The relationship between internal corporate governance mechanisms and the quality of external audit process - empirical evidence from Jordan

Abstract

Due to prevalent corporate scandals and audit failures around the world in the recent years, there has been a renewed interest in the relationship between Internal Corporate Governance Mechanisms (ICGM) and External Audit Quality (EAQ). This research seeks to investigate important and recent interrelated issues; specifically, the main aim of this research is to examine empirically the relationship between ICGM and EAQ. Empirical findings prior to this study are inconclusive and not comprehensive enough to address different aspects ICGM in terms of its effect on EAQ. Hence, this research extends the scope of previous empirical studies and fills the research gaps by offering empirical evidence relevant to the debate about how these mechanisms can influence EAQ in Jordan. This is essential, as the Jordanian regulations and international auditing standards highlighted the importance of these mechanisms for the external audit process such as JCGC and ISA. In order to achieve the set objectives, this research adopts mixed-methodology “sequential explanatory design”, which consists of two main phases through collecting data regarding the board of director responsibilities and characteristics, internal audit factors, audit committee responsibilities and external audit quality attributes. The first phase was a quantitative study in the form of survey questionnaire. Subsequently, follow–up semi-structured interviews were employed in order to get detail views of the external auditors to explain and clarify how the early quantitative findings are occurring as well as offer a better understanding of the study relationships. Adopting this research design (mixed methods) was mainly as a response to the recent calls as there is a lack of this kind of study that investigate the relationship between the ICGM and EAQ. This research focuses on the perception/insight of the Jordanian external auditors regarding the influence of ICGM on EAQ. Thus, this study uses a sample of 206 Jordanian external auditors for the survey and 13 participants from this sample for the interview. The results of the research aim to offer a better understanding concerning the relationships between ICGM and EAQ and what are the governance mechanisms that can influence some aspects of EAQ. The descriptive and regression findings illustrate that work performance of internal audit and audit committee as well as independence of internal auditor are the most vital monitoring factors. They have significant influence on some aspects of the EAQ. With a response rate of 66%, the majority of the Jordanian external auditors agree with the importance of the role of the board of director responsibilities in terms improving some aspects of EAQ. Moreover, the auditor perceived that audit committee plays vital role in enhancing the quality of audit process and the quality of financial reporting process especially its role in terms of reviewing and approving the company’s financial reports and auditor’s report. Further, the qualitative stage employed the thematic analysis to analyse the interview data. The interview results highlighted that there are different ways and stages that the ICGMs can influence the EAQ, for example, through holding effective regular meeting, ensuring the auditor compliance with the audit requirements “regular monitoring”, discussing the initial and significant audit results “draft of discussion”, taking necessary follow-up actions “feedback” as well as requesting the auditor to conduct additional tests which can in turn enhance the EAQ. The results also suggest that ICGM can assist improving different aspects of EAQ such as the quality of the evidence that are collected by the ICGM and the valuable guidance from the ICGM to the external auditor. The communication between the ICGM and external auditor can be focused on different issues related to the audit process such as auditors’ findings, the effectiveness of internal control, scope limitations and material misstatements which allow improving the effectiveness of audit process. This indicates that, the auditor must be aware of the dynamic deciding of the role of particular mechanisms in improving the external audit process. Moreover, the results have implications for the practitioners and regulators who are assessing the role of ICGM in improving the reliability of the financial report and auditor’s report. The empirical findings demonstrate that different ICGM can influence different aspects of the EAQ. More importantly, the results reveal that audit practice in Jordan is experiencing some difficulties in terms of the independence of the auditor especially, for the small local firms and providing non-audit service. In addition, there is no professional body for board of director; internal audit and audit committee like Jordanian association of certified public accountant (JACPA) for the external auditor, thus, responsibility of the bodies need to be formally overseen by a higher authority. For the policymakers, this study offers a unique proposition to improve the effectiveness of the ICGM to achieve EAQ. These empirical findings of this study also highlight the importance of improving EAQ as a solution for the agency problems through reducing information asymmetry, improving the disclosure practice, level of confidence and assurance of the financial reporting as well as deterring the opportunistic behaviour from different parties. Key Terms: External Audit Quality, Internal Audit, Corporate Governance, Board of Director, Audit Committee.