The research, undertaken in collaboration with international colleagues Dr Vlad-Andrei Porumb (University of Manchester), Professor Gerald Lobo (University of Houston) and Dr Yasemin Zengin-Karaibrahimoglu (University of Groningen), found that without external audit reviews, firms were found to be associated with a higher cost of debt of 0.3% per year.
This amounts to a significantly higher cost to firms that if they were to pay the fees of an audit review, which begs the question: why are firms willing to tolerate a higher financial cost in lieu of receiving an external audit? The analyses of this research suggest that without external audit reviews, CEOs can have more facility in manipulating reported earnings and chasing a higher stock-based compensation.
“Canada is among the very few countries allowing public firms to determine whether or not to opt-in external reviews of interim financial reports”, said Dr Shuo Wang.
“There has been a long-standing debate among Canadian regulators, practitioners, and academics about whether external audit reviews should indeed be mandatory.”
Advocates of audits believe that market integrity matters and that forgoing external audit reviews can result in financial report manipulations, at the cost of investors. On the other hand, opponents argue that external audit reviews' benefits cannot offset the incremental audit fees associated with the review.
Dr Shuo adds: “Our study responds to this debate by confirming the superiority of voluntary external audit review because the voluntary mechanism allows regulators and investors to differentiate between high- and low-risk firms.”
Going forward, this research intends to use Canada as a case study to examine whether other benefits and costs are associated with the external audit review, and whether the ‘cost:benefit’ analysis can be extended to private firms. The research results from this work will be presented to the European Financial Reporting Advisory Group (EFRAG).
To read more about this research, visit the European Accounting Review.