Auditor selection, client firm characteristics, and corporate governance: evidence from an emerging market

This study investigates the relationship between auditor selection, client firm characteristics, and corporate governance measures for firms listed in the ISE for the years 1999- 20042. The argument that varying levels of audit quality are demanded by companies with different firm characteristics constitutes the basis for our research. The paper focuses on determining the degree of association between the client firms’ choice of external auditors and the following client firm characteristics: percentage of shares held by foreign investors, percentage of shares open to the public (the float), membership in the finance industry, leverage, size, return on assets, and the market-to-book ratio. In addition, the effect of the client firms’ levels of Transparency and Disclosure (T&D) and compliance with local Corporate Governance Principles on the auditor selection process is also investigated.3 Whether the Big-Five4, second tier, and local audit firms are perceived as distinct groups in terms of credibility in the eyes of ISE firms is analyzed. We find that client firm size, level of shareholdings by foreign shareholders, and membership in the finance sector are the firm-specific variables that are positively and significantly associated with the choice of a Big-Five versus the other two types of auditors. This finding is consistent with the findings of extant auditor choice literature in both developed markets and in the emerging market of Athens Stock Exchange. Like Citron and Manalis (2000), we posit and find the positive relationship between foreign shareholding status and the selection of a Big Five auditor is an indication of the role of the Big-Five in providing audit credibility in the eyes of international investors. However, contrary to our expectation that agency costs will be mitigated by widespread public ownership, we find a significant negative association between the level of public shareholdings and selection of a Big-Five auditor. This might be a peculiar finding in the ISE where the managers, in serving the interests of majority family owners, may opt for the non-Big-Five that are more likely to allow managers to use discretionary, if not unethical, accounting methods that would expropriate wealth from minority shareholders and other stakeholders as we have seen in the case of bankrupt family banks. We also find that, although the Big-Five auditors’ clients are more profitable than the other types of auditors’ clients, the association is not a significant one. This might be a result of the downturn of the Turkish economy in 1998 and in 2001 that have negatively affected the profitability of all ISE companies. We expect the results of this study to be useful for auditors, their clients and the regulators that have an oversight function over both.