How Household Ownership Controls The Affiliation Among Auditors Team’s Economic Knowledge And Incomes’ Management?

Literature Review

The auditors’ team is among the key components in the company’s governance structure that helps to monitor and control the management (Arun, Almahrog, & Aribi, 2015). Experts consider the auditors’ team as the board of managements’ sub-committee that enables the official communication among the external auditor, the internal monitoring system, and the board. In addition, the experts consider the auditors’ team as the most essential sub-committee of any firm’s management board. According to Ugrin, Odom, and Ott (2014), the auditors’ team guards the business’s financial integrity and can enhance the financial reporting quality through reviews of the financial reports as they represent the board (Azeez, 2015). 

The regulators have become interested to know the efficiency of the auditors’ team in monitoring the financial reporting of companies while responding to the key accounting scandals in America. According to Chen and Komal (2018), among the important developments meant to enhance the efficiency of the quality of auditors’ team concentrates on the auditors’ team members’ economic knowledge, with several studies declaring that the auditors’ team financial expertise (ATEK) is among the essential factors in auditors’ team’s efficiency. Chen and Komal asserts that, in 1999, there was a recommendation from the BRC that all the auditors’ team members ought to be financially knowledgeable with an accounting or associated knowledge of financial management. In addition, the Sarbanes-Oxley Act (2002) requires that the auditors’ team should have a member who is a professional in finance. Furthermore, earlier research works assert that the auditors’ team members’ economic knowledge plays a critical part in limiting the incomes’ management practices. According to Zalata, Tauringana, and Tingbani (2018), many countries now require some auditors’ team members to possess the economic knowledge.

Earlier research works show that the styles of ownership differ considerably across the nations especially the Asian countries with many publicly traded companies concentrating and mainly regulated a few people and relatives (Holderness, 2017). According to Leung, Richardson, and Jaggi (2014), it is evident that agency problems among the shareholders who are both majority and minority may dominate the companies that families control, hence, have a great motivation to steal the firms’ properties as they seek individual interests by sacrificing the minority investors.

Consequently, involving the companies’ governance instruments such as the auditors’ team economic know-how (ATEK) to offer the optimum monitoring is required such that to reduce the agency problems arising in the companies families control and lessen the EM practices in order to safeguard the wealth of the minority stockholders from being stolen.

The current study’s findings will add value to the prevailing works, since, several Arab businesses are those that the families own and control. Therefore, various nations that have exclusive characteristics of the ownership concentration, legal environment, and household dealings can use the results of this study (Martin, Campbell, & Gomez-Mejia 2016). Additionally, the current research adds to the literature by offering the understanding and new insights to examine the affiliation among the auditors’ team financial expertise (ATEK) and EM that the families’ ownership control (FOC) influences in the context of Jordan.

Effect of FOC on the Affiliation among the ATEK and EM

The current study is organized in numerous sections as follows: literature review and hypothesis development on ATEK, FOC, and EM. Then, follows the methodology and sample data. Lastly, a summary and discussion of the results and discussion, and conclusions.

According to Lin, Hutchinson, and Percy (2015), the auditors’ team’s major duty is overseeing the companies’ procedures of auditing and financial reporting and, therefore, the members ought to have adequate know-how in order to comprehend the matters that the auditors’ teams discuss or investigate. Numerous research works have found positive affiliation among the efficiency of the auditors’ teams and the economic knowledge of the members especially their abilities to make sure that there is a good quality procedure of financial reporting and complying with the associated guidelines. Earlier studies have offered sufficient proof of the significance of the auditors’ team economic know-how in limiting the EM practices. According to Gaynor, Kelton, Mercer, and Yohn (2016), the economic knowledge of the auditors’ teams improves the probability to detect the material misstatements, which the auditors’ team gets informed about and is corrections done in time. Abbott, Daugherty, Parker, and Peters (2016) assert that the number of the members of the auditors’ team who have the accounting knowledge is positively related to the financial reporting quality of enhancing the financial reports’ value. In addition, Gonzalez and Garcia-Meca (2014) assert that the EM is minimized with the members of the auditors’ team that include a member or more who have the experience in financial or corporate issues. Sun, Lan, and Liu (2014) found out that corporations with auditors’ team members that are famous for having the competence, experience, and economic knowledge rarely practice the EM as likened to other Malaysian businesses. Soliman and Ragab (2014), found similar findings Egyptian firms while Elijah and Ayemere (2015) found similar results in Nigerian companies. Furthermore, Kankanamge (2016), found similar findings in Sri Lanka while Zalata et al. (2018) found the same in America.

The experimental evidence and the regulatory concern in Jordan recommended that to enhance the auditors’ team’s decisions and performance requires the possession of the appropriate know-how and understanding, largely in auditing and accounting. The Jordanian Corporate Governance Code of 2009 (JCGC) calls for all the auditors’ teams to hire one or more auditors’ team members with the appropriate and current financial know-how. As a result, the auditors’ teams, which have high financial know-how degrees are most likely to limit EM in Jordan. According to Hamdan, Mushtaha, and Al-Sartawi (2013) the auditors’ team financial expertise, which is among other features of the auditors’ teams of the companies that are registered with the ASE, limits the EM practices to enhance the reported earnings’ quality.

Abdullah, Percy, and Stewart (2015), assert that in spite of the evidence of the efficiency of the auditors’ team financial expertise in discouraging the EM practices, earlier studies submit that the kind of ownership structure greatly affects the company’s governance mechanisms’ efficiency. Abdullatif, Ghanayem, Amin, Al-Shelleh, and Sharaiha (2015) findings confirmed the same suggestions where the household ownership in Jordan dominates, hence, restricting the auditors’ teams to do their responsibilities.

Ndofor, Wesley, and Priem (2015) asserts that the agency problems in companies are influential EM practices’ sources mostly in the developing marketplaces, which have highly concentrated ownership. In such markets, the agency conflict is normally among the conflicting interests of the minority and controlling stockholders instead of the problem being among the company owners and the executives in the ownership situations, which are dispersed. Nevertheless, the agency conflicts are very severe in the companies owned by families because the owners might have both the capability and a motivation to get individual benefits meant for the minority stockholders, hence, increasing the level of the EM practices. Therefore, although there is an agreement that concerns the efficiency of the auditors’ team financial expertise in limiting the EM practices, FOC might influence the efficacy of the auditors’ team in the sense that the auditors’ team might become not fully efficient in alleviating the EM.

According to Saleem Salem Alzoubi (2016), there is no study that has evaluated the influence of the including FOC on the relationship among the auditors’ team financial expertise and EM. Therefore, the current study presents FOC, which is the moderator variable on the affiliation among the auditors’ team financial expertise and EM in Jordan. The research chooses Jordan because the ownership of the controlling family is extensive and the law is feeble at protecting the minority stockholders. Hence, the current study comes up with the hypothesis below in order to test this anticipation:

H₂: FOC deteriorates the affiliation among the auditors’ team economic know-how and the EM.

The sample comprises every manufacturing company that is registered with the ASE. According to Saleem Salem Alzoubi (2016), ownership of families is more in the industrial and financial organizations. The current study does not include the financial corporations in the sample, since, there are variances in the regulatory requirements. 68 organizations were registered with the ASE by 31^st December, 2016. The researcher gathered information from all of the 68 companies between 2012 and 2016 making a period of 5 years.

The researcher obtained both the financial and non-financial data from the ASE’s website www.ase.com.jo. The site contains the yearly financial statements of the manufacturing listed companies in Jordan. The annual financial accounts for 3 organizations could not be obtained because they were registered with the ASE after 2012. Other 5 businesses were delisted along the period of study. Therefore, a list-wise removal of cases that missed the values led to the ultimate sample that comprised 300 firm-year observations of 60 organizations.

The present study utilized two models of regression to help in testing the hypothesis as follows. The researcher started by assessing the affiliation among the auditors’ team economic know-how (ATEK) and EM in model 1. Then the researcher used model 2 to evaluate the influence of FOC on the affiliation among the EM and ATEK by including an interaction term among the FOC and the ATEK.

Model (1):  ADA_it = a₀ + β₁ ATEK_it + β₂SIZ_it + β₃LV_it + β₄GRO_it + ε_it

Model (2):  ADA_it = a₀ + β₁ ATEK_it + β₂SIZ_it + β₃LV_it + β₄GRO_it + β₅FOC_it + β₆ ATEK_it * FOC_it + ε_it

Table 1 below presents the summary of the formulas’ variables defined.

Table 1: The Variables’ Measurements

Variables	Symbol	Measurement
Dependent Variable:
Incomes’ management	ADA	The optional accruals that Kothari et al. (2005) model predicted.
Independent variables:
Auditors’ Team Economic Know-how	ATEK	The ratio of the members of the auditors’ team who have financial know-how to the total members.
Control variables:
Firm size	SIZ	The assets natural logarithm
Firm leverage	LV	Liabilities scaled by the assets.
Firm Growth	GRO	The variation in the assets scaled by the total assets, which lag.
Moderator variable:
Family ownership control	FOC	The ratio of the members of the family to the managers on the board.

Following earlier research works, the current study used the optional accruals to substitute the EM. Several earlier research works use the Kothari et al. (2005) model, since, the model demonstrated using various statistical assessments that the optional accruals model, which is performance-matched remains vigorous to identify the EM. The model is shown below:

TAC_it⁄TA_it = α (1⁄TA_it–₁) + β₁( (?REV_it ? ?REC_it)⁄TA_it–₁) + β₂ (PPE_it⁄TA_it–₁)

  + β₃ ROA_it–₁+ ?_it                         

Where,

TAC_it = the entire firm’s accruals.

TA_it-1 = the entire assets for year t-1.

?REV_it = the variation in the firm’s incomes.

?REC = the variation in the firm i’s debtors for year t from year t-1

PPE_it = the company’s property, plant and equipment

ROA_it-1 = the company’s return on assets in year t-1.

α β₁ β₂ β₃ = Estimated parameters.

?_it = The residual.

The independent variables comprise FOC, the moderate variable and the interaction term among ATEK and FOC, and ATEK, which is a predictor variable. According to Basu, Krishnan, Lee, and Zhang (2017), ATEK is the ratio of the members of the auditors’ team who have financial know-how to the total members. The accounting and financial know-how is necessary to the members of the auditors’ team because the key task of the members is to make sure that there is honesty in financial reporting.

Zattoni, Gnan, and Huse (2015), asserts that the FOC is the ratio of the members of the family to the managers on the board. Previous research works such as the Leung, et al. (2014) and Idris, Siam, and Nassar (2018a) have discovered that FOC has a moderating influence on the affiliation among the auditors’ team’s independence, board’s independence, and the EM.

According to Leung, et al. (2014) and Idris et al. (2018a), to identify the moderator influence, experts multiply the FOC (moderator variable) with the ATEK (predictor variable) to get the interaction variable (ATEK * FOC).

The researcher presents the descriptive statistics of the current study’s variables in Table 2 below. ADA’s mean is 0.214, and its minimum value is 0.006 while the maximum value is 0.596. ATEK’s mean is 39.2% showing that around 39.2% of the auditors’ teams in current study meet what the JCGC needs of possessing one or more financial professionals in the auditors’ teams’ membership. This result is consistent with the previous Jordan studies such as that of Hamdan et al. (2013) who asserts that ATEK’s mean of 40% in the manufacturing companies registered with ASE is the appropriate one. The ATEK’s minimum value of 0 shows that some organizations in the current research did not follow the rules. From the table 2 below, FOC varies from 0% to 100%, and its average value is 33.8% and standard deviation is 23.6%.

Table 2: Descriptive Statistics

Variable	Mean	Standard Deviation	Maximum	Minimum
ADA	0.214	0.083	0.596	0.006
ATEK	0.392	0.233	0.750	0.000
FOC	0.338	0.236	1.000	0.000
SIZ	7.217	0.485	8.103	5.860
LV	0.383	0.263	1.796	0.003
GRO	0.012	0.191	-0.541	1.143

Source: Authors (2018)

In addition, the table indicates the descriptive statistics for SIZ, LV, and GRO, which are the control variables that the researcher uses in the current study. From the table, SIZ’s mean is 7.217, which is consistent with the previous Jordan studies such as that of Idris, Siam, and Ahmad (2018b). The LV’s mean for the companies in the sample is 38%. This result is consistent with the previous studies such as that of Alnabsha, Abdou, Ntim, and Elamer (2018). who studied all manufacturing companies registered with the ASE. Lastly, the GRO ratio’s mean is 0.012 and its standard deviation is 0.191

Main Empirical Results

Table 3: Regression Analysis for the FOC, ATEK, and EM.

From table 3 above, the following signs correspond to their significance levels in the brackets ***(1%), **(5%) and *(10%). Table 1 above describes the details of the variables with the exception of ATEK * FOC, which is the interaction variable for the families’ ownership control and auditors’ team economic know-how.

From table 3 above, the results of the current study show a significant affiliation among the ATEK and EM although it is inverse. This relationship indicates that when the auditors’ team has a financial professional, he or she plays a vital duty of assuming the monitoring responsibility of the committee, hence, decreasing the EM practices. The result is consistent with the theory, which calls for all the auditors’ teams to hire one or more auditors’ team members with the appropriate and current financial know-how in order to monitor the financial reporting quality. This result is consistent with the previous studies such as that of Elijah and Ayemere (2015) who asserts that there is a negative affiliation among the EM and ATEK. Many studies consider ATEK as an important characteristic in the efficacy of the auditors’ team that reduces the incidence of EM (Badolato, Donelson, & Ege, 2014). Therefore, the JCGC requires the auditors’ teams to hire one or more auditors’ team members with the appropriate and current financial know-how in order to monitor the financial reporting quality.

In addition, the present study concentrates on the testing of the influence of FOC on the affiliation among the EM and ATEK. Table 3 above shows that the interaction among the EM and ATEK is positive and statistically significant. It means that the affiliation among the two variables weakens once there is an ownership of the controlling family in the organization. The result supports Abdullatif et al. (2015) study, which asserts that the auditors’ teams’ efficacy in stopping EM is low in Jordan where there is a lot of family businesses.

From this discussion, the findings show consistence with what the agency theory expects. The theory submits that companies that are under the control of families will not have high demand for efficient auditors’ teams like those not controlled by families. According to Alnabsha, et al. (2018), family businesses want to benefit at the expense of the minority stockholders, particularly in Jordan where there is a lot of family ownership and the law is feeble at protecting the minority stockholders.

Conclusion

The present research evaluates the influence of ATEK on EM on a sample of 44 manufacturing companies that are registered with the Amman Stock Exchange (ASE) from 2012 to 2016.  The study examines whether FOC has any effect on the affiliation among EM and ATEK. The findings show that ATEK is efficient at monitoring mechanism to decrease EM’s level. It means that when firms have financial professionals on the committee of audit, they alleviate the incomes’ management, hence, managers stop practicing EM to guard the stockholders’ interests. ATEK is not so efficient in the businesses that families control and the financial professionals on the committee of audit, cannot reduce EM practices effectively in those businesses. Therefore, ATEK’s role is not so effective in decreasing the EM when there is a lot of family ownership.

The limitations of the present research include focusing only on the manufacturing companies registered with the ASE and disregards the rest, hence, experts might not apply the results to the other industries. Additionally, the other variables, which might have an impact on EM were not evaluated in the present research such as the independence of the auditors’ team, and the organizational and foreign ownerships.

Policy makers and the regulators will find the current research findings important, particularly on the matters to do with the interaction among the EM practices and companies’ governance mechanisms. The findings will assist the policy makers and the regulators in making the necessary variations in order to enhance the decent companies’ governance practices, thus, try to limit the EM incidence in Jordan.

References

Abbott, L. J., Daugherty, B., Parker, S., & Peters, G. F. (2016). Internal Audit Quality and Financial Reporting Quality: The Joint Importance of Independence and Competence. Journal of Accounting Research, 54(1).

Abdullah, W. A. W., Percy, M., & Stewart, J. (2015). Determinants of Voluntary Corporate Governance Disclosure: Evidence from Islamic Banks in the Southeast Asian and the Gulf Cooperation Council Regions. Journal of Contemporary Accounting & Economics, 11(3).

Abdullatif, M., Ghanayem, H., Amin, R., Al-Shelleh, S., and Sharaiha, L. (2015). The Performance of Audit Committees in Jordanian Public Listed Companies. Corporate Ownership and Control, 13(1).

Alnabsha, A., Abdou, H. A., Ntim, C. G., & Elamer, A. A. (2018). Corporate Boards, Ownership Structures, and Corporate Disclosures: Evidence from a Developing Country. Journal of Applied Accounting Research, 19(1).

Arun, T. G., Almahrog, Y. E., & Aribi, Z. A. (2015). Female Directors and Earnings Management: Evidence from U.K Companies. International Review of Financial Analysis, 39.

Azeez, A. A. (2015). Corporate Governance and Firm Performance: Evidence from Sri Lanka. Journal of Finance, 3(1).

Badolato, P. G., Donelson, D. C., & Ege, M. (2014). Audit Committee Financial Expertise and Earnings Management: The Role of Status. Journal of Accounting and Economics, 58(2-3).

Basu, S., Krishnan, J., Lee, J. E., & Zhang, Y. (2017). Economic Determinants and Consequences of the Proactive Disclosure of Internal Control Weaknesses and Remediation Progress in IPO. Auditing: A Journal of Practice and Theory.

Chen, S., & Komal, B. (2018). Audit Committee Financial Expertise and Earnings Quality: A Meta-Analysis. Journal of Business Research, 84.

Elijah, A., & Ayemere, I. L. (2015). Audit Committee Attributes and Earnings Management: Evidence from Nigeria. International Journal of Business and Social Research, 5(4).

Gaynor, L. M., Kelton, A. S., Mercer, M., & Yohn, T. L. (2016). Understanding the Relation between Financial Reporting Quality and Audit Quality. Auditing: A Journal of Practice & Theory, 35(4).

Gonzalez, J. S., & Garcia-Meca, E. (2014). Does Corporate Governance Influence Earnings Management in Latin American Markets? Journal of Business Ethics, 121(3).

Hamdan, A. M. M., Mushtaha, S. M. S., and Al-Sartawi, A. A. M. (2013). The Audit Committee Characteristics and Earnings Quality: Evidence from Jordan. Australasian Accounting, Business and Finance Journal, 7(4).

Holderness, C. G. (2017). Culture and the Ownership Concentration of Public Corporations around the World. Journal of Corporate Finance, 44.

Idris, M., Siam, Y. A., and Nassar, M. (2018a). Board Independence, Earnings Management, and the Moderating Effect of Family Ownership in Jordan. Management & Marketing, 13(2).

Idris, M., Siam, Y. A., and Ahmad, A. (2018b). The Impact of External Auditor Size on the Relationship between Audit Committee Effectiveness and Earnings Management. Investment Management and Financial Innovations, 15(3).

Kankanamge, C. (2016). Relationship between Audit Committee Characteristics and Earnings Management in Sri Lanka (2013–2015): Sri Lanka Institute of Information Technology.

Leung, S., Richardson, G., & Jaggi, B. (2014). Corporate Board and Board Committee Independence, Firm Performance, and Family Ownership Concentration: An Analysis Based on Hong Kong Firms. Journal of Contemporary Accounting & Economics, 10(1).

Lin, T., Hutchinson, M., & Percy, M. (2015). Earnings Management and the Role of the Audit Committee: An Investigation of the Influence of Cross-Listing and Government Officials on the Audit Committee. Journal of Management & Governance, 19(1).

Martin, G., Campbell, J. T., & Gomez-Mejia, L. (2016). Family Control, Socioemotional Wealth, and Earnings Management in Publicly Traded Firms. Journal of Business Ethics, 133(3).

Ndofor, H. A., Wesley, C., & Priem, R. L. (2015). Providing CEOs with Opportunities to Cheat: The Effects of Complexity-Based Information Asymmetries on Financial Reporting Fraud. Journal of Management, 41(6).

Saleem Salem Alzoubi, E. (2016). Ownership Structure and Earnings Management: Evidence from Jordan. International Journal of Accounting & Information Management, 24(2).

Soliman, M. M., and Ragab, A. A. (2014). Audit Committee Effectiveness, Audit Quality and Earnings Management: An Empirical Study of the Listed Companies in Egypt. Research Journal of Finance and Accounting, 5(2).‏

Sun, J., Lan, G., & Liu, G. (2014). Independent Audit Committee Characteristics and Real Earnings Management. Managerial Auditing Journal, 29(2).

Ugrin, J. C., Odom, M. D., & Ott, R. L. (2014). Examining the Effects of Motive and Potential Detection on the Anticipation of Consequences for Financial Statement Fraud. Journal of Forensic & Investigative Accounting, 6(1).

Zalata, A. M., Tauringana, V., & Tingbani, I. (2018). Audit Committee Financial Expertise, Gender, and Earnings Management: Does Gender of the Financial Expert Matter? International Review of Financial Analysis, 55.

Zattoni, A., Gnan, L., & Huse, M. (2015). Does Family Involvement Influence Firm Performance? Exploring the Mediating Effects of Board Processes and Tasks. Journal of Management, 41(4).