Determinants of Auditor Choice in Tunisian Context

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The purpose of this article is to examine the association between the firms 'choice of external auditor and the following client firms characteristics: the level of complexity in the organization, investment opportunities, leverage and the costs of disclosing proprietary information to competitors.

We develop a logit regression model to test the impact of firms' characteristics on auditor choice decisions made by 27 companies listed during a period of 2005-2008 in Tunisia.

We find that firms with high investment opportunities and high level of organizational complexity are more likely to hire "Top 15" auditors. Further, firms with high leverage and high costs of disclosing proprietary information to competitors are less likely to hire "Top 15" auditors.

Introduction

During the last decade of last century, the informational opacity has been one of the factors that led to the most widespread financial scandals around the world (Enron, Worldcom, Parmalat ...). In this regard, to ensure the relevance and credibility of financial and accounting information provided by the company, the intervention of a legal auditor in the life of organizations is fundamental.

The legal auditor can thus give reasonable assurance that financial statements accurately reflect the company's situation. Therefore the audit of accounts can mitigate the asymmetric information between the various stakeholders of the company (shareholders, creditors, investors, employees ...). In this context the legal audit finds its legitimacy in signaling theory and in agency theory. Hence, in attesting to the credibility of accounting information provided by management, independent audits play an external monitoring role on behalf of the owners/shareholders and are an essential component of the corporate governance (Abdel-khalik, 2002; Ashbaugh &Warfield, 2003). Nonetheless the utility of audit services depends upon the quality of auditing.

Several prior studies documented that firm with high agency costs are inclined to choose a high-quality auditor to alleviate the potential agency problems (Hay & Davis, 2004; Fan & Wong, 2005). Relatively speaking, low-quality auditors may not be able to exercise an effective monitoring of clients' financial reporting process (Mayhew et al., 2003).

Thus the quality of independent audits will directly affect firms 'operations (Cohen et al., 2002). There is always a trade-off between hiring a high-quality auditor to improve the transparency of information, quality financial reporting and hiring a low-quality auditor to disguise information. Due to the inability of directly observing audit quality, several observable factors are used as a surrogate, including the size of audit firms (De Angelo, 1981; Palmrose, 1988; Citron & Taffer, 1992; Copley & Douhett, 2002).

Therefore, offers on the audit market are divided into two groups: the large audit firms supposed to provide a high quality audit service and other firms expected to provide a lower audit-quality.

We will seek to answer the question: What are the firm characteristics that influence the auditor choice decisions (hiring high-quality auditor Vs low-quality auditors) in Tunisian context?

The audit market in Tunisia presents an interesting arena for the study of auditor choice. Because there are few empirical studies that examine auditor choice decisions in the emerging economies. In addition, the occupations of the Tunisian government to strengthen the oversight role pursued by the legal auditor (Act No. 2005-96 of 18 October 2005 on strengthening the security of financial relations), provides a good opportunity to study the auditor choice decisions for Tunisian listed companies.

This paper contributes to the literature in the following ways. First, it explores other determinants of auditor choice that have not been studied before in the Tunisian context, there are investment opportunities and the costs of disclosing proprietary information to competitors. Second, it eliminates the simple dichotomous distinction between "Big" and "No Big" and proposes a new typology of the audit quality in the Tunisian audit market.

The purpose of this paper is to examine the association between the auditor choice decisions in Tunisia and the following client firm characteristics: the level of complexity in the organization, investment opportunities, leverage and the costs of disclosing proprietary information to competitors.

We develop a logit regression model to test the impact of firms' characteristics on auditor choice decisions made by 27 companies listed during a period of 2005-2008 in Tunisia.

The empirical results show that firms with high investment opportunities and high level of organizational complexity are more likely to hire "Top 15" auditors. Further, firms with high leverage and high costs of disclosing proprietary information to competitors are less likely to hire "Top 15" auditors.

The remainder of this paper is organized as follows: the next section reviews the auditing environment in Tunisia. Section 3 outlines the prior literature and hypotheses tested in this article. Section 4 describes the empirical analysis. Section 5 presents our result. At Last, we offer concluding remarks and study limitations.

2. Auditing environment in Tunisia

2.1. Legal framework

The auditing profession in Tunisia was primarily regulated by the Commercial Code of 1959, followed by the Commercial Companies Code in 2000 and also the contribution of some specific legislation the profession of accounting.

For several years, the legal audit has been reserved exclusively for Chiefs Accountants; it is only with the enactment of Law No. 2002-16 of 04/02/2002 on the organization of the accountancy profession as the statutory audit has been extended to accounting technicians enrolled in the company of accountants in Tunisia.

According to Article 13 of Law n ° 2005-96 of 18/10/2005 on strengthening the security of financial relations, the statutory audit is no longer a requirement for joint stock companies but only for limited liability companies that meet at least two of the limits set by decree:

- Total balance sheet: 100 000 dinars;

- Total incomes excluding taxes: 300 000 dinars;

- Average number of employees: 10.

Under the provisions of the law of 04.17.1995 on the restructuring of companies in economic difficulties, as supplemented and amended by Law No. 99-63 of 15.07.1999 and Law No. 2003-79 of 29 / 12 / 2003, the auditor is responsible for informing the Committee Monitoring Economic Companies of any economic hardship which may pose a threat to the continuity of the activity of its client company, it must also disclose to district attorney anomalies and offenses discovered during the course of his mission.

Through these laws, the legislature has given great importance to the role of chief accountant in companies, it cooperates more with the statuary bodies supervisory as the board of directors, and audit committee.

For this reason, the Tunisian legislature does not cease to strengthen the independence of the auditor, and this through Article 262 of the Commercial Companies Code that is incompatibility of the exercise of statutory auditor and also through Article 13 bis of Act No. 2005-96 organizes the auditor tenure and Article 13ter requires the appointment of two or more auditors for some companies.

2.2. Tunisian audit market features

Since the early eighties, the function of audit in Tunisia has been regulated under public control. Moreover, public control is now seen internationally as a major element in maintaining confidence in the audit function.

However, the audit profession recognizes limits in Tunisia, is a profession that remains negligible compared to developed countries. In fact, the number of chiefs accountants increased in a very small amount of one year to another, or 751 firms are inscribed in the Order of the Chiefs Accountants of Tunisia in 2008. Whose majority is composed of individual audit firms and a minority is made up of large audit firms which are mainly representatives of the "Big4" and of the large local audit firms.

The following table shows the evolution of the number of chiefs accountants over the past four years.

.

According to the National Institute of Statistics in 2007, the Tunisian economic context is characterized by a majority of family companies is 85.6%. While the Legal persons are 14.4%: 1% of Public limited Companies, 10.8% of limited liability companies and 2.6% of other legal persons.

The details of this distribution are shown in the table below.

Since 2007, there were approximately 691 audit firms are required to audit the accounts of According to the distribution of Tunisian firms by legal form, we find that the area where the auditors provide services is limited public limited companies 5240 and 56,581 limited liability companies. This means that the audit market in Tunisia is characterized by competition and concentration.

The large international audit firms 'Big 4' are the leaders in Tunisian audit market, the remaining market is shared between large local audit firms and individual audit firms.

We will analyze in the next section the audit quality and determinants of auditor choice in view of the socio-economic Tunisian context.

Background and hypotheses development

3.1. Audit quality

Audit quality refers to two components: the ability to detect misstatements and the willingness to report the misstatement uncovered in an audit engagement (De Angelo, 1981; Copley & Douthett, 2002). However, a variety of definitions are used to proxy for audit quality in the literature. Due to the inability of directly observing audit quality, several observable factors are used as a surrogate, including the size of audit firms (De Angelo, 1981; Palmrose, 1988). A high-quality auditor should have independence, sufficient expertise, and high integrity.

De Angelo (1981) suggests that the auditor independence is the joint probability that auditors will find and report misstatements in the financial statements. She argues that the quality of an auditing firm is positively associated with firm size of the firm's market share. Despite some recent high-profile cases (e.g., Arthur Andersen), the collective evidence is strongly supportive that large audit firms can provide higher audits and better monitoring (De Angelo, 1981; Lee et al., 2003; Francis, 2004; Lennox, 2005).

Previous studies in Anglo-Saxons' countries, shows that there is a significant difference between the audit quality from "Big 4" and the audit quality from other audit firms "No Big4" (De Angelo, 1981 ; Palmarose, 1988). Nevertheless, researchers from emerging countries like China and Tunisia (Zehri, 2007, Lin & Liu, 2009) have not found the same results because the specifics of the audit market in these countries are different from those in Anglo Saxon, due to cultural differences and socio-economic differences between the two environments.

Recognize the reality of the audit market in emerging countries and particularly in the Tunisian audit market, Zehri (2007) developed an empirical study in 2007 on the legal audit quality in Tunisia.

She proposed a tripartite typology of audit quality, which is better suited to the specificities of the Tunisian context:

The first typology: membership of auditor to large international firms "Big4".

The second typology : large local audit firms who have more than ten years of experience, that is they are registered on the board of Order of the Chiefs Accountants of Tunisia (OCAT) before 1999 and they have a number of collaborators higher than 20.

The third typology: other audit firms, obtained by eliminating the first and second typology.

It makes more sense then to create a new typology called "large local audit firms", and to abandon the simple dichotomous distinction "Big / No Big". So, the large local audit firms in Tunisia have a high audit quality like audit quality of "Big 4" auditors.

Zehri (2007) has shown that large local audit firms significantly limit the exercise of discretions accounting made by the directors of small and medium Tunisian companies.

3.2. Hypotheses development

- Organizational complexity

As a company grows larger it becomes more complex and difficult to control (Kinney & Mc Daniel, 1989). An increasing asset, number of subordinates, locations and transactional complexity may reduce overall efficiency in the organization and give rise to moral hazard problems between the manager/owner and the subordinates.

De Angelo (1981) suggests that there exists a positive association between the size of the firm and the audit quality. So as the society becomes larger, a higher quality audit will be needed

for monitoring or bonding and will also be of relatively greater benefit in proportion to its costs under any of the other explanations (Hay & Davis,2004).

As a result, organizations that are complex are more likely to select a high quality auditor (Simunic & Stein, 1987; Abdel-Khalik, 1993; knechel et al., 2008) leading to our first hypothesis:

H1: The choice of auditor is positively associated with the complexity of the firm.

Investment opportunities

Investment opportunities are growth options that can be taken or forgone at the managers'discretion (Myers, 1977). They represent future investments the value of which is uncertain because they depend on discretionary expenses made by the managers. Hence, the managers are likely to have more information about investment opportunities and their value than the shareholders (Bizjak et al., 1993).

Furthermore, the management of investment opportunities requires decision-making in an uncertain environment and consequently managerial action is more unobservable (Smith & Watts, 1992).

Hence, shareholders of firms with high investment opportunities have a greater need of monitoring their managers.

In addition, firms with high investment opportunities have a high audit risk (Tsui et al., 2001) and high level of discretionary accruals. Consequently theses firms are more needed to hire a high quality auditors. The second hypothesis is as follows:

H2: The choice of auditor is positively associated with investment opportunities of the firm.

-Leverage

Extensive prior research suggests that one major source of a demand for auditing is the need to mitigate the client's agency costs arising from conflicting interests among management, owners and creditors (Jensen & Meckling, 1976).

Companies in need of financing will first turn to local banks or financial institutions. Evidence suggests that a company can reduce its effective interest rate by engaging high quality auditors (Blackwell et al., 1998; Mansi et al., 2004).

Prior research suggests that firms can use income-increasing accounting methods to avoid debt covenant violations (DeFond & Jiambalvo, 1994) so an audit facilitates the enforcement of debt covenants that restrict management actions.

Knechel et al. (2008) suggest that a creditor's risk is also affected by the extent of collateral available to support a loan and the notional value of collateral may be overstated as a result of aggressive accounting practices by a borrower. Consequently, the borrower's choice of auditor is conditional on the extent of a firm's leverage, leading to our third hypothesis:

H3: The choice of auditor is positively associated with a firm's leverage.

-Costs of disclosing proprietary information to competitors

A primary objective for any company is to develop and retain a competitive advantage. For competitors to successfully imitate the strategy of another, have the incentive to compete, be able to diagnose the source of the competitive advantage. Businesses have an incentive to avoid revealing proprietary information that could be harmful to the competitive position of the company (Porter, 1980).

Several studies suggest that competition increases as disclosing decreases, and that the proprietary costs of disclosure are higher in more competitive markets (Harris, 1998; Verrecchia, 1990).

Hiring a low quality auditor may increase the opportunities for a company to use income-decreasing accounting methods to disguise the true performance of the firm (Knechel et al., 2008). This leads to our fourth hypothesis:

H4: The choice of auditor is positively associated with the costs of disclosing proprietary information to competitors.

4. Research methodology

We describe first our sample and we are going to present the logistical regression model and finally, we are going to define all variables used.

4.1. Sampling

Our sample covers 27 Tunisian firms listed in Tunisian stock exchange (TSE) from the beginning of 2005 to the end of 2008.This firms are distributed in five business sectors: the industry, the agriculture, the services, the business and the tourism.

We excluded the financial institutions because they are subjected to a specific regulation in establishment of financial reporting.The data of our model are taken from the financial reporting from the Tunisian Financial Market Council (FMC). Others data about auditors characteristics are taken from the National Statistics Institute (NSI) and from the Order of the Chiefs Accountants of Tunisia (OCAT).

4.2. Model specification

The basic objective of this study is to examine whether firms auditor choice is associated with their characteristics (organizational complexity, investment opportunities, leverage and the costs of disclosing proprietary information to competitors).

In this study we use a binary classification to divide auditors in Tunisia into two categories: the 15 largest auditors "Top 15" to proxy for high-quality auditors and "no Top 15" to proxy for low-quality ones.

Since the dependent variable (auditor choice) is binary in nature (Top 15 vs no Top 15), we applied logit regression with the following auditor choice model to test Hypotheses 1-4:

So Audior Choice = f {Organizational complexity (proxy by MOD, CTR, CRV); Investment opportunities (proxy by INV); Leverage (proxy by END); Costs of disclosing proprietary information to competitors (proxy by CONC, ROA)}.

This regression will be estimated on the panel of 108 firms-year observations.

4.3. Variables Measures

Variables used in the present study are defined as follows:

4.3.1. Dependent variable

CHOIX =1 if the auditor is a Top 15; 0 otherwise.

The Top 15 audit firms represent the high-quality auditor in Tunisia. So its includes the big national audit firms and "the big 4" in Tunisia.

We are assumed that the big national audit firms in Tunisia represent the auditors are more than ten years old of experiences, that are registered on the board of the Order of the chiefs accountants of Tunisia (OCAT) before 1999 and they have a number of collaborators higher than 20.

4.3.2. Independents variables

- Organizational Complexity

MOD: Is the ratio of salaries to operating expenses.

Reflects operational and informational complexity of an organization (Abdel-Khalik, 1993; Hay & Davis, 2004).

CTR: Is the ratio of inventory and receivables to total assets.

Reflects asset and transactional complexity (Stice, 1991; Hay et al., 2006).

CRV: defined the percentage growth in sales for a specific company (Kinney & Mc. Daniel, 1989).

For all three variables, we expect a positive association between the measure of complexity and the choice of auditor.

-Investment opportunities

We use factor analysis to derive a composite measure of investment opportunities three variables. The measures of investment opportunities that I use in factor analysis follow Gul & Tsui (1998); Lai (2009).

Market to book asset (FIRMASS): Is the ratio of the sum of market value of equity and book value of long-term debt to the total assets of the firm.

Market to book equity (MKTBKEQ): Is the ratio of the market value of equity to book value of equity.

Gross property, plant and equipment (PPEGT): Is the ratio of gross property, plant and equipment to the sum of market value of equity and book value of long-term debt.

According to Myers (1977), the value of a firm consists of assets-in-place and investment opportunities. FIRMASS and MKTBKEQ are expected to be positively related to investment opportunities larger values of these measures mean higher firm value in relation to assets-in- place. Conversely, PPEGT is expected to be negatively related to investment opportunities because a higher value means more assets-in-place and a lower proportion of firm value that is represented by investment opportunities.

INVi,t = FIRMASS + MKTBMEQ - PPEGT

We expect a positive association between the measure of investment opportunities and the choice of auditor.

-Leverage

END: Is the ratio of total liabilities to total assets.

Reflects the percentage of funds used in the asset which result from external creditors (Mitra et al., 2007),

We expect a positive association between the measure of leverage and the choice of auditor.

-Costs of disclosing proprietary information to competitors

Several studies suggest that the proprietary costs of disclosure are higher in more competitive markets (Verrechia, 1990). Consequently; there is a relationship between measures of competition in the industry and auditor choice. Our measure focuses on market concentration is the Herfindahl index "CONC"

CONC: Is the sum of divided by the square of the sum of Zi, where Zi refers to the sales of the i th sample firm in our sample.

The general assumption in the literature is that competition decreases as market concentration increases (Harris, 1998). A higher value of the ratio means that the industry is more concentrated, so we expect a positive relationship between CONC and the auditor choice.

The theoretical association between completion and concentration of the industry is ambiguous so we also use profitability as an alternative measure of competition.

ROA: Is the firm's return on assets.

A company has an incentive to hire a low quality auditor in order to make it easier to disguise its true profitability. So we expect a negative relationship between ROA and the auditor choice.

-Size

TAILLE: Is the natural logarithm of total assets.

We expect a positive association between the measure of firm's size and the choice of auditor.

5. Empirical results

The descriptive results concerning the different variables presented above are set out successively with those of the regression models.

5.1. Descriptive statistics

Table 4 provides selected descriptive statistics of the sample by Top 15 versus no Top 15 auditors.

The audit market in Tunisia is somewhat different from that in US. The big 4 auditing firms dominate the market and audit most of the listed firms in the US. However, Top 15 audit firms in Tunisia have audited only 62, 93% of the sample listed firms in this study.

Firms with Top 15 auditors have larger in size (TAILLE) than firms with no-Top 15 auditors. In addition, they have higher investment opportunities (INV) than no-Top 15 firms, suggesting that firms with high investment opportunities are more likely to hire Top 15 auditors. However, firms with Top 15 auditors have lower salaries to operating expenses ratio (MOD),lower inventory and receivables to total assets ratio (CTR), lower percentage growth in sales (CRV), lower total liabilities to total assets ratio (END), lower (ROA) and lower market concentration (CONC) than firms with no-Top 15 auditors.

The correlation results for the variables used in model are presented in table 5.

The choice of Top 15 auditors is positively related, at the significant level, to the investment opportunities (INV), industry concentration (CONC) and salaries to operating expenses ratio (MOD), and negatively related to the inventory and receivables to total assets ratio (CTR).

5.2. Regression results

Table 6 provides empirical results from the regression to test the association between firms' characteristics and their audit choice decisions. The sample consists of 27 listed firms during 2005-2008. With a pseudo R-square of 0.334 and a Chi-square of 43.953, the model is statistically significant and can differentiate the listed firms choosing Top 15 (high-quality) auditors from those choosing no-Top 15 auditors.

The both complexity variables MOD and CRV have positive coefficient with a p-value of 0,221 and a p-value of 0,314 respectively.CTR has the predicted positive sign and its is significant at the p < 0, 1 level. The finding is consistent with H1. As a result, organizations that are complex are more likely to select a high-quality auditor (Simunic & Stein, 1987; Abdel-Khalik, 1993; knechel et al., 2008). It suggests that Tunisian firms with organizational complexity and control, will be needed a high-quality (Top 15) auditor for monitoring.

The coefficient for the variable of investment opportunities is positively significant at the 1% level (β4 = 0,827; Wald = 10, 139). It suggests that with a high level of investment opportunities, the listed Tunisian firms are more likely to choose a Top 15 (high -quality) auditor. The finding is consistent with H2. The result reveals that firms with high investment opportunities are more likely to have more discretionary accruals. However, this relationship

is weaker when those firms are audited by Top 15 auditors. These results suggest that the likelihood of earnings manipulation is higher for firms with high investment opportunities but a high quality audit is able to curb the manipulation (Lai, 2009; Tsui et al., 2001).

As indicated by β5, the leverage is negatively related to choosing a Top 15 (high-quality) auditor. The result is significant at the 1% level (β5 = -3,066; Wald = 7,797), suggesting that firms with higher leverage are less likely to choose a Top 15 auditor, which reject H2. Although some studies found that firms with higher leverage can use income-increasing accounting methods to avoid debt covenant violations, so high-quality audit facilitates the enforcement of debt covenants that restrict management actions (DeFond & Jiambalvo, 1994; Knechel et al., 2008). Our finding demonstrates that firms with high leverage choose a no-Top 15 auditor to dissimulate their methods accounting manipulation.

Consistent with H4, CONC is positively related to choosing a Top 15 auditor, but only at a marginal level of 10%. In addition ROA has the predicted negative sign but its is not significant. Suggesting that when the costs of disclosing proprietary information to competitors are higher, a listed firm is more likely to hire a high-quality (Top 15) auditor. This finding indicates that competition increases as disclosing decreases, and that the proprietary costs of disclosure are higher in more competitive markets, so hiring a low quality auditor may increase the opportunities for a company to use income-decreasing accounting methods to disguise the true performance of the firm (Knechel et al., 2008).

For the control variable, firm size (log of total assets) is positively related to the selection of Top 15 auditors. The results suggest that large firms are inclined to hire high-quality auditors in the Tunisian stock market as well.

In summary, the empirical results support H1, H2, and H4 and reject H3, during the period 2005-2008.

6. Conclusions

The purpose of this study is to investigate the association between the firms 'choice of external auditor and the following client firm characteristics: organizational complexity, investment opportunities, leverage and costs of disclosing proprietary information to competitors, in the Tunisia context.

Though logit regression, we identify the impact of the client firm characteristics variables on the auditor choice decisions undertaken by the 27 listed firms in Tunisia during 2005-2008.

The results of this paper indicate that firms with high investment opportunities and high level of organizational complexity are more likely to hire high-quality "TOP 15" auditors. Further, firms with high leverage and high costs of disclosing proprietary information to competitors are less likely to hire "TOP 15" auditors.

We find that large local audit firms occupy a considerable place in the auditing Tunisian market and they show a high quality of audit. So we eliminated the simple dichotomy distinction between "Big N/no Big N" and we proposed a tripartite typology of audit quality in Tunisia: the big four, the large local audit firms and others. This new typology we allowed to categorize Tunisian auditors into two groups, Top 15 (high-quality) and no-Top 15 (low-quality).

There are some limitations in this study. First our sample was based only on the listed companies. Second our identification of the large national audit firms in Tunisia is subjective.

Future research could examine others determinants of auditor choice such as audit committee characteristics. Finally we suggest a replication of this study by evaluating the audit quality according to the direct approach.

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