1. Introduction
Auditing and financial reporting scandals like Enron and WorldCom have brought audit quality and governance mechanisms into the spotlight. External auditors serve a monitoring role to ensure the quality of financial reporting (
Iatridis 2012), reduce agency costs arising from managers’ opportunistic behavior, and lessen asymmetric information between firms and stakeholders (
Francis and Wang 2008). Earnings management practices have a detrimental impact on investor confidence, capital market development and transparency of financial reporting. Users of financial statements look towards audit report when they are skeptical about the reliability of financial statements (
Tsipouridou and Spathis 2012).
Pakistan is a common law country, having adopted International Financial Reporting Standards (IFRS) after their promulgation on 1 January 2005. However,
Ashraf and Ghani (
2005) argue that Pakistan exhibits characteristics of code law countries, having less developed equity market, reliance on banks and financial institutions for debt financing, poor investor protection laws for minority shareholders, and concentrated ownership dominated by family business groups. Empirical studies of international comparison among countries have demonstrated that Pakistan is among the countries with the highest levels of earnings management practices (
Leuz et al. 2003), despite adoption of International Accounting Standards (IAS) from the outset.
Agency Theory (
Jensen and Meckling 1976) highlights the existence of agency problem between managers and shareholders due to separation of ownership and control in the corporate form of organization, which may lead to an entrenchment effect and expropriation of shareholders’ wealth by managers. Another type of agency problem may also arise between controlling and minority shareholders. Both of these types of agency problems can result in the expropriation of wealth and lead towards manipulation of financial statements and earnings management practices. External auditors are expected to play a monitoring role in ensuring the reliability of financial statements, constraining opportunistic earnings management and reducing agency conflict between management and shareholders. However, the effectiveness of external auditors has been questioned in Pakistan and has often been criticized for low-quality financial reporting and disclosure practices by academics(
Ashraf and Ghani 2005) and press alike (
Baig 1997).
Earnings management is more pervasive in countries that are characterized by weaker investor protection, inefficient judicial system, poor enforcement mechanisms, irrelevant equity markets and concentrated ownership (
Leuz et al. 2003). Recently,
Persakis and Iatridis (
2016) investigated the joint effect of audit quality and investor protection on earnings management among an international sample of countries based on the classification of (
Leuz 2010). Their findings were that higher audit quality is associated with stronger investor protection and legal enforcement in all clusters of countries. Secondly, earnings quality and audit quality are stronger in countries with stronger investor protection, implying the significance of enforcement mechanisms, legal structure and institutional environment in improving earnings and audit quality. When the demand for quality of auditing is lower and the regulations are less stringent, auditors will act in a less conservative manner and earnings management will be more pronounced (
Tsipouridou and Spathis 2012). Therefore, the objective of this paper is to examine the role of auditors in potentially approving or limiting firms’ earnings management practices in institutional settings that do not provide incentives for auditors to deliver higher audit quality.
In this study, we aim to investigate the relation between earnings management and audit quality for firms listed on the Karachi Stock Exchange (KSE), Pakistan for the period 2009–2013. Although there has been plentiful research on earnings management, the role of auditors in constraining or approving management’s opportunistic behavior in different settings needs to be further investigated, especially in the presence of International Financial Reporting Standards (IFRS) that aim to provide useful financial statements.
International Financial Reporting Standards (IFRS) are intended to provide international harmonization of accounting and auditing standards, reduce discretion in reporting, and call for detailed disclosures to address the information needs of financial statements users (
Tsipouridou and Spathis 2012). Therefore, IFRS implementation can be linked with improving financial reporting quality and reducing earnings management activities.
Francis and Wang (
2008) argued that institutional settings and enforcement mechanisms may be more relevant than accounting standards in determining financial reporting and audit quality. More recently, studies have provided evidence that the mere mandatory adoption of accounting standards might not affect earnings management practices in countries with weaker investor protections and regulatory environments (
Garrouch et al. 2014;
Pelucio-Grecco et al. 2014). The argument established by these studies is that IFRS can have a limiting effect on earnings management activities if these are accompanied by efficient enforcement mechanisms, and appropriate corporate governance and regulatory environments. This further substantiates the need to study the effect of auditor quality on earnings management in an environment of weaker investor protection and lax enforcement standards, governance mechanisms and regulatory regimes, like Pakistan, which have adopted IAS and IFRS from the beginning. The results of this study would thus be significant to evaluate whether the adoption of IFRS has been successful in curbing managerial opportunism and earnings management practices in Pakistan in the presence of ineffective governance, enforcement and regulatory environment.
We use signed discretionary accruals and performance-adjusted discretionary accruals as proxies for earnings management activities and auditor firm size (Big 4 vs. Non-Big 4) and audit opinion (Qualified vs. Unqualified) as proxies for auditor reporting. As the purpose of external audit is to improve financial reporting quality, we examine whether there are significant differences in earnings management activities between clients of Big 4 and non-Big 4 audit firms. Further, we investigate if there are differences in the type of audit opinions (Qualified vs. Unqualified) that are issued in response to the level of earnings management activities of the firms. The examination of these relationships is reasonable when we consider the findings that Big 4 auditors act in a less conservative manner in settings where there are fewer restrictive regulations and enforcement mechanisms, and where the demand for high-quality auditing by stakeholders is lower (
Ajona et al. 2008). We also examine the relation between family ownership and earnings management and the monitoring role of Big 4 auditors in constraining or controlling owners’ opportunistic behavior.
Family firms are the prevalent form of business organization in Pakistan and are characterized by controlling ownership and the presence of family members on the board, which presents a unique governance problem. In family-controlled firms, concentrated ownership gives rise to the development of agency conflict between controlling and minority shareholders (
Chi et al. 2015). Because controlling family owners are in charge of accounting policies and flow of information to the public, they are perceived to have incentives for opportunistic earnings management for private benefit at the expense of minority shareholders (
Fan and Wong 2002). Big 4 auditors are expected to play a monitoring role and ensure the integrity of accounting figures and moderate the relation between family firms and earnings management. This provides an interesting platform to research the role of Big 4 auditors in ensuring the quality of financial reporting in the presence of controlling family ownership and poor investor protection laws for minority shareholders. As the objective of this paper is to examine the role of auditors in intuitional settings that do not provide incentives for auditors to deliver high audit quality and curb management’s earnings management practices, family dominance of firms is one such setting to research this objective. Therefore, we examine the role of Big 4 auditors in the presence of family dominance of firms and test whether Big 4 auditors moderate the relationship between family firms’ dominance and earnings management. This could be one of the reasons why external auditors are less effective in Pakistan.
Our results reveal that there are no significant differences in the earnings management activities of Big 4 and non-Big 4 auditors’ clients, as both the Big 4 and non-Big 4 auditors have weaker incentives to prevent earnings management activities (
Tsipouridou and Spathis 2012). Audit opinion qualification is not issued in response to the earnings management activities of the firm. Further, we find that earnings management is pervasive in family-dominated firms, and Big 4 auditors do not moderate the positive relationship between family ownership and earnings management.
The findings of this study can be useful for investors as well as policy makers and regulators. The Government of Pakistan is trying to attract foreign direct investment, as it believes that foreign direct and indirect investment can help them overcome energy crisis which has plagued the economy for the past few years. Further, the Government is following the policy of privatization of state owned enterprises and liberalization of economy, also targeting foreign investors for disinvestment of sick industrial units and enterprises (
Ayyub 2014). Investors who intend to enter the Pakistani market should be aware of the relationship between auditor report and earnings management as investors rely on the auditor’s report to make conclusion about financial reporting quality.
This study contributes to the literature as the relationship between earnings management and auditing has not been studied in Pakistan in the past, to the best of our knowledge, and the results drawn from United States and other developed countries may not be relevant because of the differences in economic and institutional environment such as level of investor protection, regulatory quality, legal enforcement and ownership structure. We also study the relationship between family firm ownership and earnings management. Further, we examine the monitoring role of Big 4 auditors in the presence of influential family ownership and highlight family dominance of firms as one of the reasons for ineffectiveness of Big 4 auditors in Pakistani market.
The remainder of the paper is organized as follows.
Section 2 provides an overview of institutional environment in Pakistan.
Section 3 discusses related literature and hypotheses of our study. In
Section 4, data and sample selection is discussed.
Section 5 provides the research design and methodology. Empirical results are discussed in
Section 6.
Section 7 presents robustness results, while
Section 8 concludes the paper and provides avenues for future research.
2. Institutional Environment in Pakistan
Pakistan is a common law country, having adopted International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) after their promulgation. Researchers argue that although Pakistan is a common law country, it exhibits characteristics of code law countries, having a weak equity market, reliance on banks and financial institutions for debt financing, concentrated ownership dominated by family business groups, and a generally observed low quality of accounting and disclosure practices (
Ashraf and Ghani 2005;
Baig 1997).Financial reporting quality cannot be achieved without the presence of effective enforcement mechanisms which include investor protection mechanisms, efficiency of legal system, protection of minority shareholders, and insider trading laws (
Hope 2003). Enforcement mechanisms are generally considered to be weak in Pakistan. In the absence of robust enforcement mechanisms, accounting standards cannot achieve their desired objective of producing transparent and reliable financial statements. Further, absence of effective enforcement mechanisms along with judicial inefficiency lowers the demand for high quality auditing in Pakistan.
Efforts have been made over time to improve the regulatory framework, including the promulgation of the Securities & Exchange Ordinance of 1969. Corporate Law was established in 1981 which was restructured as the Securities & Exchange Commission of Pakistan (SECP) in 1999 under the Securities and Exchange Commission of Pakistan Act 1997. SECP has the mandate to regulate the corporate sector and the capital market. The Companies Act of 1913, which was adopted from colonial India, was replaced with the Companies Ordinance of 1984. Section 234 of the Companies Ordinance, 1984 requires all listed companies to present their financial statements in accordance with the requirements of International Accounting Standards and International Financial Reporting Standards (IFRS).
The Code of Corporate Governance was issued in 2002, and requires companies to provide a statement that they are complying with IFRS applicable in Pakistan for the presentation of financial statements. The code also requires firms to design, implement and monitor a system of internal control and provide information about this fact. The Code of Corporate Governance also increased disclosure requirements for firms, and they are required to provide a statement of compliance with the code of corporate governance. All of these reforms were aimed at ensuring that Pakistani companies comply with international best practices (
Ashraf and Ghani 2005).
The auditing profession in Pakistan is self-regulated. The Institute of Chartered Accountants of Pakistan (ICAP) was established under the Chartered Accountants Ordinance (1961). ICAP has instituted a Quality Control Review Program (QCR) to ensure the quality of audits performed and auditors of listed firms are required to achieve a satisfactory QCR rating. The review is conducted on a sample basis, and the reviewers conduct reviews of only two audit engagements of selected firms. In this scenario, auditors may not believe that they have a probability of being caught for providing low-quality audits. Even if they are caught, penalties or sanctions are not stern enough to cause auditors to provide high quality audits. Big 4 accounting firms, like in other South Asian countries, do not operate directly under their brand name; rather, they operate under the name of local affiliates. This practice also reduces the incentives to protect brand name reputation by providing high-quality audits.
Family ownership is another distinctive feature of business organization in Pakistan, where ownership is highly concentrated and closely held in the form of influential business groups. Generally, family members are also board members and occupy positions as chairperson and chief executive officer (CEO) and are directly involved in the management of the firm. In case of business groups, some family members who are executives in one company may be working as non-executive or independent directors in another firm of the same group. This leads to the creation of a nexus that can potentially cause serious threats to the independence of auditors in family-dominated environments (
Ashraf and Ghani 2005). Managers also communicate information regarding financial performance directly to family owners reducing reliance on financial statements.
Banks are a major source of financing in such economic and institutional environment. Banks also develop direct relationships with firms, and they can obtain all information directly and may not rely on published financial statements. Information asymmetries are resolved through private channels, which reduce the stakeholders’ demands for high-quality auditing. In Pakistan, business decisions are also influenced by personal relationships, like family ties, etc. Auditors who are selected on the basis of personal relationships may also not object to the firm’s earnings management practices. Overall, enforcement mechanisms are weak, and sanctions and penalties are not harsh enough to cause the auditors to provide high-quality audits.
3. Literature Review and Hypothesis Formulation
Agency theory posits that monitoring mechanisms are assumed to align the interests of managers and shareholders and remove the conflict of interest inherent in the corporate form of organization and the manager’s opportunistic behavior (
Alzoubi 2016). Auditing function is one such monitoring mechanism that aligns the interests of managers and shareholders, restricts managers’ opportunistic behavior with regard to earnings management, and decreases information asymmetry among managers and shareholders (
Arens et al. 2012).
However, research that demonstrates that Big 4 auditors provide better-quality audits than non-Big 4 auditors has mostly been carried out in the United States and other countries where auditors face a high litigation risk from shareholders if they provide a lower quality of auditing. Recent evidence suggests that differences in audit quality between Big 4 and non-Big 4 auditors are due to client characteristics, especially size (
Lawrence et al. 2011).
Ajona et al. (
2008) argue that Big 4 auditors behave differently with regards to earnings management in different countries and it varies systematically with differences in economic environment and individual institutional settings. Chen, Chen, Lobo, and Wang (
Chen et al. 2011) investigated the effect of audit quality on earnings management and cost of equity capital for Chinese listed firms. They found a significantly lower level of earnings management for non-state-owned enterprises (NSOEs) audited by Top 8 auditors than for state owned enterprises (SOEs) audited by Top 8 auditors. Top 8 auditors also behave differently in reducing earnings management between NSOEs and SOEs. They argue that the asymmetric effects of audit quality on earnings management between SOEs and NSOEs are due to differences in ownership structures, agency problems and different managerial incentives to mediate in the financial reporting process.
Big 4 auditors will enforce higher earnings quality and greater conservatism on financial statements of clients in response to stringent investor protection establishments, including the ability of stakeholders to initiate legal proceedings against the auditors for negligence and strong regulatory actions to discipline auditors for delinquency (
Francis 2004;
Francis and Wang 2008). Research in countries like Belgium, France, Greece, Korea, Malaysia and Turkey provides evidence that there is no significant difference in levels of discretionary accruals of Big 4 and non-Big 4 audited firms (
Bauwhede and Willekens 2004;
Ching et al. 2015;
Jeong and Rho 2004;
Othman and Zeghal 2006;
Tsipouridou and Spathis 2012;
Yasar 2013).
Ching et al. (
2015) studied the effect of audit quality on earnings management practices and financial performance for Malaysian firms and their findings are that audit quality does not restrict earnings management activities. They argue that this is due to the differences in the audit environment that are significantly different from developed countries.
Persakis and Iatridis (
2016) investigated the joint effect of audit quality and investor protection on earnings management for an international sample of countries. Their findings are that audit quality is positively associated with investor protection, and audit quality is higher for firms with stronger investor protection and legal enforcement among all clusters of countries. Audit quality has a positive relation with earnings quality, but earnings quality is higher in countries with stronger investor protection, implying the relative significance of stronger investor protection and legal enforcement in establishing higher audit and earnings quality. Therefore, achievement of higher audit and earnings quality is contingent upon establishment of strong enforcement mechanisms, corporate governance rules, regulatory environment and legal enforcement (
Garrouch et al. 2014). In the absence of legal enforcement and strong investor protection, mere adoption of accounting standards cannot achieve higher audit and earnings quality (
Alzoubi 2016;
Garrouch et al. 2014;
Pelucio-Grecco et al. 2014).
In Pakistan, litigation risk by stakeholders is virtually nonexistent for auditors, where there has never been a legal case against the auditors (
Ashraf and Ghani 2005). Over time, the legal and judicial systems have remained inefficient and require a series of reforms for the protection of minority investors’ rights. Pakistan’s scores for regulatory quality, rule of law and control of corruption in World Governance Indicators Report for 2015 were −0.62, −0.79 and −0.76, respectively. Pakistan also ranks among the bottom twenty-five percentile ranks among all countries. Auditors do not believe that they will be subject to legal action by shareholders. Even if a legal suit is filed by the shareholders against the auditors, it will take years to complete legal proceedings and the penalties or sanctions will be minimal. Further, enforcement mechanisms are not effective at disciplining auditors. Auditors are rarely penalized for low-quality audits and they do not believe that they have a chance of getting caught by regulators for providing low-quality audits (
Jeong and Rho 2004).
Research has also pointed out that those firms which require greater monitoring due to higher information asymmetry between shareholders and managers would demand higher-quality audits (
Defond 1992). Information asymmetries can be resolved through private channels (
Filatotchev et al. 2011) if the reliance on the equity market is lower, thus lowering the demand for high-quality auditing. Previous research on earnings management in Pakistan has focused on the relation between earnings management and corporate governance mechanisms (
Shah 2014) and the finding is that majority shareholders expropriate the interests of minority shareholders and alter financial statements for their vested interests.
Afza and Nazir (
2014) investigated the effect of audit committee characteristics on firm value and found that audit committee size and the quality of external audit have significant positive impacts on firm value. Apart from that, the relationship between audit quality and earnings management and the impact of family firm dominance on earnings management has generally been neglected, to the best of our knowledge, which further established the need to carry out this research.
Businesses in Pakistan are mostly owned by family business groups which are very influential.
Ashraf and Ghani (
2005) quoted an associate of a Big 4 audit firm, “It is very difficult to stand against the aspirations of management, if they own more than seventy percent of voting rights”. Economic bonding, according to L. E.
DeAngelo (
1981), provides incentives to auditors to report favorably and obtain more revenues especially if the client is large and all firms in the business groups are being audited by the same auditors. Big 4 audit firms also do not operate under their international brand name in Pakistan; rather, they operate under the names of local affiliates in Pakistan. This also reduces the incentives for Big 4 auditors to protect their brand name and reputation by providing high quality audits. Thus, it is difficult for auditors to remain objective and independent in a relationship-based economy (
Jeong and Rho 2004) when institutional settings do not provide incentives for auditors to deliver a high-quality audit. Thus, we hypothesize that;
Hypothesis 1. Given the institutional environment in Pakistan, there is no significant difference between earnings management activities of firms audited by Big 4 and non-Big 4 auditors.
As another measure of audit quality, we examine whether the audit report (Unqualified vs. Qualified) is issued in response to the earnings management activities employed by firms. One stream of research posits that qualified reports are positively associated with level of discretionary accruals (
Bartov et al. 2000;
Francis and Krishnan 1999), while others found no evidence of the association between discretionary accruals and qualified reports (
Tsipouridou and Spathis 2012). Similarly,
Tsipouridou and Spathis (
2014) investigated the association between qualified audit opinions and earnings management and found that audit opinions and earnings management have no relation. Rather, firm characteristics such as size and profitability are important drivers of going concern audit opinion. This means that there is no unanimity among researchers that firms receiving qualified audit opinions are managing earnings more than those receiving unqualified audit opinions (
Butler et al. 2004).
Butler et al. (
2004) argue that auditors discuss with their clients any material misstatements in financial statements and any deviation from accounting standards, and negotiate with the management to make relevant adjustments. High-quality auditors are those who are able to detect material misstatements and get them corrected before issuance of audit reports. Therefore, lower earnings management activities will be expected, and the auditors will issue an unqualified audit opinion.
However, in Pakistan, the incentives of auditors are different from in other developed markets, as outlined in the previous hypothesis. These include financial incentives to obtain greater revenues from large clients and their inability to withstand pressure from the management in case of concentrated ownership in form of influential business groups. Second, auditors in Pakistan do not face the same litigation risk experienced by auditors in developed countries, because of poor legal enforcement. Therefore, auditors may not be able to convince management to make relevant adjustments in financial statements. In that scenario, they have two options; either to issue an unqualified audit opinion and absolve the management from material misstatements in financial statements and deviation from accounting standards or issue a qualified audit opinion. In the latter case, auditors have the further option to issue a qualified audit opinion that does not affect the overall audit opinion as an alternative to issuing a sterner qualified audit opinion that does affect the overall audit opinion. In this way, auditors are able to issue a qualified opinion as well as avoid the risk of losing their influential clients and revenues. Thus, our second hypothesis is;
Hypothesis 2. Given auditors’ incentives in Pakistan, the audit opinion (unqualified vs. qualified) is not issued in response to the earnings management activities employed by firms.
Fan and Wong (
2005) find that in East Asian markets, high-quality auditors play a monitoring role, and firms with higher agency conflicts hire high-quality auditors.
Chen et al. (
2011) provide evidence that governance role of high-quality auditors are limited and varies with SOEs and NSOEs in China. This is largely due to the fact state-owned enterprises and non-state-owned enterprises have different ownership structures, agency issues and managerial incentives. We exploit family domination of firms as one such setting to examine the monitoring role of auditors in Pakistan, where ownership structures, agency problems and managerial incentives to mediate in the financial reporting are different from non-family-dominated firms.
There is mixed evidence on the impact of family control on earnings management in the accounting literature. There is one stream of research which provides evidence that family firms are more likely to provide higher earnings quality because family owners have a long-term investment horizon, reputational concerns, and are able to monitor managers better (
Prencipe and Bar-Yosef 2011;
Tong 2007;
Wang 2006). Another stream of research posits that family firms are more likely to engage in earnings management practices because of concentrated ownership, which gives rise to the expropriation of wealth by controlling shareholders at the expense of minority shareholders (
Chi et al. 2015;
Fan and Wong 2002).
In Pakistan, ownership is highly concentrated and firms are mostly controlled by influential family business groups (
Ashraf and Ghani 2005;
Mirza and Azfa 2010). The presence of family members on the board, lower demand for high-quality financial reporting because of a less developed capital market, concentrated ownership and weaker investor protection lend support to the argument that family firms may engage in earnings management practices. Information asymmetries can be resolved through private channels and managers convey financial information directly to family owners. Banks and financial institutions, which are major source of financing, can also obtain information directly establishing close tie with family firms and reliance on published financial statements is lower, thus reducing the incentives for auditors to provide high-quality audits.
External auditors are expected to play a monitoring role to ensure the quality of financial reporting by curbing manager’s opportunistic behavior. In Pakistan, it is difficult for external auditors to stand against the aspirations of influential family groups (
Ashraf and Ghani 2005). Family members also sit on the board and occupy the influential positions of chairperson or CEOs and involved in the management of the firm. Family members who are executive directors in one firm may work as nonexecutive or independent directors in another company of the same business group. This leads to the creation of a nexus that can undermine the independence and objective of external auditors in family dominated firms. In the case of family groups, thus, it is expected that auditors will fail to perform a monitoring role and constrains earnings management practices in family-dominated firms. We expect that if the audit quality is the same for both types of auditors (Big 4 vs. Non Big 4), there should be no differentiation in their monitoring role in family firms. Thus, we test these related hypotheses;
Hypothesis 3. In Pakistan, there is a positive association between family firm’s dominance and the level of earnings management.
Hypothesis 4. The presence of Big 4 auditors does not moderate the relation between family firm dominance and earnings management.
8. Discussion and Conclusions
This study examined the role of auditors in monitoring managers’ earnings management practices after the adoption of IFRS in the period from 2009 to 2013. Further, we investigated earnings management practices in family-controlled firms and the monitoring role of Big 4 auditors in the presence of controlling family ownership. As a proxy for earnings management, we used discretionary accruals estimated by modified Jones P. M.
Dechow et al. (
1995) and
Kothari et al. (
2005) model, and as a measure for audit quality, we used audit firm size (Big 4 vs. non-Big 4) and audit opinion type (unqualified vs. qualified).
Empirical evidence shows that there is statistically no significant difference between discretionary accruals of firms audited by Big4 and non-Big4 auditors in the context of Pakistan, where institutional settings do not provide incentives to auditors to deliver high quality and constrain manager’s opportunistic behavior. Economic bonding of auditors with their clients leads them to behave opportunistically and undermine their independence and objectivity. A small audit market, weaker investor protection laws, ineffective enforcement mechanisms to discipline auditors combined with minimal litigation risk leads them to lower audit quality and pursue revenue seeking behavior. As for audit opinion, audit qualification is not issued in response to the level of discretionary accruals employed by firms. Audit qualification is also not explained by a firm’s financial characteristics. Earnings management is pervasive in family-controlled firms and Big 4 auditors are ineffective in constraining earnings management in the presence of family-controlling ownership. This probably explains the reasons for insignificant difference in audit quality between Big 4 and non-Big 4 auditors. Big 4 auditors are unable to exert their independence and objectivity in the presence of influential family ownership. Economic bonding of auditors coupled with poor enforcement mechanisms and investor protection undermine their independence.
This study has implications for policy makers and practitioners, suggesting that the reliabilty of financial statements cannot merely be achieved by hiring Big 4 auditors. Regulators and policy makers should be mindful of the fact that earnings management still exists despite implementation of IFRS, and auditors may not be able to curb earnings management behavior. Each country has its own institutional environment and distinctive characteristics that need to be taken into account for integration of financial reporting and auditing standards (
Tsipouridou and Spathis 2012). Regulators have to strengthen enforcement mechanisms and develop rules and regulations that constrain earnings management behavior of firms and provide incentives to auditors to deliver higher quality.
Despite the adoption of IFRS, financial reporting quality has not improved and peculiar economic and institutional environment of Pakistan has an effect on auditor independence and objectivity in determining financial reporting quality. Our resullts are peculiar to economic and institutional environment of Pakistan and cannot be generalized to other settings. The limitation of this study is that the models for estimation of discretionary accruals have been subject to criticism for providing unreliable estimates and researchers are still not in consensus on any one particular model (
Stubben 2010). Second, using audit firm size as a measure for audit quality also has its limitiations, as it is unlikely that all Big 4 and non-Big 4 auditors will offer the same level of audit quality across different time periods. Future research could focus on non-audit services provided by auditors, and the bearing they could have on auditors’ indepence and objectivity in determining financial reporting quality in presence of influential family business groups.