit committee is to oversee the financial reporting process with the
ultimate objective of ensuring high-quality financial reporting.
KPMG (2006) outlines five guiding principles for audit committee
for playing an effective role. These are: 1) recognize that one size does
not fit all, 2) have the “right” people in the committee, 3) monitor and
insist on the right “tone at the top,” 4) ensure that the oversight
process facilitates the committee's understanding and monitoring of
key roles, responsibilities, and risks within the financial reporting
environment, and 5) articulate and exercise the committee's direct
responsibility for the external auditor.
An effective independent audit Committee is seen as one of the
determinants of audit quality, see for example Dhaliwal, Naiker, and
Navissi (2006). Such a committee recommends external auditors and
manages the relationship between them and the company, according
to AICPA (2004) and OECD (2004). Zhang, Zhou, and Zhou (2007)
report that firms with an ineffective audit committee are more likely
to be identified with an internal control weakness. Krishnan (2005)
finds that there is a positive relationship between audit committee
independence and the quality of internal control prior to the enact-
ment of SOX. However, others report that the role of audit committees
in overseeing and strengthening the audit process is not significant,
Carcello, Hermanson, Neal, and Riley (2002); Abbott, Parker, Peters,
and Raghunandan (2003).
Piot and Missonier-Piera (2007) report that audit quality, unlike
quality of corporate governance, measured by firm size (Big and non-Big)
does not have a significant influence on the cost of debt of non-financial
French listed firms. These results are robust even after controlling for a
set of auditees' characteristics such as firm size, profitability, asset
structure, and interest coverage ratio. However, others report that one of
the most important functions corporate governance can play is ensuring
quality of financial reporting process (see for example, Blue Ribbon
Commission, 1999)). Dechow, Sloan, and Sweeney (1996); Beasley
(1996); Beasley, Carcello, and Hermanson (1999); Beasley, Carcello,
Hermanson, and Lapides (2000); Carcello and Neal (2000); and Klein
(2002) report an association between weaknesses in governance and
poor financial reporting quality, earnings manipulation, financial
statement fraud, and weaker internal controls.
Audit quality might be impaired by a number of factors especially
by the pressure on the accounting firms to increase profit, reduce
costs, and increase fees. Otley and Pierce (1996) and Willett and Page
(1996) report that it is not unusual for accounting firms to trim their
time budgets and increase control over their staff so as to increase
profits, which thus leads to the response of the audit staff to these
pressures by resorting to dysfunctional behavior such as falsifying
audit work. Otley and Pierce (1996) also argue that a performance-
evaluation system might represent a threat to audit quality.
Furthermore, the pressure to meet the time budget is found to lead
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
auditors and imposition of a limit for liabilities affect the economic
incentives that deliver good audits.
4. Research methodology and sample characteristics
This study was undertaken in two stages. The first stage involved
the use of a mail-in questionnaire to seek the views of loan officers and
investment analysts on the issues of the auditing firm's size and the
attributes of audit quality. The second stage entailed a series of
interviews with senior auditors of audit firms, banks, and investment
companies on the issues of size of the auditing firms and audit quality,
with the aim of more detailed analysis.
The use of the questionnaire is motivated by an argument in
Beattie and Fearnley (1998, p. 264) that “the questionnaire approach
provides richer insights than is possible using secondary data analysis,
which focuses on economic factors, because the questionnaire
instrument includes both economic and behavioural factors.” They
also point out that a behavioral or qualitative technique is important
to clarify theories in accounting research because it can provide “new
insights into buyers' behavior is offered by the ‘relationships
approach’ to professional services developed in the service marketing
literature, which classifies relationships (in the present case, auditor–
client relationships) based on buyer type.” They note further that an
“economic-based framework can be expected to provide only a partial
explanation of auditor choice.”
The corporate debt secondary market in Bahrain is thin, with only
two issues, which means that companies seeking credit must rely on
bank loans. There are also limited numbers of listed companies, so
considerable equity investment in local companies is directed to non-
listed companies or to companies whose financial statements are not
publicly available.
Thus, a survey approach to examine the role of firm size in
determining audit quality from the users' perception is the best approach
in Bahrain. Moreover, some of the factors the author tests in the study
(non-audit services and outsourcing internal audit services) are not
disclosed even by listed companies, which are required by law to publish
annual and quarterly reports. This makes a survey approach the only
viable methodology.
The survey instrument was developed upon review of literature
and after consultation with five analysts with appropriate experience.
It was comprehensively tested to improve its quality and to make sure
involves analysis of financial statements for credit and investment
decisions; and their qualifications, age, and length of experience in
decisions on investing and lending. Table 1 describes the respondents.
Section II asks of a number of questions found in the accounting and
corporate governance literature to determine audit quality; Section III
asks respondents to state their perceptions on the important compe-
tencies of auditors that might affect the credibility of an audit firm; and
Section IV asks two questions soliciting respondents' perceptions of the
credibility of audit reports issued by Big Four and non-Big Four auditors.
Finally, Section V requires participants to state their perceptions of the
effect of effectiveness of audit committee on quality of audit.
The respondents work for retail banks (38.4%), wholesale banks
(42.1%), and investment companies (19.5%). Although the respondents
hold a variety of positions in their organizations, the author wanted to
reach those who analyze company reports for the purpose of obtaining
decisions on investment and lending, and respondents were asked to
indicate the purpose for which they analyze reports. Around 54.9% are
investment analysts, whereas 45.1% are credit analysts. The majority of
the respondents (74.4%) held graduate degrees or qualifications with
respect to accounting or investment analysis. A majority of the
respondents also had more than five years of experience, whereas
around 60% of those with experience of less than five years had
professional accounting qualifications. Hence, the information gathered
ought to be reliable and could be generalized to the whole population.
5. Results and analysis
The first question the respondents were asked to answer is about
their confidence in the independence of the auditors performing their
audit engagements. Auditor independence is seen by many as an
important prerequisite for audit quality (DeAngelo, 1981b). Lack of
auditors' independence indicates that clients may be exerting influence
over the results of their audit. If this is the case, an auditor will be unable
to carry out the necessary duties to reduce agency problems and ensure
credible financial statements.
The majority of the respondents seem to be confident (but not
extremely confident) that the auditors are independent when they
express their opinion. Table 2 shows the means and standard deviations
Table 1
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
auditors in Bahrain as independent but not highly independent. This
observation came from credit analysts as well as financial analysts,
although financial analysts thought that auditors were more indepen-
dent than credit analysts.
To test whether this difference is significantly different from zero,
the author applies a Levene test and t-test. The homogeneity of the
variances of the responses of two groups is confirmed by the results
obtained from the Levene test, so a t-test is performed to test the
differences in the mean of the responses between credit and financial
analysts. The results show that the mean difference is not significantly
different from zero, indicating that both groups seem to agree that
auditors in Bahrain are independent of their clients.
Another measure of audit quality is that financial statements are free
from unintentional misstatements or omissions of material information.
Respondents were asked to indicate their confidence level with regard
to whether the financial statements of Bahraini companies meet a
standard using such a definition of audit quality. The mean rank of the
responses shows that the majority of respondents (86.6%) are at least
confident, and only 2.4% do not have any confidence at all in the financial
statements.
The results also show that, on average, financial analysts are more
confident in financial statements than credit analysts (mean of response
of 3.49, 5.00 being extremely confident compared with the mean of
3.38). The t-test results indicate that the mean difference is significantly
different from zero, indicating that the two groups are homogeneous in
their perceptions of the quality of audits. This can also be seen from the
results of the Levene test, which shows that variances of the responses of
the two groups do not differ significantly. The relatively high confidence
of financial analysts in financial statements might be due to 1) their
reliance on these statements as the main source of information, and
therefore, they need to believe that such financial statements are more
reliable than the credit analysts do; 2) financial analysts deal mainly
with financial statements of listed firms which are audited by either the
Big Four or BDO Jawad Habib, whereas credit analysts deal mainly with
the small- and medium-sized firms, the accounts of which are audited
mainly by small audit firms. This might imply that “audit quality” has
been socially constructed to fit needs of financial analysts more than the
users of financial statements. Credit analysts, on the contrary, have
access to their clients facilitating the process of obtaining more
information from clients whenever the need arises.
Whether auditor reports influence credit and investment decisions is
the third question in the questionnaire. The mean of the responses
indicates that those reports do influence analyst decisions. The majority
of respondents appeared to take auditors' reports into consideration to
different degrees; only 8.5% of the respondents answered that the
reports do not influence their decisions at all. Mean responses indicate
financial analysts (3.49) appear to be influenced more by auditors'
reports than credit analysts' reports (3.38).
The results of Levene's test for the equality of variances indicate no
significant difference between the variances of the responses of both
groups, but the results of the t-test indicate the mean responses of the
groups differ significantly from each other.
These results might be explained by two reasons: 1) credit analysts
can obtain additional information from clients who are seeking
financing, and 2) bank–client relationships give creditors more leverage
to know their clients, their financial positions, and their probability of
defaults. Investors and financial analysts do not generally have these
advantages. Financial analysts would be expected to rely more on
financial statements and auditors' reports as one way to determine the
credibility of a financial statement.
The effect of non-audit services (NAS) by firms' external auditors is
one factor cited in the literature as having an impact on auditor
independence and audit quality. Such services tend to be regarded by
regulators in the UK, the US, Australia, and various other countries as a
threat to auditor independence (Craswell, 1999, p. 29). In fact,
research findings on a connection between the joint provision of
audit and NAS and auditor independence have been inconclusive and
contradictory (Ashbaugh, 2004; Brandon, Crabtree, & Maher, 2004;
Chung & Kallapur, 2003; DeFond, Raghunandan, & Subramanyam,
2002; Frankel, Johnson, & Nelson, 2002; Geiger & Rama, 2003;
Kleinman, Palmon, & Anandarajan, 1998; Reynolds, Deis, & Francis,
2004).
A review of the literature by Beattie and Fearnley (2002) shows no
evidence to support the hypothesis that the joint provision of audit
and NAS could threaten auditor independence; it is acknowledged
that it might threaten the appearance of independence (but the audit
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 independence would not be affected by NAS because this
client association would improve audit quality. The reasons are that an
auditor's knowledge of the client company can be improved by the
provision of NAS, resulting in increased objectivity (knowledge
spillover); independence (Goldman & Barlev, 1974; Wallman, 1996);
and economies of scope (Arrunada, 1999).
Others, including Brandon et al. (2004), Frankel et al. (2002),
Glezen and Millar (1985), Jenkins and Krawczyk (2002), Lowe and
Pany (1995, 1996), Raghunandan (2003), and Wines (1994) argue that
performing non-audit and audit services will pressurize auditors not
to conduct the audit function objectively, impairing their indepen-
dence. Auditors will end up auditing their own work, according to
“Revision of the Commission's Auditor Independence Requirement,”
2001. Auditors will be weakened if they rely on NAS (Canning &
Gwilliam, 1999). This will ultimately impair the quality of an audit.
Elstein (2001) contends that high consulting fees negatively affect
auditor independence and worsen audit quality; having provided NAS,
auditors become more likely to give the client the benefit of the doubt,
including more flexibility in recording and adjusting discretionary
reserves that could lead to manipulation of earnings figures.
The respondents of the survey conducted by the author were asked
to determine how much they agree with the statement that “the
provision of non-audit services by audit firms will impair auditor
independence and therefore its quality of services.” The results show
that the majority agreed that auditors offering non-audit along with
audit services might compromise their independence, leading to a
poorer quality of their audit. The Levene test and t-test results show
that the perceptions of the two groups were similar.
Abbott, Parker, Peters, and Rama (2007) argue that the effect of
outsourcing internal audit services to external auditors will lead to
economic bounding only if companies outsource routine internal
audit tasks and also will result in a loss of internal auditors'
independence, although outsourcing non-recurring internal audit
tasks will not lead to economic bonding. In Bahrain, although some
non-financial non-listed companies outsource their internal audit to
non-external auditors, some companies do outsource such services to
their external auditors.
To test how credit and financial analysts perceive the effect on audit
quality of outsourcing internal audit tasks to external auditors,
respondents were asked to express their opinion of the role of
outsourcing in the credibility of financial statements. The results show
that the majority (more than 76%) do not look favorably on outsourcing
internal audit tasks to a firm's external auditors. Levene's test on the
variances of the responses shows that the variances are homogeneous.
The mean difference is not significantly different from zero, indicating
that credit analysts and financial analysts share similar opinion.
Auditor tenure is one among the factors that affect audit quality,
although the relationship is complex. Auditors auditing a client for the
first time generally need more time to understand the client's
business, which increases the risk of missing material and misstate-
ments. Yet, although a very long association may lead to a better
understanding of the client's business and make it more likely that the
auditor will detect misstatements and earnings management, it might
also produce a poorer quality audit.
Shockley (1981) and Deis and Giroux (1992) argue that long
tenure has the potential to cause complacency, more relaxed audit
procedures, too much dependence on management representations,
and less skepticism and less diligence in gathering evidence. Myers,
Myers, and Omer (2003) and Ghosh and Moon (2005) contend that
long relationship improves audit quality and that mandatory limits on
an auditor's term might put on unnecessary cost burden on investors.
More recently, Knechel and Vanstraelen (2007) find that long
associations between auditors and clients do not impair auditor
independence; they do not find evidence to support the contention
that long-term relationships will make auditors better at predicting
bankruptcy.
The author's survey results show that opinions of the respondents
vary, although the largest group perceives tenure to have little effect
on the quality of an audit. Levene's test for equality of variances shows
that variances of the responses of the groups are homogeneous. The t-
test shows no significant difference between the means of the
responses of the two groups.
Fourteen competencies (attributes) have been found in the literature
to contribute to the quality of the audit service and ultimately the audit
report: specialization; independence; industry expertise; technical
competence in applying GAAP & GAAS/IFRS & ISA, a wide range of skills
such as analytical skills; provision of real value for the audit fees paid by
clients; proactiveness, taking initiative; due care; commitment to
providing and maintaining quality service; professional audit expertise;
reputation; high ethical standards; and possessing strong accounting and
auditing knowledge.
Survey respondents were asked to state their perceptions with
regard to the level of importance of each of those competencies for the
quality of audit, using a 6-point Likert scale, where zero indicates that
the competency is not important in determining audit quality and 5
indicates that it is extremely important. Table 3 presents the summary
statistics.
Accounting and auditing knowledge is ranked first, followed by
professional audit expertise (with a mean of 4.52). Auditor indepen-
dence is ranked third with a mean of 4.49. Real value for the audit
fees is ranked last by both groups of analysts with a mean of 3.46.
The low ranking of this factor should come as no surprise because
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
might lead to a compromise on the quality of an audit. The four factors
most important to financial analysts (mean is higher than 4.5) were
accounting and auditing knowledge; independence; ethical stan-
dards; and professional audit expertise. Credit analysts rank only
accounting and auditing knowledge and professional audit expertise
as extremely important and rank auditor independence in third place.
The Levene test and t-tests of the mean difference show no significant
difference between the variances of the responses of all factors, except
for independence, proactiveness, and reputation. The test results also
indicate that the mean responses of the credit analysts and of the
financial analysts do not differ significantly, indicating that the two
groups perceive the importance of the factors similarly.
To test respondents' perceptions of the effect of firm size on audit
quality, they were requested to answer two questions on how they
perceived the quality of audits performed by Big Four firms and the
quality of audits by non-Big Four firms. The means of the responses
show that both groups of analysts think financial statements audited
by one of the Big Four as being more credible than those of firms that
are not classified as Big Four. Financial analysts rank the credibility of
financial statements audited by Big Four significantly higher than the
rank of financial analysts. This difference should not be interpreted as
that credit analysts favor statements audited by non-Big four firms, as
both credit and financial analysts consider the quality of financial
statements audited by non-Big firms as average.
These results should be interpreted along with the respondents'
perception of the importance of 14 factors that are likely to determine
the quality of the audit service. These factors are shown in Table 4.
Because these factors are likely to be characteristic of Big Four firms,
these firms are more likely to be perceived as providing better-quality
audit reports. These results would be consistent with those of many of
the studies that find that Big Four firms produce better quality reports
because they have better resources. This is also additional evidence
supporting the current CBB policy that non-Big Four firms are not
allowed to audit retail and wholesale banks and large investment
companies. The results also justify the decisions of listed companies to
demand audit services from companies with an international presence
because they can access the expertise needed even if it is not available
in the auditor's local offices, providing assurance of a quality that meets
the expectations of investors and creditors.
Two regression models are used to test the effect of the 14 attributes
on the perception of the credibility of financial statements. The
dependent variable in the first model is the perception of the
respondents of the credibility of reports audited by Big Four firms. The
dependent variable in the second is the perception of the respondents of
the credibility of statements audited by non-Big Four firms. In both
models, the independent variable is the sum of the ratings of the 14
competency factors as perceived by respondents. Each model is run
three times. The first assumes that the dependent variable is the
perception of all the respondents; the second is the perception of the
credit analysts; and the third is the perceptions of the financial analysts.
Table 5 shows the regression results.
The adjusted R2 in the first model is 17.9% and significant at less
than 5%, and the coefficient of the competencies is 0.031 and
significant at less than 5%, indicating that the total rating of the
competencies is one of the determinants of the audit quality. When
the dependent variable is replaced with the perceptions of credit
analysts and then with those of financial analysts, the R2 changed to
9.40% and 51.90%, respectively. In both regressions, the coefficients of
independent variable remain significant with a priori expected sign.
The adjusted R2 in the second model is 0.8% and insignificant at the
conventional level, and the coefficient of the competencies is 0.09 and
insignificant. Similar regression results are obtained when the model
is tested using the two subsamples (credit analysts and financial
analysts). The outcomes of the six regression runs also indicate that
both credit analysts and financial analysts perceived that the Big Four
firms, unlike non-Big Four, are more likely to have the needed
competencies to ensure audit quality from a user's perspective. These
results lend further support to those reported by Carcello et al. (1992),
Eichenseher and Shields (1983), Shockley and Holt (1983), and Frantz
(1999).
Subsequently, step-wise regression is carried out after replacing
the independent variable with the individual values of the 14
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
addition to the constant, only professional audit expertise, reputation,
and wide range of skills are included in the final model, with an R2 of
24%. The coefficients of the three variables are positive and significant
at less than 2.8%. When the dependent variable is replaced with the
perceptions of the credit analysts, the final model has an R2 of 62.7%
and includes professional audit expertise, wide range of skills,
reputation, and accounting-and-auditing knowledge. When the
dependent variable is replaced with the perceptions of financial
analysts, the final model has an R2 of 70% and includes professional
audit expertise, real value for fees, wide range of skills, ethical
standards, and accounting-and-auditing knowledge. When the
dependent variable is replaced with the credibility of a report audited
by one of the non-Big Four, for the entire sample, only two variables
(proactive and takes initiative) remain in the final model, with a
significant R2 of 8.9%. When the sample is limited to the credit
analysts, the final model includes only one variable, “due care”, with a
significant R2 of 5.1%. The final step-wise regression is carried out for
the sample that is limited to financial analysts. The final model has a
significant R2 of 34.9% and includes the following variables: due care,
expertise in the industry, and commitment to quality.
The audit committee is considered an important board committee
that plays a role in implementing corporate governance guidelines.
One of the most important functions of the committee is to oversee
internal and external audit performance and to advise the board on
audit matters. Therefore, an effective audit committee should enhance
audit quality. Corporate governance principles (OECD, 2004) outline
the importance of audit committee in enhancing audit quality. Abbott,
Parker, and Peters (2004), Yang and Krishnan (2005), DeZoort and
Salterio (2001), and Lin, Li, and Yang (2006) find a positive relation
between audit quality and the effectiveness of audit committee.
Banks and investment companies are required by law to have audit
committees, but not non-financial companies listed on the Bahrain
Stock Exchange. To measure the impact of an audit committee on
perceived audit quality, respondents were asked about their reactions
with regard to the role of an effective audit committee in audit quality.
To test the effect of the role of the committee in improving audit
quality, respondents were asked to state their perception of the
importance of effectiveness of audit committee on the quality of audit,
using a 6-point Likert scale, where 0 indicates not important in
determining audit quality and 5 indicates that it is extremely
important. The survey does not elaborate on the requirements for
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
corporate culture, financial reporting risks, and governance needs can
vary dramatically from company to company.” The mean of the
responses of the whole sample is 4.15 and 0.82 standard deviation.
The mean and the mode of the responses clearly show that these users
of financial statements perceive that an audit committee affects the
audit quality.
Splitting the responses into the groups, the mean responses of the
credit analysts is 4.12 and 0.76 standard deviation, whereas mean
responses of the financial analysts is 4.17 and a standard deviation of
0.88. Levene's test (F = 3.056, p value of 0.082) on the variances of the
two groups indicates no significant difference between the variances.
The null hypothesis that the two groups of analysts view the effect of
the role of audit committee in determining audit quality as equally
important is accepted because the p value of 0.729 is more than the
critical value of 0.05.
6. Concluding remarks
The author has reported the results of a survey of credit and
financial analysts on perceptions of audit quality and the factors that
determine that quality. Consistent with the evidence in developed
markets, the bigger auditing firms are perceived to provide better
quality audits and to be more independent of the management of
companies they audit compared with smaller firms. Findings are
similar in both the questionnaires and personal interviews. The
conclusion is that the Big Four auditing firms have characteristics that
place them in a better position to produce better quality audits than
smaller firms.
A review of the 2007 annual reports of 41 companies listed on the
Bahrain Stock Exchange shows that 82.5% of the companies are
audited by one of the Big Four. The author's interviews indicate that
the Big Four auditors are better able to resist management pressure in
cases of conflict. Their greater resources, technical knowledge, and
global reach allow them to deal with clients more objectively without
a fear of termination.
Financial analysts rely more on the audited financial statements
than credit analysts. This is likely because a bank–client relationship
allows credit analysts to obtain more information from their clients;
they are also in a better position to evaluate the financial position of
their borrowers than financial analysts. Both groups of analysts think
that provision of non-audit services will negatively affect auditor's
independence and ultimately impair the quality of an audit. An
effective audit committee is seen as one factor that should improve
the credibility of financial statements.
Regression results indicate that both groups of analysts perceive
financial statements audited by Big-Four firms to be of better quality
than those audited by non-Big firms. This is because of the
characteristic of Big Four firms, which are not matched by other
audit firms. This is an evidence supporting CBB's current policy that
audit of retail and wholesale banks and large investment companies
should be performed by Big-Four firms. Furthermore, credit analysts
have found that the creditability of an audit report by one of the Big
Four is determined by professional audit expertise, wide range of
skills, reputation, and accounting-and-auditing knowledge. However,
for financial analysts, the credibility of these reports is a function of
professional audit expertise, real value for fees, wide range of skills,
ethical standards, and accounting-and-auditing knowledge.
Future research may be directed toward determining the effect of
the actual role of an audit committee on audit quality. This can be
carried out when companies start establishing such committees and
ensure that they act in an independent and effective manner. This is
likely to take place when Bahrain issues its corporate governance
code.
Acknowledgements
I am grateful to the two anonymous reviewers for their time and
efforts. I would like also to thank the Journal co-editor, Professor J.
Timothy Sale, for his support and editorial assistance. The usual
caveats apply.
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