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This study is collecting a series of data of both audit firms and listed firms in Hong Kong stock market from 2006 to 2008 which are used to examine the association between audit quality and audit firm size in Hong Kong's relatively competitive audit market for those companies which are listed in both Hong Kong stock market's Main board and Growth Enterprise Market (GEM) board. The findings are that modified opinions are more probable to be issued larger size audit firms than smaller size audit firms. And the result also showed that higher audit fees are tending to be received by larger firms. Both findings reflect that a positive relationship between audit quality and audit firm size. This relationship indicates that different size of audit firms not indifference in audit quality, although all the audit firms are competed in a comparatively mature market.
1. Problem Development and Objectives
1.1 Statement of the Problem
In the past two decade, Hong Kong had been turned into a financial centre from a industrialize city and become a famous international financial centre after the established of HKSAR. The rapidly development of the financial market attracted lots of oversea investors to make investment and establish their office in Hong Kong. At that moment, providing and facilitating financial services to the public investors were the major sector of the Hong Kong economy. To implement with these development, the listed companies' financial statement must be audited by certified public accountant who were practicing which governed by the Company Ordinance to ensure the true and fair view of the financial statement. However, there was still occurred scandal of Enron and Ernst and Young which were happened in the early 2000s and 2008s. As the purpose of audit is used to provide a degree of assurance that the contents of the financial statement are given a true and fair view. This assurance on the audited financial statement is used by the public investors to be one of the investment decision making criteria bases.
Although the regulation required the listed companies' financial report must be audited by the certified public accountant, it had not stated out explicitly that the standard of the assurance is required, thus some of the companies may employ smaller audit firm to perform the audit for their financial statement. Other reasons for choosing small size audit firm are that the audit fee is less than those large firms. Besides, the small audit firm is tend to be easy-go then that larger audit firm because of their small clients portfolio and is less independence which compared with those larger audit firm.
The public investor may come up a question is that whether a high quality of audit quality provided by large audit firm, such as Big 4. There are many arguments about the relationship of the audit firm size and audit quality. Pearson  argued the level of auditor independence to be completely linked with audit firm size. Lys and Watts  mentioned that large audit firms have an intention to protect their reputation, thus it will guarantee an auditor independent in providing high quality audit service. Larger audit firms have better monetary possessions and investigate facilities, advanced know-how and more professional staff to carry out large company audits than smaller audit firms, thus the audit firm size is a critical attribute to reflect auditor independence. It can be concluded that audit quality and auditor independence are interchangeable in the eye of many prior researchers. However, there are many studies on the affiliation of independence in appearance and audit firm size has argued for a much studies issues and it still can't be make a conclusion on whether large size firm is possessed a more audit independence when performing audit, it is because independence in appearance is less representative to conclude that the higher appearance, the higher independent, even small audit firm may still possible to possess high audit independence of appearance. Thus, this study is going to examine the relationship between audit firm size and audit quality which employed two dimensions by using audit fee and audit opinion to illustrate.
The chapter is prepared into four sections. The following section will mention the process of data collection and research methodology. The third section will analyze the findings. The last section will be the conclusion of this study.
1.2 Literature review
The argument of correlation between audit firm size and audit quality are already existed for several decades. The universal proposition on the relationship is that larger audit firms tend to offer higher quality audit services than those offered by smaller firms. Many studies argued that the larger sizes of audit firms are providing a higher quality of audit performance than those small scale firms. In DeAngelo's  study, it shows that large client portfolio's audit firms are willing to provide higher quality audits in order to sustain their client portfolio. In addition, there are two famous notional reasons have been mentioned to give details for the positive connection between audit firm size and audit quality. Dye , stated that large firms have more affluence at risk from lawsuit because of their "deeper pockets", so they have more incentive to pay more attention when conduct audit for their client companies. Also, those large audit firms have more to lose from a suspected failure to distinguish and account for material misstatement of earnings owing to the being of client's economic rents, mentioned by DeAngelo . Thus, there are developed two dimensions to look into the audit firm size effect.
The first dimension of this study is going to examine the degree of audit quality is linked to audit firm size. In McKinley's  study also exposed that the audit firm size had a positive relationship with auditor's independence. The data showed that financial statements audited by large audit firm would have more possible to discover fraud than those smaller firms. Like the study by Teoh and Wong , they evaluated audit quality by using earnings response coefficients and the result shown that the stock market was demonstrated more impressive result to the financial reports audited by Big 8 audit firms. Besides, there are supporting the affirmative audit firm size effects by providing facts that larger size audit firms be likely to issue more modified opinions by DeFond, Wong and Li , Citron Taffler  and Ireland .St. Pierre and Anderson  and Palmrose  were given out a proof that larger size audit firms have a lower occurrence of lawsuit. In sum, there are lots of experimental researches for the positive relationship between audit quality and audit firm size.
The second dimension of this study is to observe the relationship between audit fee audit and firm size. The essential idea is that larger size audit firms are providing higher quality service to those listed companies and thus they will receive higher audit remuneration for their premium audit work. Such a positive size effect is well documented by empirical studies like Palmrose ; Francis and Simon ; Francis and Stokes ; Francis ; Chan, Ezzamel and Gwilliam ; Anderson and Zéghal ; Rubin .Rubin  discovered that higher fees are received by larger size audit firms from large clients but not for small clients. On the other hand, it shown that larger size audit firm received higher fees from smaller clients but not for large by Palmrose .
In fact, many regulators convinced that smaller size audit firms are competence enough to provide auditing and non-auditing services for those listed companies and give confidence to those listed companied to invite such firm to be their auditor. Nevertheless, the change from a large size audit firm to a smaller one firm, for example those non-Big 4 audit firm, will be regarded as a "Warning" which apprehended by the public investors. Because of this perception, the public investors having a deep "Brand Name Orientation" to use a larger firm auditors like Big Four because of providing higher quality audits than those smaller audit firms by them (DeAngelo 1981; Feroz, Kyungjoo, and Pastena 1991; Dopuch and Simunic 1982). That is one of reason why those listed companies are not willing to switch from a larger size audit firm.
As per the hypothetical arguments and experimental findings on the affiliation between the audit quality and audit firm size, many reseraches linked audit firm size as a proxy for audit quality directly (Krishnan ; Clarkson and Simunic ). Such proxy may be problematical as for the following reasons. First, larger size audit firms provide an audit service in order to receive a higher remuneration in an oligopolistic market may not be resulting from their higher quality service but for their market power to derive the economic rents. In the study of Simmunic ; Gist and Michaels ,given that an affirmative connection lied between audit firm size and audit fee in this market does not inevitably mean that large firms offered higher quality of audit services.
Second, the majority studies of the association between audit quality and audit firm size concentrate on audit industry which are monopolized by a only some large auditors, like the Big 4. The general technique of differ audit firm size is to use dichotomy Big 4 firms as large and non-Big 4 firms as small. Nevertheless, the connection between audit quality and audit firm size in a rival markets still being vague (Krishnan and Schauer ; Niemi ).
In Chuntao, Frank, and Sonia  show that modified opinions are more possible to be issued by larger audit firms than smaller firms, and larger firms are less willing to allow inferior reporting which consent to client demands, thus larger firms are comparatively more independent. Lys and Watts  stated that smaller firms provide more tailored services because of restricted client portfolios and are likely to succumb to management request while larger client portfolios enable them to resist management stress. Pearson  claimed that smaller firms would face more complexity to cope with client stress when they are in conflict. A more adapted form of engagement that would facilitate a familiar association with their clients which are offered by smaller audit firms (Gul ; Shockley ).
Moreover, large audit firms tend not to rely on sole client's revenue since the crash to their firm was not substance, which contrasts to small audit firms. Relying on sole client may possible to create some threat to auditor independence, so DeAngelo's  reminded that a firm will loss more than that if it is dependence on a definite individual client. Followed arguments have been made by Craswell, Stokes, Laughton (2002), Reynolds and Francis (2001), and Francis (2004)
Besides, advanced know-how and more capable employees are owned by large audit firm than smaller firm, and they possess a high reputation within the industry, as a result they are having higher incentives to act independently as per McLennan and Park . Thus, the audited financial reports which produced by large firms are convinced to be more reliable and trustworthy than those of smaller audit firms which contended by Beatty , Davidson and Neu , and Titman and Trueman . According to GAO  and Mautz and Sharaf , in terms of technological facilities, employees education, and more extensive possessions possessed by large audit firms than small audit firms.
On the other hand, the others had claimed that large audit firm may not be implied a higher quality is provided; rather small audit firm may have more incentive than those so-call "Big firm". Krishnan and Schauer , and Niemi  thought that there was so complicated to determine whether the existing of that positive relationship of audit firm size and audit independence as large audit firms was always linked with considerable market share and superior standing.
However, it seems to be more likely that there does a positive relationship between the audit firm sizes and audit perception, which higher the audit quality resulting from higher audit perception.
1.3 Objective of the study
This study is focus on listed limited company rather than unlisted company which are including private limited company and public limited company. The reason is the impact of audit quality on the listed company financial report is higher to the public as the financial report of listed company that is one of the reliable financial data will can affect the public investor's decision making on their investment in stock exchange. It is always the true to the listed companies that the main source of capital is generated from the market. A modified or dirty opinion on their annual report will damage the confident of the existing and potential shareholders. Even though Hong Kong market does not follow China's to impose a earnings requirement of 10% to allot a new share, this is a significant effect to a listed company to receive a modify opinion. Most of the investment decision making is usually based on the financial statement. An incorrect decision will be made by the report users if the financial statement is misleading or misstating some of the information no matter the management is intentional or unintentional, like Enron and Lehman Brothers.
Besides, the reason for chosen Hong Kong as a research base of the project is that Hong Kong is being a significant financial centre in the world for over a decade. Comparing with Shanghai and Shenzhen, Hong Kong's GDP and number of share transaction in 2008 is higher than those two. In the IMD's global competitive report , Hong Kong ranked as the second and just left behind the U.S.A; on the other hand, China ranked as the twenty in the global ranking. According to the CICC's China City Competitiveness Rankings , Hong Kong ranked first in the overall rankings, and Shanghai and Shenzhen ranked second and fourth respectively.
In addition, Hong Kong is a well developed listing board for both foreign companies and China's companies for listing. No matter financial facilities or e-commerce system are more sophisticate than Shenzhen and Shanghai. For example, the listing rules in Hong Kong are more transparent, and the regulations are more simplify than China stock exchange. The investors are more confidence and willing to put in their money in Hong Kong, thus the investors will expect the higher quality of the audited financial report to be received and used as an indicator to make their investment decision. That is the reason why this study will choose Hong Kong as the research base.
The main objective of this study is going to examine whether the larger size audit firm will provide a higher quality of audit to a listed company. Since audit quality is an abstract concept and is complicated to understand, especially to the public citizens. Thus, to simplify this study, audit opinion will be used as an indicator to illustrate this abstract concept. As mentioned before, audit quality is an immeasurable thing which can't be neither monetary nor count it one by one, and the audit appearance is just an appropriate behavior of the auditor but not enough to determine the reliability of the auditor report. Moreover, audit opinion is observable in listed company's annual report. This item is the only factor that can be observed by the public. Thus, this study is going to test this factor whether they have a positive relationship with audit firm size. If there is a positive result of the relationship between audit firm size and audit quality. It means that a larger audit firm is providing a higher quality of audit service to a listed company.
1.4 Statement of Hypotheses
To develop the hypotheses, audit opinion is used to examine the relationship with audit firm size in this study. There is a prediction that the larger audit firms tend to offer of higher quality audit services than those offered by smaller firms. For the investigation of the assumptions, we apply audit opinion as a surrogate of audit quality and anticipate that larger audit firms are more probable to give out a modified rather than a clean opinion. The hypothesis is that:
H1: Larger audit firms are tending to be more likely to give out of modified opinion than those smaller firms, ceteris paribus.
2.1 Scope of Study
This study was conducted by using the second hand data of the Hong Kong listed companies in the period of 2006 to 2008. The reason for choosing this period because these are the most updated data which can be reflect the recent situation of the audit environment. The Hong Kong listed companies are including the companies that are listing in Main Board and GEM Board in Hong Kong Stock Exchange. Also, to determine the size of audit firm, audit firm like Big4 audit firm were treated as larger size audit firm and the non-Big4 local audit firm was treated as smaller size audit firm in this study.
As this research is based on the listed companies on the Hong Kong stock exchange in between 2006 and 2008, these data like audit remuneration paid by each listed company, listed companies' financial data, the name of the audit firm employed and the audit firm's opinion were collected from a data stream which provided by Hong Kong Baptist University. Since these types of data exactly integrated in the listed companies annual reports, thus the data were double checked against the annual report. For the sake of simplify, the total number of the listed companies collected which were based in the year of 2008 and the total numbers of listed companies were 1,345 in 2008.
To sample out the observations from 1,345 listed companies, the listed companies were assigned a number ranged from 0 to 1 randomly by the spreadsheet function. And the sampling criterion was that the listed companies which were assigned the number larger than 0.5 were sample out as the observations. There were 638 out of 1,345 listed companies being sampling out. Furthermore, there were also 116 out of those 638 listed companies were dropped out from the observation. The reason was that all of these listed companies had not been listed in the time before 2008, so there were unable to collect the financial data from the data stream and annual report. Therefore, the numbers of final observations were 520 listed companies which representing 38.66% of the listed companies in 2008. The Regression model of Probit Regression and Linear Regression will be used to examine the H1 and H2 for the statistical test respectively. In addition, to analyze the all listed companies data in the period of 2006-2008, all the data set were already pooled into one data set and hold all the year effect during the analysis. Besides the Regression, T-test was also employed to investigate the hypotheses.
2.3 Regression Model
2.3.1 Audit Opinion and Audit Firm Size Model
To examine the H1, Probit regression model was estimate:
Prob(Opinionit)=Î±0 + Î±1AuditSizeit + Î±2Assetit + Î±3Revenueit + Î±4Feeit + Î±5Zscoreit
+ Î±6Lossit + Î±7Betait + Î³1YRit + Îµit
For the dependent variable of Opinionit, it equals 1 if a listed company i receive a clean opinion. The variable equals 0 if a listed company i get a modified opinion in year t. According to the Hong Kong Standard on Auditing 700 and 705, Audit opinions' classifications are very paralleled to International Standard on Auditing 700 and 705. For the sake of simplification, four types of opinion were distanced in this study: unqualified, qualified, disclaimer, and adverse. In this study, however, explanatory notes issued with an unqualified opinion was not deemed as qualified opinion despite the existence of certain differences between an unqualified opinion with notes and a qualified opinion. Consistent with general classification among different Standard on Auditing, unqualified opinion was treated as clean opinion and the others were grouped as modified opinion.
Furthermore, Audit Size were indicated the size of an audit firm. We measure audit firm size by just distancing with Big4 and Non-Big4 audit firm. It is equal 1 if a listed company appointing a Big4 audit firm to perform audit during the year of t. Otherwise, it is 0 if a listed company appoint a Non-Big4 audit firm. Besides to look into the audit firm size effect, some factors were taken into a consideration to issue a modified opinion by an audit firm. Thus, a numbers of control variables were initiated to get rid of potential other side effects. The First control variable introduced was Client Size. Because the majority of source of income are vitally symbolized by clean opinion for an audit firm, therefore larger listed companies are most likely to have clean opinion from the auditor (Gul, Lee and Lynn ; Krishnan, Krishnan and Stephens ). In order to determine the size of a listed company, two dimensions were used: (1) the total book value of assets owned by a listed company in a given year (Asset); (2) the total amount of sales revenue of a listed company obtained in a given year (Revenue). Besides, the audit remuneration was a significant control variable that was paid by a listed company in a given year was plugged into the model in order to examine the relationship between the audit quality and audit firm size (Fee).
However, the larger size audit firms express qualified opinion in many auditors' reports which may not imply the larger size audit firms are comparatively more independent if the financial statements that are audited by those larger size audit firm are holding a concern to their financial status in reality and thus more probability to issue a qualified opinion. Therefore other control variables were added to maintain deviation in the financial reports' quality. Taken an assumption of those listed companies which situated in a poor financial position that have probabilities to have high motivation to control their earnings into consideration, two another control variables were incorporate two proxies of fiscal suffering. The first proxy, was defined after Altman , of fiscal suffering had been indicated as the likelihood of liquidation (Zscore). The lower score imply more probable that a listed company will being liquidated and, thus, the increase the audit failure risk. In sum, to protect their reputation, larger size audit firms tend to issue modified opinion.
The second proxy was a dummy variable that representing a listing company was suffering a negative profit for the period which stated in the audited financial statement in the given year (Loss). It is equal 1 if there is a loss occurs during a given year, otherwise 0. Corresponding to the anticipation that a listed company with high possibility and poor market performance which has a high encouragement to influence earnings, a market-based measurement was brought in that was used by Dopuch, Holthausen and Leftwich . Beta coefficient of the CAPM model was used to capture the systematic risk of a listed firm (Beta). It measure the volatility of risk of a listed company during changing in economy, which is higher the Beta mean higher the risk, compared with the market. Last but not least, a year dummy variable was utilized to control year effects (YR).
Under this model, some limitations were discovered during the development of this model. First, even though the sample size are 38.66% of all the listed companies in Hong Kong Stock Exchange, there were still not representative enough to draw a conclusion from the result of the study. The reason is that the proportion of listed companies of the Main Board and GEM Board exist a large variance. As most of the listed companies in Main Board are more likely to receive clean opinion compared with GEM Board's listed companies. Second, comparing with all the numbers of clients which included other form of business audited by one audit firm, the proportion included in this study was not sufficient to conclude that a larger size audit firm is providing a high quality of audit service to all of their clients.
3. Analysis and Findings
3.1 Descriptive Statistic
3.2 Regression Results
4. Discussion and Recommendations
4.1 Comparison with prior study