THE UNIVERSITY OF ECONOMICS AND LAW ACCOUNTING AND AUDITING GRADUATION THESIS THE EFFECT OF AUDIT QUALITY ON EARNINGS MANAGEMENT OF VIETNAM LISTED FIRMS SUPERVISOR 1 : PHD. LA XUAN DAO SUPERVISOR 2 : MSC. HONG DUONG SON NAME : TRAN PHUONG QUYNH CODE : K134040486 CLASS : K13409CLC HCMC, 5/2017 i ACKNOWLEDGEMENT I would like to express special appreciation to my current advisors PhD. La Xuan Dao and MSc.
Hong Duong Son. You have been tremendous mentors for me. I would like to thank you for encouraging my research and for allowing me to develop as a scientific research. Your advices on research as well as on my career have been priceless.
I would also like to thank previous advisor MSc. Nguyen Thi Phuong Loan and members in previous scientific research group for brilliant comments and suggestions in previous researches which assist me to develop current research. I would especially like to thank instructors and lectures in Center for Economics and Finance of the University of Economics and Law. All of you have been there to support me when I collected available data from Thomson Reuter DataStream for my research.
ii ABSTRACT This research measures the discretionary accruals from the Modified Jones model of Dechow (1995). This also investigates the impact of audit quality on the earnings management of listed firms in Ho Chi Minh City Vietnam from model of Lukman Ahmad, Edi Suhara and Yusri Ilyas (2016). The sample data have been collected from Thomson Reuter DataStream which includes 196 listed firms from 2012 to 2016 without particular industries as finance, insurance and real estate. This research hypothesizes two proxies presenting for audit quality like auditor’s size and level of industry specialization auditors are both negatively associated with earnings management.
However, the finding indicates that there are no different from providing audit quality between Big4 firms and non Big4 firms and audit quality do not effect on earnings management. In particular, this can be explained by auditing environment such as legal systems, low demand for high audit quality and a low risk of auditor litigation. While this finding is consistent with the results of other studies in Korea of Jeong (1999) Jongil and Won (1999) and study of Jeong and Rho (2004), this is unfamiliar with the findings of many previous studies on audit quality from De Angelo (1981), Palmrose (1988) and Becker (1998). Keywords: Earnings management, audit quality, auditor’s size and industry specialization auditors.
iii Contents ABSTRACT .ii Chapter: Introduction. Research objectives, subjective and scope. The structure of research. Contributions of research.
6 Chapter 1: The theoretical foundations and hypothesis development .1 Accrual Basis and Cash Basis .2 Agency theory and audit monitoring mechanism .2 The hypothesis development and research model .3 The impact of Audit Quality on Earnings management. 15 Conclusion for chapter 1. 18 Chapter 2: The Effect of Audit Quality on Earnings Management in Vietnam from 2012 To 2016 .1 Measurement on Earnings Management .2 Estimation models and regression formula. 22 Conclusion for chapter 2.
27 Chapter 3: Descriptive Statistics and Factor Analyses .1 Selection between Pooled OLS and Fixed Effect Model .2 Selection between Fixed Effect Model and Random Effect Model .2 Descriptive Statistics and Factor Analyses .3 Autocorrelation test and Multicollinearity test. 34 Conclusion for chapter 3. 36 Chapter 4: Limitations and Recommendations .1 Limitations of the research .2 Facts of Vietnam and Recommendations. 37 Conclusion for chapter 4.
40 v List of tables: Table: The adjustment in earnings management of listed firms from 2012 to 2014 Table 1: The list of models in earnings management Table 2.1: The group of industries from Global Industry Classification Standard (GICS) Table 2.2: The association between independent variables and dependent variable Table 3.1: The Redundant Fixed Effects Test Table 3.2: The Hausman Test Table 3.3: The descriptive statistics for regression model Table 3.4: The result of model regression analysis Table 3.5: The correlation probability of variables vi List of abbreviation CPA: Certified Public Accountant FS: Financial Statement GICS: Global Industry Classification Standard HOSE: Ho Chi Minh Stock Exchange IFRS: International Financial Reporting Standards GAAP: Generally Accepted Accounting Principles VACPA: Vietnam Association Certified Public Accountant SEC: Securities And Exchange Commission 1 Chapter: Introduction 1. Prologue In Toward Freedom of Enron’s Global Game, this mentioned symbol of corruption for whole Western economic system in the United States – Enron. From 1961 to 2001, the Enron was honored as “America’s Most Innovative Company” by Fortune magazine for nearly six consecutive years. Following next years, Enron’s share price is increased remarkably up to 90 USD per share with expectation from investors through the growth in revenue.
The manager of Enron compromised that share price can be risen up to 130 USD per share in near future. This attracted many investors and pension management funds to pour majority of savings into this type of blue chip. Suddenly, the share price of Enron was in downward trend to just cents per share and savings of billion dollars from investors went disappeared. There are several fraudulent activities from Enron which had great impact on financial market.
Enron created fake offshore entities, sold assets at inflated price, hide losses, made loans to look like profit from sale and repurchased sale contracts. Furthermore, Enron also had corporation with other parties like banks and law firms to mislead investor perception. In particular, the unrealistic assets had been sold with overvalued price with bank assistance. Some favorable transactions had been restructured and prepared incorrectly and then submitted to SEC with law firm assistance.
In fact, Enron had been audited by Arthur Andersen at the end of the 20th century which was one of leading firms in accounting and auditing firms in the world. Unfortunately, Arthur Andersen had been accused for woefully negligent in its role of overseeing and auditing Enron’s financials. Thus, Arthur Andersen should take partially responsibility for expressing inappropriate audit opinion on the financial statements of Enron. This raises more concerns about audit quality on earning management.
According Tuoitre newspaper, the event of Bach Tuyet Cotton Corporation in 2008 became the target for controversial topic in Vietnam which caused significant damage for nearly 1,500 shareholders. Bach Tuyet Cotton Corporation stopped the transaction and 2 subsequently canceled listing in stock exchange on August 2009 by breaching of disclosure obligations and trading 3 consecutive years of losses. The responsibility of auditors in case of Bach Tuyet Cotton Corporation is involved partially for ensuring true and fair view on the financial statements. Following Vietstock statistics, the amount earnings management from listed firms that had been adjusted after auditing from 2012 to 2014 is statically recorded in below table.
Table: The adjustment in earnings management of listed firms from 2012 to 2014 Year Adjustment Earnings Management Number Percentage 2012 Increasing 219 36% Decreasing 280 46% No adjustment 110 18% 2013 Increasing 179 28,6% Decreasing 300 48% No adjustment 146 23,4% 2014 Increasing 198 30,8% Decreasing 263 48,9% No adjustment 182 28,3% 6/2015 Increasing 138 20% Decreasing 214 32% No adjustment 327 48% Source is statically recorded from Vietstock forum The rate of adjustment in earnings management is adequately high but tends to decrease over the years. Information regarding that both of increased and decreased 3 adjustment after auditing is above 70% total companies from 2012 to 6 months of 2015. The first 6 months in 2015 are also accounted for nearly 52% total companies. In general, the number of decreased adjustment after auditing has higher rate than increased adjustment.
There are some evidences in Vietnam to reveal the adjustment in earnings management in practical issues. The Group Ocean Group (OGC) suddenly turned income hundred billion VND into losses of thousand billion VND and many audit firms issued series of qualified opinion. OGC claimed that the reason for adjusting earnings due to revenue and provision recognition. In 2014, the event that leaders of OGC are captured and business information was affected significantly by adjustment from subsidiaries and affiliates as well as internal changes.
This made profit of OGC which is valued nearly 400 billion VND suddenly evaporate into a loss of more than 2,000 billion VND. Likewise, the case of Hanoi South Urban Development JSC (NHN) has made the shareholders surprise by announcing the semi-annual financial statements of 2016 information. The profit after tax was suddenly negative of nearly 99 billion VND while NHN had publicized profit before auditing. The one of notorious events that has shaken stock market recently in 2016 is the case of Truong Thanh Furniture Corporation (TTF).
This is leading firm in the manufacturing sector in Vietnam by exporting wood which was audited by DFK Company. In first quarter 2016, TTF announced profit of 54 billion VND and then suddenly had unexpected loss of up to 1.123 billion VND in the second quarter 2016. Afterward, the Ernst and Young Vietnam Limited have audited TFF and discovered the great amount of inventory up to 980 billion VND was missed by physical examination in audit procedure. Furthermore, the majority of provision for bad debts and lacking of inventory make TFF suffers the significant losses.
This made many investors and other stakeholders confuse about the truth behind financial statements and business performance. In the financial market, the financial statements takes indispensable role for delivering listed firms information and the audit firms are recognized as third parties to 4 mitigate information asymmetry and express opinion on true and fair view. Many empirical studies have been researched in developed countries to indicate the relation among earnings management and audit quality. However, this topic in developing countries is still limited.
Therefore, the research of “The Effect of Audit Quality on Earnings Management of Vietnam listed firms” reflects the current earnings management affected by various factors which include quality of audit services. Research objectives, subjective and scope The objective of research are investigating and analyzing the impact of audit quality on earnings management of listed companies in Ho Chi Minh City (HOSE) from 2012 to 2016 in Vietnam. To achieve the objectives, the conclusion of research has to answer the question: “Do the audit quality affect on earnings management of listed companies in Ho Chi Minh City?” The research subjective is financial statements of 196 listed firms in Ho chi Minh Stock Exchange from 2012 to 2016. The scope of research analyzes audit quality of 196 listed firms from 2012 to 2016.
Therefore, the research has 980 observations for measuring discretionary accruals and regression model. This is gathered from DataStream of Thomson Reuters in the Center for Economic and Financial Research of the University of Law and Economics. Listed firms are classified into 8 main industries from Global Industry Classification Standard (GICS) from the standard classification of Thomson Reuters excluding those specialized industries as finance, insurance and real estate. Research methodology The research uses the data which are aggregated statistically from Thomson Reuters DataStream from 2012 to 2016 including five years and 196 listed companies on Ho Chi Minh City Stock Exchange (HOSE).
The listed companies come from various industries except financial service, insurance and real estate because these groups of industries have different characteristics to others. 5 The research of earnings management is quantitative method and evaluates the data model combining Pooled-OLS (ordinary least squares), Random Effects Model (REM) and Fixed Effects Model (FEM). The data is arranged into panel data which includes many cross-company units and each cross-time units. The first chapter in the research was designed to review empirical studies regarding earnings management and audit quality.
From the empirical studies, the research has proposed 5 main hypothesizes mentioned below: H1: The logarithm firms’ size is positively associated with earnings management. H2: The operating cash flow is negatively associated with earnings management. H3: The firm’s leverage is positively associated with earnings management. H4: The level of auditor’s size is negatively associated with earnings management.
H5: The level of industry specialization auditors is negatively associated with earnings management.