Amsterdam Business School
Do female auditors demand a higher level of conservatism?
Evidence from companies listed on the London Stock Exchange
Name: Rutger Wijnker Student number: 10876308
Thesis supervisor: Dr. J.J.F. van Raak Date: 10 May 2016
Word count: 10.990
MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam
Statement of Originality
This document is written by student Rutger Wijnker who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.
The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
This study investigates the relation of both corporate governance and auditor gender on accounting conservatism. Supplementary this study also looks at the moderating effect of auditor gender on the relation between corporate governance and accounting conservatism. Two measures for conservatism are employed, one accrual-based measure and one market-based measure. Building on corporate governance and gender theories it is predicted that both a strong corporate governance structure and female audit engagement partners positively influence the level of accounting conservatism in companies. In addition to this, it is expected that female audit engagement partners positively influence the relation between corporate governance and accounting conservatism. To test these theories, a sample of companies from the London Stock Exchange for the years 2011 up to and including 2014 is being used. This study finds no evidence for a relation between corporate governance and accounting conservatism. A trend is found for a negative relation between auditor gender and accounting conservatism on the market-based measure, however statistical significance was not reached. The moderating effect of auditor gender on the relation between corporate governance and accounting conservatism has a positive influence on both the measures. The accrual-based measure suggests a positive trend, however not statistical significant, and the market-based measure finds a positive significant relation. Based on these results a clear conclusion about the direct effects of corporate governance and auditor gender was not found. However this study did find that female audit engagement partners positively influence the relation between corporate governance and accounting conservatism. This study has some limitations, corporate governance strength could not be measured in the same way as prior literature did due to unavailable data. Also, the sample consists out of companies with a premium listing on the London Stock exchange, this may cause an issue for generalizability to all the companies on the London Stock Exchange and this also limited the sample size causing a limited amount of female auditors in the sample. This study contributes to the growing literature on gender differences that affect audit judgements and decisions.
Contents
1 Introduction ... 5
2 Literature review ... 8
2.1 Accounting conservatism ... 8
2.2 The agency problem and Corporate governance ... 9
2.3 Gender of the Audit Engagement Partner ... 11
2.4 The London Stock Exchange Reporting Regulation ... 12
3 Research design ... 13
3.1 Sample ... 13
3.2 Research method ... 14
3.3 Proxies for the strength of the corporate governance structure ... 14
3.4 Proxies for accounting conservatism ... 15
3.5 Measurement models and control variables ... 16
4 Data ... 19
4.1 Descriptive statistics ... 19
4.2 Corporate governance, auditor gender and accounting conservatism ... 24
5 Conclusion ... 28
1 Introduction
This study examines the impact of the presence of a female or male audit engagement partner (i.e. auditor gender) on the relation of corporate governance and accounting conservatism. Accounting conservatism is an important aspect of the financial reporting as it can reduce exposure to litigation risk for managers and auditors and is associated with a lower likelihood of a firm’s future stock price crashes, which is interesting for investors (Kellogg, 1984; Kim and Zhang, 2013). Research has tried to link auditors to conservatism before but has primarily looked into auditor firm characteristics. Basu, Hwang and Jan (2001) suggest that firms being audited by Big 4 audit firms report more conservative earnings than firms audited by non-Big 4 audit firms. However recently the focus of research has shifted from audit firm specific characteristics to characteristics of the individual auditors responsible for the audit (Chin and Chi, 2008; Breesch and Branson, 2009; Chung and Monroe, 2001; Niskanen, Karjalainen, Niskanen and Karjalainen, 2011; Hardies, Breesch and Branson, 2016). In audit firms each audit engagement partner is in control of its own audit engagement. As auditing requires, to a large extent, that the auditor applies its professional judgement, it is unlikely that they provide the same quality of work as other auditors, even though auditors receive similar training (Hardies et al., 2016). It is therefore more likely that specific characteristics of an audit engagement partner will influence their judgement and thus their level of conservatism. As people often hold different characteristics it is therefore unlikely that the level of conservatism is homogenous amongst audit engagement partners.
The question of whether accounting conservatism is affected by auditor gender is of interest because a number of recent studies indicate that gender differences exist within executives and/or board members (Ho, Li, Tam, and Zhang, 2014; Francis, Hasan, Park and Wu, 2015). These studies find that female executives and/or female presence within boards results in higher accounting conservatism (Ho et al, 2014; Francis et al. 2015). Some preliminary evidence regarding the association between conservatism and the gender of an audit engagement partners has been found by Niskanen et al. (2011). Niskanen et al. (2011) used the Modified Jones model by Dechow, Richard and Amy (1995) to measure earnings management and found that female audit engagement partners are associated with more income decreasing discretionary accruals in small and medium sized companies. Niskanen et al. (2011) conclude that their evidence suggests that female auditors are associated with higher conservatism. However this conservatism of female audit engagement partners has not yet been linked to accounting conservatism. Watts (2003) notes that earnings management cannot fully explain accounting conservatism. Francis, LaFond, Olsson, and Schipper (2004) add to this that earnings management and accounting conservatism are two distinct earnings attributes, in that they have different intended functions of accounting. Thus the
question, if female audit engagement partners are associated with higher accounting conservatism, is left unanswered. To fully document if indeed female (male) audit engagement partners are associated with a higher (lower) level of conservatism, a different model is required.
Following prior studies (e.g. Ahmed and Duellman, 2007; Francis et al., 2015), I employ two measures of conservatism, one accrual-based measure and one market-based measure. I expect that female engagement partners are more likely to be associated with accounting conservatism than their male colleagues as women have been found to be associated with more ethical behavior, less overconfident and more risk adversity than men (Byrnes, Miller and Schafer, 1999; O’Fallon and Butterfield, 2005; Ibrahim and Angelidis, 2009; Charness and Gneezy, 2011). However, auditors are still an external party and to be able to make an impact on financial reporting they require cooperation from inside the firm. Individuals inside the firm have a stronger impact on accounting conservatism as insiders are more involved in the daily operations of the company. Prior research has documented that corporate governance mechanisms, such as board independence, are associated with higher accounting conservatism (e.g. Beekes, Pope and Young, 2004; DeFond, Hann and Hu, 2005; Ahmed and Duellman 2007; Chi, Liu and Wang, 2009). Therefore it is likely that female audit engagement partner positively influence the relation between corporate governance and the level of accounting conservatism.
I use a sample of 524 firm year observations of companies listed on the London Stock Exchange for my empirical analysis. My results find no significant relation between corporate governance and accounting conservatism or auditor gender and accounting conservatism. However this study finds a positive moderating effect of auditor gender on the relation between corporate governance and accounting conservatism. This indicates that although there is no direct significant effect of auditor gender on accounting conservatism, there is a significant positive effect on accounting conservatism by having a female audit engagement partner in combination with a strong corporate governance structure.
The objective of this study is to give us a greater insight in the impact of the gender of the audit engagement partner on the relation between corporate governance mechanisms and accounting conservatism. To the best of my knowledge, this is the first study that looks at the possible impact of auditor gender on accounting conservatism and on the relationship between corporate governance and accounting conservatism. These results contribute to the literature in two ways. First, these findings contribute to the growing literature on gender differences that affect audit judgements and decisions (e.g. Chin and Chi, 2008; Breesch and Branson, 2009; Niskanen et al. 2011; Hardies, Breesch, and Branson, 2012; Hardies et al, 2016). Second these findings also
extend the literature on accounting conservatism and auditing of public companies. Public companies play a major role in the savings, investment, and retirement plans of many European citizens. As lots of pension plans and/or funds invest in stock of public companies it is not only important for the regular investor, but also for regular citizens as they invest indirectly in these companies.
The remainder of this paper is structured as follows. Section 2 contains the literature review on conservatism, gender and corporate governance. Subsequently the hypotheses are set in this section and the section ends with an review of the British audit market and audit reporting regulations for companies listed on the London Stock Exchange. Section 3 contains the sample and more information regarding the model used in this study. Section 4 contains the descriptive statistics, the Pearson 2-tailed correlation matrix and the regression with results. This section discusses the findings and includes possible explanations for the findings. Section 5 contains the summarized findings, implications, limitations and suggestions for future research.
2 Literature review
This section consist out of four subsections. First an introduction is given on accounting conservatism, its definition and why it is relevant for companies. Subsequently the agency problem and the role of corporate governance in mitigating this agency problem is being discussed. The third subsection covers the audit engagement partner and a background on gender differences. The fourth and final subsection contains the London Stock Exchange Reporting Regulation. This subsection contains information on audit requirements, corporate governance requirements for companies listed on the London Stock Exchange.
2.1 Accounting conservatism
The influence of conservatism on accounting practice has been significant and in the past conservatism has been rated as the most influential practice of valuation in accounting (Sterling, 1970). Accounting conservatism is traditionally defined by the expression of Bliss (1924) which states “anticipate no profit, but anticipate all losses”. This means that one should not anticipate profits before there is a legal claim to the revenues generating them and that these revenues are verifiable (Watts 2003). Watts (2003) states that conservatism does not imply that all revenue cash flows should be received before profits are recognized but rather that those cash flows should be verifiable. A different definition is given by Basu (1997), he defines conservatism as capturing accountants’ tendency to require a higher degree of verification for recognizing good news than bad news in financial statements. Under the interpretation of Basu (1997) there exist different degrees of conservatism. The degree of conservatism is determined as the difference in the required verification for gains versus losses.
Ball and Shavikumar (2005) split conservatism in two distinct forms. The first form is unconditional conservatism which means that due to aspects of the accounting process at the inception of the recognition of the assets and liabilities these will yield expected unrecorded goodwill. This reduction in earnings happens independently of economic news. The second form is conditional conservatism, which means that values of assets are impaired at adverse circumstances but not revaluated upwards under favorable circumstances, with the latter being the conservative behavior (Ball and Shavikumar, 2005; Beaver and Ryan, 2005).
Applying conservative accounting has the potential to benefit the users of the financial statements. As conservatism requires a higher degree of verification for recognizing good news than bad news managers opportunistic behavior to make payments to themselves is constrained (Watts, 2003). Watts (2003) argues that conservatism also mitigates the agency problem associated
with managerial investment decision as it reduces managers’ ex ante incentives to take on negative net present value projects and improves the ex post monitoring of investments. The agency problem will be discussed more in depth in the next paragraph. Ahmed and Duellman (2011) found this to be true as companies with more conservative accounting have higher future cash flows, gross margins and a lower likelihood and magnitude of special item charges than firms which apply less conservative accounting. Conservative accounting also makes it possible to monitor debt contracts which are based on conservative numbers, which in turn trigger violation of the debt covenants faster (Watts 2003; Ball and Shivakumar 2005). Next to this conservative accounting also provides obvious benefits in reducing exposure to litigation risk (Kellog, 1984). Prior studies find that lawsuits against auditors are more often related to overstatements of earnings or net assets than for understatements (Kellog 1984; St. Pierre and Anderson 1984). This creates an incentive for management and auditors to report more conservative values for net assets and earnings (Kellogg, 1984).
2.2 The agency problem and Corporate governance
Directors play an important role as they control the top level decision making in large companies (Fama and Jensen, 1983). However an agency problem arises due to the conflicts of interest between managers, board members, shareholders and other stakeholders, as managers effectively control the firms’ asset but generally do not own a significant amount of the total equity of the company and thus do not bear the full risks of their actions (Berle and Means, 1932; Jensen and Meckling, 1976). Financial reporting represents a particularly clear example of an activity in which the preferences of managers and shareholders may not be perfectly aligned. Published financial statements are an important source of information for shareholders’ investment decisions. However accounting numbers are also widely used in management compensation contracts (Ittner, Larcker and Rajan, 1997). This creates moral hazard problems which are often countered by contracts to create incentives or constrains to act in the best interest of shareholders. However these conflicts cannot be completely resolved through contracts as it is costly and this might not outweigh the benefits of creating a better alignment of managers’ interest with shareholders. Next to this it is also virtually impossible to write and enforce complete contract covering all possible aspects. Therefore shareholders also employ other corporate governance mechanisms to reduce these conflicts of interest.
Corporate governance is a set of mechanisms that companies can put in place to ensure that there is effective monitoring of management and prevention of inappropriate distribution of assets to managers or other parties at the expense of the shareholders. (Shleifer and Vishny 1997).
Corporate governance mechanisms can exist out of numerous things, such as board characteristics, incentive contracts, managerial and institutional ownership, and financing structure (Ahmed and Duellman, 2007). The main corporate governance mechanism studied in this study are the characteristics of the board and its operations.
Shareholders elect the board of directors to ensure managers act in their best interest. The board of directors monitor and evaluate the activities of senior management and therefore play a central role in corporate governance. As the potential of the careers of the inside directors’ are closely linked to the CEO, monitoring and evaluating management is primarily allocated to the outside board members. This means that the outside directors play an important role in mitigating the agency problems that arise between managers and shareholders. Lim (2011) argues that an effective board is likely to demand that managers adopt conservative accounting practices to prevent overcompensation, to reduce litigation risks and to reduce the probability and magnitude of corporate collapses. Lara, Osma, and Penalva (2009) support this, arguing that conservative accounting information can provide an early warning signal to governance bodies, such as the board of directors. This will promote early investigation into the reasons for bad news. Under this viewpoint, effective monitoring is predicted to be a positive function of the proportion of the outside members of the board and the amount of meetings the board has.
Studies examining the relationship between corporate governance and accounting conservatism have been performed in different institutional settings and have yielded different results (Beekes et al. 2004; Ahmed and Duellman 2007; Chi et al., 2009). Beekes et al. (2004) examined, for companies in the United Kingdom, whether earnings timeliness and conservatism was affected by the proportion of outsider board members. They find that companies with a higher proportion of outside board members are more likely to recognize bad news in earnings on a timely basis. Ahmed and Duellman (2007) find in companies from the United States that accounting conservatism is positively related with the percentage of outside directors’ and the shares held by outside directors. The most recent study regarding this subject by Chi et al. (2009) however finds mixed support for a relationship between corporate governance and accounting conservatism. Employing the C-score by Khan and Watts (2009) they find that for companies in Taiwan a greater percentage of shares held by institutional investors leads to a lower demand for accounting conservatism.
Based on the studies above I expect that strong boards will demand greater conservatism because it can help to reduce agency cost. Although mixed results have been found in different settings, the setting of this study is much alike the setting of Beekes et al. (2004) who did find
evidence of a relationship between corporate governance and accounting conservatism. Therefore I set the following hypothesis:
H1: Stronger corporate governance structures are associated with more conservative accounting. 2.3 Gender of the Audit Engagement Partner
Prior literature on judgement and decision-making has revealed that gender effects arise mainly due to a difference in risk taking (e.g. Hinz, McCarthy and Turner, 1997; Sundén and Surette, 1998; Jianakoplos and Bernasek, 1998; Byrnes et al., 1999; Dwyer, Gilkeson and List, 2002). Men and women appear to have a different level of risk which they find acceptable. The gender of an investor has found to be an important factor as women tend to hold larger proportions of wealth in financial assets with lower volatility of returns compared to men. (Hinz, McCarthy and Turner, 1997; Sundén and Surette, 1998; Jianakoplos and Bernasek, 1998). Females investors also tend to exhibit less risk-taking tendencies than men in their largest and riskiest mutual fund investment decisions (Dwyer et al., 2002). To the extent that a similar risk aversion difference exists between males and females, female (male) audit engagement partners should exhibit less (more) risky judgements in their audit approach.
However in the literature there is only limited research done regarding differences between the gender of the audit engagement partner. Two recent studies however find that female auditors tend to be more conservative in two different ways (Hardies et al., 2016; Niskanen et al., 2011). A recent study by Hardies et al. (2016) finds that female audit engagement partners in Belgium are more likely to issue a going concern opinion for companies in financial distress. They argue that as women are more risk adverse then men they are more likely to issue a more conservative opinion about the going concern status. Niskanen et al. (2011) find that female auditors are more likely to be associated with income decreasing accruals in small and medium sized companies. These results imply that female audit engagement partners are more conservative than their male colleagues.
Based on the above paragraphs it is expected that even in trained financial specialists gender difference arise in risk taking. Risk-taking is about accepting the option that a decision can lead to negative consequences (Byrnes et al., 1999). Prior literature has primarily found that females tend to be more risk adverse than men. It is therefore expected that female audit engagement partners will demand a higher level of accounting conservatism in financial reporting to reduce risks such as litigation. Therefore the following hypothesis is formulated:
H2: Female audit engagements partners positively influence the level of accounting conservatism in companies.
However although the audit engagement partner has some bargaining power, their audit opinion, he or she remains an outsider of the company and does not control decision making in a company. As insiders of the company have a stronger impact on financial reporting it is expected that a strong corporate governance structure will empower the female auditor to make an impact. Based on the above the following hypothesis is formulated:
H3: The relation between accounting conservatism and corporate governance is stronger for firms with a female audit engagement partner.
2.4 The London Stock Exchange Reporting Regulation
Companies which are listed on the London Stock Exchange are required to have their financial statements audited by a registered auditor. This mandatory audit will ensure that financial statements provide a true and fair view of the financial position of the entity, so that stakeholders can make decisions with the assurance that the financial statements are free of material error.
There are also some options for companies when they are admitting their equity securities on the Main Market. Companies can choose one of three routes to the market, Premium listing, Standard listing and admission via the High Growth Segment. These three different listings create different requirements and possibly benefits for companies. This study only focusses on companies with a premium listing as they are required to meet special high quality United Kingdom standards regarding regulation and corporate governance (“Listing regime”, 2016). These companies with a Premium listing are required under the Listing Rules to report on how they have applied the United Kingdom Corporate Governance Code (hereafter: the Code) in their annual report (“UK Corporate governance code”, 2016). The Code sets out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders. The code contains broad principles and more specific provisions. Listed companies are required to report on how they have applied the main principles of the Code, and either to confirm they have complied with the Code’s provisions or, where the companies did not, to provide the readers of the annual report with an explanation. As a consequence these companies may enjoy a lower cost of capital through greater transparency and through building investor confidence.
3 Research design
This section exists out of five different sections. The first section contains information regarding the way the final sample was derived. The second section contains the research method used in this study. The section contains information on which databases, why they are used and what kind of information is collected from them. The third section contains the proxies used in this study for corporate governance strength and the reasoning for them. The fourth section contains information on the independent variables used in this study as proxy to measure for accounting conservatism. Finally the last section discusses the measurement models used and explain reasoning for the control variables.
3.1 Sample
The sample consists of companies listed on the London Stock Exchange from the year 2011 up to and including 2014. The focus for the United Kingdom is because the London Stock Exchange is one of the biggest stock exchanges in the European Union and a place where, due to legislation, auditors have to sign their full personal name under the financial statements. The research period of 2011 up to and including 2014 has been selected to take the most recent period possible. This research is motivated to investigate the current practices and it is therefore only logical to get the most recent financial years.
Table 1 gives an overview of the course of data collection and its impact on the amount of firm years available for this study. Initially the sample started with 7.180 firm year observations. All companies active as a financial institution, such as banks, insurance companies and securities companies are dropped from the sample leaving a total of 5.168 firm year observations (Chi et al. 2009; Hardies et al., 2016). Companies are also selected on the basis if they have a premium listing on the London Stock Exchange, as this might pre select the companies with high corporate governance quality. This leaves the sample with 1.564 firm year observations. Not all financial statement data contained the full name of the auditor making it impossible to determine their gender. This left 1.464 firm year observations in the sample. Subsequently the database Orbis is used to capture financial data of the companies, however not all the financial data needed for the variables was available, leaving the sample with 798 firm year observations. Subsequently the Datastream database was used and corporate governance data was retrieved for 524 firm year observations. Finally, some of the variables have been winsorized which means that the top and bottom of each variable will be removed to avoid extreme values. This resulted in a final sample of 524 firm years available for this study.
Table 1 Sample
Removed Size
Collected firm years 7.180
Less companies acting as financial institutions (2.012) 5.168 Less companies with no premium listing (3.604) 1.564 Less companies with missing auditor information | Financial statements (100) 1.464 Less companies with missing financial information | Orbis (666) 798 Less companies with missing corporate governance values | Datastream (274) 524 Total firm years left in the sample 524
3.2 Research method
The research method for this study is based on a mix of archival research and hand collection. Information on auditor gender is retrieved through hand collection in the following way: first, the name of the auditor was retrieved from the Independent Auditor’s Report from the annual reports published on the companies official websites. Subsequently the names of the auditors are searched through various canals such as Google, LinkedIn and the official website of the auditing company to determine the gender of the auditor. The decision for this method is based on the fact that databases do not fully disclose auditor full name and/or gender yet. Therefore hand collection was necessary. As for data from the financial statements and data on corporate governance mechanisms, this data is reasonably available for companies listed on the London Stock Exchange. Therefore by using databases time was more efficiently spend. Financial data of these companies is retrieved from Orbis for the years 2010 up to and including 2015. Corporate governance data is retrieved from ASSET4 which is part of the Datastream database.
3.3 Proxies for the strength of the corporate governance structure
To control for corporate governance an index is made out of three different corporate governance attributes. This index will be used to score companies corporate governance structure. This approach is similar to the approach of Bertrand and Mullainathan (2001) and Davila and Penalva (2006). This index incorporates the level of antitakeover protection, which acts as an external corporate governance mechanism, and CEO involvement and board effectiveness, which both act as are internal corporate governance mechanisms. Cremers and Nair (2005) argue that the external
and internal corporate governance mechanisms are complementary and that both are needed to achieve the desired effects that corporate governance can entail.
The first attribute is ANTITAKOVER measured as a score based on the amount of anti-takeover provisions a company has above two. The choice regarding the measurement of this attribute is based on the availability of data in the database ASSET4. As it only contains the amount of takover protection above 2. Cremers and Nair (2005) argue that the amount of anti-takeover provisions measure the anti-takeover vulnerability of a company. Higher values are associated with more protection against takeovers with less protection for lower values.
The second attribute is CEOCHAIR measured as a dummy variable in which companies where the CEO is also the chairman of the board receive a 1 and a 0 for companies where the CEO is not also the chairman of the board. The involvement of the CEO in the board is of importance as CEO has more influence in the company and on corporate governance when he or she also holds to chairman position in the board. Therefore when the CEO is also the chairman of the board it is expected to be negatively associated with the level of conservatism.
The third attribute is BOARDMEETINGS, measured as the inverse score of the amount of board meetings during the year. The number of board meetings give a good indication of the effectiveness of the board as it captures the effort that directors put into monitoring management (Vafeas, 1999). As a higher number of meetings is expected to have a positive influence on conservatism, the inverse score of the amounts of board meetings is used to match the previous two attributes.
Based on the above attributes the composite corporate governance variable CORP_GOV is formed by taking the unweighted average of the standardized variables just like Bertrand and Mullainathan (2001) did. To take into account the different scales of the variables above, a standardization is performed to make up the composite measure. Based on the information above, higher amounts of the variable will be an indication of weak corporate governance structure where as a low value will be an indication of a strong corporate governance structure. For the ease of interpretation the variable CORP_GOV is rescaled by multiplying it by -1. Now high scores of CORP_GOV will indicate a strong corporate governance structure and it is expected that the score of CORP_GOV will be positively associated with accounting conservatism.
3.4 Proxies for accounting conservatism
In this study, two different proxies for conservatism are used based on prior conservatism literature (e.g. Ahmed and Duellman, 2007; Francis et al., 2015). The first proxy is an accrual-based
proxy from Givoly and Hayn (2000). The second measure is a market-value based proxy based on Beaver and Ryan (2000).
The CON_ACC dependent variable is income before extra-ordinary items less cash flows from operations plus depreciation expense deflated by average total assets, and averaged over a 3-year period centered on 3-year t, multiplied by negative one. By multiplying it by negative one a positive value will indicate a greater level of conservatism. Givoly and Hayn (2000) argue that conservative accounting results in persistently income decreasing accruals. Therefore the more income decreasing accruals are being used over respective periods, the more conservative the accounting practice is. By averaging over a number of periods the potential temporary effects of large accruals are mitigated. Richardson, Sloan, Soliman and Tuna (2005) argue that this is true as accruals tend to reverse within a one to 2-year period. This conservative measure based on accruals is not affected by future economic rents or growth opportunities. However Ahmed and Duellman (2007) argue that it does not reflect total or cumulative conservatism because it ignores the effects of conservatism in prior periods.
The CON_MKT is measured as the book-to-market ratio of a company multiplied by -1 for the ease of interpretation. This is a market-value based proxy based on Beaver and Ryan (2000). When companies apply conservative accounting they understate their assets and understate profits, this will in turn lead to understatement of the book value of equity. Therefore a higher book-to-market ratio should indicate conservative accounting by the firm (Beaver and Ryan, 2000). By multiplying the measure by -1, the companies with a larger gap between the book value of their equity and their market value will be closer to 0 as conservative companies will score a small negative amount.
3.5 Measurement models and control variables
I estimate the following empirical model containing the three board characteristics, the gender of the auditor, which are discussed above, and seven control variables using OLS regression:
CONi1 = β0 + β1 CORP_GOVi + β2 GEN_AUDITORi + β3 CGi*GAi + β4 SIZEi + β5
SALESGROWTHi + β6 LEVERAGEi + β7 R&D/SALESi + β8 CFO/TAi + + β9 CASH i + β10
BIG4i
1 CON stands for one of the two conservatism measures of this study: CON_MKT and CON_ACC. Both models
Just like other studies who have examined conservatism (e.g. Ahmed, Billings, Morton and Stanford-Harris 2002; Ahmed and Duellman 2007; LaFond and Roychowdhury, 2008; Francis et al., 2015) this study includes multiple firm-level control variables in its regressions. Whereas SIZE is the natural log of average total assets, SALESGROWTH is the percentage of annual growth in total sales, LEVERAGE is the total long-term debt divided by average total assets,R&D/SALES is research and development expenditures divided by sales, CFO/TA is cash flows from operations divided by average total assets, CASH is total cash and cash equivalents divided by average total assets and BIG4 is a dummy variable which scores 1 if the company is audited by a Big 4 accounting firm and 0 otherwise.
The first control variable is firm size (SIZE). I control for the firm size as it is argued by LaFond and Watts (2008) that information asymmetry is often smaller for larger companies than for small companies. This is due to the fact that large companies often have more corporate disclosure to their investors and other stakeholders. They argue that as companies already disclose a lot of information to their investors this reduces the demand for conservative accounting for large companies. Therefore it is expected that there is a negative relation between firm size and accounting conservatism. The second control variable is the growth of sales (SALESGROWTH). I also include sales growth as I expect a positive relation between the growth of sales in a company and CON_MKT. Ahmed and Duellman (2007) argue that large sales growth inflate the market expectation of future cash flows which in turn will increase the market to book ratio. Consistent with Ahmed et al. (2002) I expect a negative relationship with CON_ACC because sales growth affects accruals such as inventory and receivables, which in turn affects CON_ACC.
The third control variable is the leverage of debt in a firm (LEVERAGE). Firms with higher leverage have a greater share-holder and bond-holder conflict. Accounting conservatism mitigates this conflict over dividend policy and reduces the cost of debt for companies (Ahmed et al. 2002). Lenders also benefit from conservative accounting as conservative accounting triggers violations of debt covenants more quickly (Zhang, 2008). In addition, Beatty, Weber and Yu (2008) find that financial reporting conservatism is required to satisfy lenders’ demand for information as contract modifications alone are not able to do this. The fourth control variable is the expenditure on research and development (R&D/SALES). Ahmed (1994) argues that research and development expenses capture economic rents generated by assets-in-place, growth opportunities and conservatism mandated by the applicable accounting standards.
In this study I also control for the profitability of the firm (CFO/TA). Ahmed et al. (2002) find a positive relation between profitability and conservatism which they argue exist due to the
fact that the cost associated with conservative accounting are lower for high profitability firms than for low profitability firms. I control for cash holding (CASH), as Watts (2003) argues that conservatism can reduce cash outflows and cash wastage and can also lower agency costs associated with cash holdings. Therefore I expect a positive relation between cash holdings and conservatism. The last control variable is a dummy variable which controls for firms audited by a Big 4 auditor (BIG4). Basu et al. (2001) suggests that firms being audited by Big 4 firms report more conservative earnings.
4 Data
This section exists out of two subsections. First information on the amount of observations per industry is given, followed by the descriptive statistics of all variables and the 2-tailed Pearson correlation matrix. Subsequently the second subsection contains the regressions in which I test the hypotheses based on the two different measures for conservatism. In this subsection the results are discussed and possible explanations for the findings are given.
4.1 Descriptive statistics
Table 2 shows the industry distribution of the sample based on the NACE Rev. 2 sections. With 35,3% the manufacturing industry is the biggest industry followed by the wholesale and retail trade industry with 11,8%. The smallest industries are the arts, entertainment and recreation and the other service activities industry, both with 0,8% firm year observations of the total sample. No observations are in the sample for the following industries: agriculture, forestry and fishing, water supply and human health and social work. The 8 firm years for financial and insurance activities are still in the sample as selection for removal was based on criteria applied by Chi et al. (2009).
The descriptive statistics of all the variables are summarized in table 3. The accrual measure for conservatism, CON_ACC, has a small positive value of 0.005. This amount is close to Francis et al. (2015) who also document a small positive score. A positive amount on this measure indicates conservatism, thus companies tend to only apply conservative accounting to a small extend. CON_MKT has a value of -.629 which is a relatively small value and thus indicates conservatism. As the amount is -.629, this indicates that the companies in this sample approximately have a market capitalisation that is a little under two times the value of the total equity of the companies in the sample.
The average corporate governance score is .004. As this measure exist out of the average of three standardized variables it is only logical that this amount is near 0 as standardized variables have a score relative to the mean of their sample. On average in this sample the annual reports are audited by 9.4% female auditors. Whereas within the data a small increase is seen in the amount of female auditors signing the independent auditors report from 2011 to 2014, suggesting that women more often get to the top and gender diversity within the top at accounting firms also tends to shift.
Table 2
Observations per industry
Section Description Observations % A Agriculture, forestry and fishing 0 0,0 % B Mining and quarrying 46 8,8 %
C Manufacturing 185 35,3 %
D Electricity, gas, steam and air 8 1,5 %
E Water supply 0 0,0 %
F Construction 37 7,1 %
G Wholesale and retail trade 62 11,8 %
H Transportation and storage 21 4,0 %
I Accommodation and food service 23 4,4 %
J Information and communication 29 5,5 %
K Financial and insurance activities 8 1,5 %
L Real estate activities 35 6,7 %
M Professional, scientific and technical activities 33 6,3 %
N Administrative and support services 29 5,5 %
Q Human health and social work 0 0,0 %
R Arts, entertainment and recreation 4 0,8 %
S Other service activities 4 0,8 %
Table 3 Descriptive Statistics
Variable Mean Median Std. Dev. Minimum Maximum
CON_ACC .005 .006 .060 -.212 .199 CON_MKT -.629 -453 .509 -2.002 -.049 CORP_GOV .004 .048 .528 -1.698 1.248 BOARDMEETINGS 8.695 8.000 2.780 4.000 26.000 ANTITAKOVER 1.753 2.000 1.399 .000 6.000 CEOCHAIR .044 .000 .205 .000 1.000 GEN_AUDITOR .094 .000 .291 .000 1.000 SIZE 9.328 9.270 .633 7.673 11.358 SALESGROWTH .108 .077 .221 -.319 1.281 LEVERAGE .190 .162 .165 .000 .701 R&D/SALES .016 .000 .023 .000 .084 CFO/TA .109 .096 .084 -.063 .411 CASH .094 .682 .086 .001 .042 BIG4 .992 1.000 .087 .000 1.000
Research timelines is 2011 through 2014. Total number of firm year observations for accounting conservatism is 524.
CON_ACCi =income before extra-ordinary items less cash flows from operations plus depreciation expense deflated by average
total assets, and averaged over a 3-year period centered on year t, multiplied by negative one. CON_MKTi = Book to market ratio
multiplied by negative one; CORP_GOVi = unweighted average of standardized variables BOARDMEETINGSi, inverse score of
ANTITAKEOVERi and CEOCHAIRi; BOARDMEETINGSi = Number of board meetings in given year; ANTITAKEOVERi
= Number of anti-takeover provisions above 2; CEOCHAIRi = Dummy variable (1= if the CEO also is the chairman of the board,
0= otherwise); GEN_AUDITORi = Dummy variable (1= if the company is audited by a female auditor, 0= otherwise); SIZEi =
The natural log of total assets; SALESGROWTHi = Change of revenue in relation to prior year; R&D/SALESi = Total R&D
expenses divided by total sales; CFO/TAi = Cash flow from operations divided by average total assets; LEVERAGEi = Total long
term debt divided by average total assets; CASH i = Cash and cash equivalents divided by average total assets; BIG4 i = Dummy
variable (1= if the company is audited by a Big 4 accounting firm, 0= otherwise)
As for the control variables, the average log of total assets is 9.328 (€ 2.128 million assets) indicating that the sample contains very large companies. Sales growth for these companies is on average 10.8%, indicating that the companies in the sample are still growing based on their revenue. Leverage is 19% indicating that on average companies finance their activities with 19% of long term debt. Research and development expenses are on average 1.6% of the total sales, however
for a lot of companies this amount is 0. This can be noticed from the median which is zero, indicating that over 50% of the companies spend no money on research and development. The companies have an average of 10.9% operational cash flows compared to their total assets. Cash holding is 9.4% of the total assets of the companies. And at last, almost all companies in the sample are audited by Big 4 audit firms. Only 0.8% of the companies choose a non-Big 4 audit firm.
In table 4 the 2-tailed Pearson correlation matrix is reported with all the variables in it from both models. This correlation matrix can be used to determine if multicollinearity exist within the sample. For this study the threshold of Field (2000) is applied, whereas correlations above .9 indicate multicollinearity. All reported values in table 4 are below the threshold of .9 that Field (2000) described, with the highest value at 0.431 between CON_ACC and CFO/TA. This suggests that there are no multicollinearity issues in the data.
For the correlation results, CON_ACC and CON_MKT are positively correlated, however the correlation is only minor and is not significant. CORP_GOV is positively related to CON-ACC, however it is negatively related to CON_MKT. This indicates that there is no clear effect of corporate governance on conservative accounting. Both correlations are non-significant, indicating that the correlations are not strong. GEN_AUDITOR is negatively correlated with CON_ACC and CON_MKT. This is not in line with the expectations of H2, which predicts a positive relation between auditor gender and accounting conservatism.
The interaction effect GC&GA is negative correlated with CON_ACC and positively correlated with CON_MKT, this interaction effect is significant for CON_ACC (significant at the 0.10 level) and not significant for CON_MKT. These findings are mixed and thus not in line with H3, where it is expected that the relation between accounting conservatism and corporate governance is stronger for firms with a female audit engagement partner.
SALESGROWTH and CON_ACC are negatively correlated and significant at the .10 level. This is in line with the expectations of Ahmed et al. (2002) who claims that this negative relationship is caused as sales growth affects accruals such as inventory and receivables, which in turn affects CON_ACC. CFO/TA is positively correlated with CON_ACC at the significance level of .01 level indicating that more profitable firms indeed are more conservative. CASH is positively correlated with CON_ACC, at the 0.01 level. This is in line with Watts (2003) who predicts a positive relation between cash holding and conservatism. The last control variable, BIG4, is significantly positively correlated with CON_ACC (significant at the 0.01 level), indicating that companies audited by a Big 4 make more use of conservative accruals.
Table 4
2-tailed Pearson correlation matrix containing dependent, independent and control variables
Variablea 1 2 3 4 5 6 7 8 9 10 11 12 (1) CON_ACC 1.000 (2) CON_MKT 0.033 1.000 (3) CORP_GOV 0.023 -0.016 1.000 (4) GEN_AUDITOR -0.002 -0.103** 0.015 1.000 (5) CG*GA -0.075* 0.068 0.322*** 0.049 1.000 (6) SIZE -0.040 0.061 -0.161*** -0.137*** 0.001 1.000 (7) SALESGROWTH -.0.091** -0.008 -0.122*** -0.015 -0.106** -0.082* 1.000 (8) LEVERAGE -0.045 0.069 0.043 -0.113** -0.002 0.153*** -0.023 1.000 (9) R&D/SALES 0.071 0.041 0.079* -0.046 -0.140*** 0.034 -0.062 0.182*** 1.000 (10) CFO/TA 0.431*** 0.034 -0.057 0.020 -0.024 -0.270*** 0.084* -0.165*** 0.109** 1.000 (11) Cash 0.180*** -0.050 0.126*** -0.028 -0.025 -0.187*** 0.039 -0.237*** 0.143*** 0.300*** 1.000 (12) BIG4 0.180*** -0.024 0.022 0.028 0.001 -0.019 -0.153*** -0.059 0.041 0.098** 0.080** 1.000
*/**/*** Significant at 0.10/0.05/0.01 level (Pearson correlation | 2-tailed)
CON_ACCi =income before extra-ordinary items less cash flows from operations plus depreciation expense deflated by average total assets, and averaged over a 3-year period centered on year t, multiplied by negative one
CON_MKTi = Book to market ratio multiplied by negative one; CORP_GOVi = unweighted average of standardized variables BOARDMEETINGSi, inverse score of ANTITAKEOVERi and CEOCHAIRi; GEN_AUDITORi
= Dummy variable (1= if the company is audited by a female auditor, 0= otherwise); CG*GAi = CORP_GOVi*GEN_AUDITORi; SIZEi = The natural log of total assets; SALESGROWTHi = Change of revenue in relation
to prior year; R&D/SALESi = Total R&D expenses divided by total sales; CFO/TAi = Cash flow from operations divided by average total assets; LEVERAGEi = Total long term debt divided by average total assets; CASH i =
4.2 Corporate governance, auditor gender and accounting conservatism
The relationship between corporate governance and accounting conservatism (H1), auditor gender and accounting conservatism (H2) and the moderating effect of auditor gender on corporate governance and accounting conservatism (H3) is analyzed through two different conservatism proxies. The first model includes an accrual-based measure for conservatism (CON_ACC) with the second model containing a market-based measure (CON_MKT).
The results of the first measure (CON_ACC) are reported in table 5. Where coefficients with a positive value will indicate a positive relation with conservatism. A regression is performed which includes all the independent and control variables. In addition to the control variables shown in Table 5, the regression also controls for year and industry fixed effects, however data regarding these are not included in table 5. The regression also includes robust results based on company fixed effects.
The model has a R2 of.451 indicating that 45.1% of the variance of CON_ACC is explained
by the variables in the model. CORP_GOV and GEN_AUDITOR both have a small negative coefficient, however this coefficient is not significant for both independent variables. This means that both a strong corporate governance structure and female auditors do not have a significant effect on the amount of conservative accruals used within a firm. These findings indicate that there is no support for H1 and H2. The findings regarding H1 are not in line with the findings of Ahmed and Duellman (2007) and Ahmed and Henry (2012) who find that a strong corporate governance structure has a positive influence on accounting conservatism. A possible explanation for the absence of support could be that in this study only a limited amount of, and somewhat different, variables have been used as a proxy for corporate governance strength. This is due to the fact that there is a lack of corporate governance variables available in the ASSET4 database.
The variable CG*GA has a positive coefficient but is just short of reaching significance (significance at the 0.10 level). Although H3 formally finds no support, it would be too arbitrary to determine that there are no findings as the significance level is 0.002 short of reaching significance at the 0.10 level. These findings indicate that when there is a combination of strong corporate governance and a female auditor, there is a trend which shows that companies use more income decreasing accruals.
LEVERAGE has a positive coefficient and is significant (significant at the 0.05 level). This is in line with Ahmed et al. (2002) who argues that firms with higher leverage have a greater share-holder and bond-share-holder conflict and therefore benefit from accounting conservatism. CFO/TA also has a positive coefficient and is significant (significant at the 0.01 level). This indicates that
high profitability firms tend to apply more conservative accounting. This is also in line with the expectation of Ahmed et al. (2002) who argues that the cost associated with conservative accounting are lower for high profitability firms than for low profitability firms. At last, BIG4 also has a positive coefficient and is significant (significant at the 0.01 level). This confirms the suggestion of Basu et al. (2001) that firms being audited by Big 4 audit firms are associated with more conservative earnings.
Table 5
Regression of the accounting conservatism measure CON_ACC on Corporate governance and Auditor Gender
Expectation Coef. Significance
Intercept ? -.040 (.688) CORP_GOV (+) -.002 (.665) GEN_AUDITOR (+) -.003 (.665) CG*GA (+) .021 (.102) Control variables SIZE (-) .000 (.947) SALESGROWTH (-) -.014 (.282) LEVERAGE (+) .041 (.034)** R&D/SALES (-) -.059 (.675) CFO/TA (+) .170 (.001)*** CASH (+) .011 (.803) BIG4 (+) .030 (.003)*** R2 .451
Research timelines is 2011 through 2014. Total number of firm year observations for accounting conservatism is 524.
I control for year and industry fixed effects, however data regarding these are not included in table 5. The regression also includes robust results based on company fixed effects.
*/**/*** Significant at 0.10/0.05/0.01 level
CON_ACCi = β0 + β1 COPR_GOVi + β2 GEN_AUDITORi +β3 CGi*GAi + β4 SIZEi + β5 SALESGROWTHi + β6 R&D/SALESi
+ β7 CFO/TAi + β8 LEVERAGEi + β9 CASH i + β10 BIG4i; CORP_GOVi = unweighted average of standardized variables
BOARDMEETINGSi, inverse score of ANTITAKEOVERi and CEOCHAIRi; GEN_AUDITORi = Dummy variable (1= if the company is
audited by a female auditor, 0= otherwise); CG*GAi = CORP_GOVi*GEN_AUDITORi; SIZEi = The natural log of total assets;
SALESGROWTHi = Change of revenue in relation to prior year; R&D/SALESi = Total R&D expenses divided by total sales; CFO/TAi = Cash
flow from operations divided by average total assets; LEVERAGEi = Total long term debt divided by average total assets; CASH i = Cash and cash
The second test contains the market-based measure for conservatism, CON_MKT. Companies that have their book value further away from to their market value will yield a higher scores on this measure for accounting conservatism. Thus coefficients with a positive value will indicate a positive relation on accounting conservatism. The results are of measure CON_MKT are reported in table 6.
Table 6
Regression of the accounting conservatism measure CON_MKT on Corporate governance and Auditor Gender
Expectation Coef. Significance
Intercept ? -.411 (.618) CORP_GOV (+) -.004 (.952) GEN_AUDITOR (+) -.224 (.123) CG*GA (+) .291 (.056)* Control variables SIZE (-) .020 (.798) SALESGROWTH (+) -.005 (.961) LEVERAGE (+) -.375 (.263) R&D/SALES (+) 2,261 (.194) CFO/TA (+) .297 (.488) CASH (+) -.589 (.176) BIG4 (+) -.181 (.303) R2 .105
Research timelines is 2011 through 2014. Total number of firm year observations for accounting conservatism is 524.
I control for year and industry fixed effects, however data regarding these are not included in table 5. The regression also includes robust results based on company fixed effects.
*/**/*** Significant at 0.10/0.05/0.01 level
CON_MKTi = β0 + β1 COPR_GOVi + β2 GEN_AUDITORi +β3 CGi*GAi + β4 SIZEi + β5 SALESGROWTHi + β6 R&D/SALESi
+ β7 CFO/TAi + β8 LEVERAGEi + β9 CASH i + β10 BIG4i; CORP_GOVi = unweighted average of standardized variables
BOARDMEETINGSi, inverse score of ANTITAKEOVERi and CEOCHAIRi; GEN_AUDITORi = Dummy variable (1= if the company is
audited by a female auditor, 0= otherwise); CG*GAi = CORP_GOVi*GEN_AUDITORi; SIZEi = The natural log of total assets;
SALESGROWTHi = Change of revenue in relation to prior year; R&D/SALESi = Total R&D expenses divided by total sales; CFO/TAi = Cash
flow from operations divided by average total assets; LEVERAGEi = Total long term debt divided by average total assets; CASH i = Cash and cash
The model has a R2 of .105 indicating that 10.5% of the variance of CON_MKT is
explained by the variables in the model. Again, CORP_GOV is not significantly related to the proxy for accounting conservatism, indicating no effect of the corporate governance structure on accounting conservatism. As discussed above, the absence of findings might be attributable to the different variables used as a proxy for a strong corporate governance structure as was used in previous literature (e.g. Ahmed and Duellman, 2007; Ahmed and Henry, 2012). GEN_AUDITOR has a significance level of .123 and thus is just short of reaching the significance threshold of 0.10. However this variable has a negative coefficient which is not in line with the prediction of H2. H2 predicts a positive relation between auditor gender and accounting conservatism. These findings indicate a trend in which auditor gender is associated with lower accounting conservatism measured through CON_MKT. It is hard to determine if these results indicate correlation or causation. In other words, do less conservative companies tend to hire female auditors or is this lower accounting conservatism caused by the female auditors. Based on these results it is impossible to determine what actually occurs in practice.
CG*GA has a positive coefficient and is significant (significant at the 0.10 level). This is in line with H3 as these results indicate that the relation between accounting conservatism and corporate governance is stronger for firms with a female audit engagement partner. This means that when there is a strong corporate governance structure and the auditor is a female, there is a relative larger gap between the book value of these companies and their market value, which indicates the use of conservative accounting. These findings are also in line with the trend found at the CON_ACC dependent variable as conservative accruals also tend to increase the gap between the book value of companies and their market value. These findings might indicate that a strong corporate governance structure empowers female auditors to demand more conservative accounting in the financial statements of companies.
No control variables reach significance in this model (significance at the .10 level). The variables closest to this significance level are CASH and R&D/SALES. CASH has a negative coefficient which is not line with the argument of Watts (2003), who argues that conservatism can reduce cash outflows and cash wastage and can possibly also lower agency costs associated with cash holdings. R&D however has a positive coefficient, this is in line with Ahmed (1994) who argues that R&D expenses are already mandated by accounting standards.
5 Conclusion
More focus has been put on gender equality in the recent years. Various corporate governance codes require companies to have an equal amount of men and women in boards and if they do not comply, these companies have to report the reason. Prior literature has studied gender differences amongst boards, management and other key personnel in companies. However there is only limited research done on the gender differences amongst auditors who audit these firms and thus also play a vital role. To further study gender differences within auditors, I study the effect of corporate governance and auditor gender on accounting conservatism as accounting conservatism is an important aspect of the financial reporting. Additionally I also test if auditor gender has a moderating effect on the relation between corporate governance and accounting conservatism.
To measure accounting conservatism I employ two measures, one accrual-based measure and one market-based measure. I find no direct relation between corporate governance and accounting conservatism on both measures. As for auditor gender, no relation was found on the accrual-based measure. There were also no significant findings on the market-based measure, however there is a trend visible supporting a negative relation between auditor gender and conservatism. These findings were not expected as from theoretical underpinning it was expected that there would be a positive relation between auditor gender and accounting conservatism. Regarding the moderating effect of auditor gender a trend for a positive moderating effect was found on the relation between corporate governance and accounting conservatism. On the market-based measure a significant positive influence of auditor gender on the relation between corporate governance and accounting conservatism was found.
The objective of this study was to give us a greater insight in the impact of gender of the audit engagement partner on both accounting conservatism and on the relationship between corporate governance mechanism and accounting conservatism. Based on these results there are however, no clear implications. For example, shareholders looking for more conservative accounting in companies might demand an audit performed by a female auditor. However, beforehand it is not clear if this strategy will pay off as it highly depends on the company’s corporate governance structure. Subsequently, as a trend was found for a negative relation between female auditors and accounting conservatism, this strategy could also backfire and possibly lower the conservative accounting for the company. Therefore based on the current state of research it is difficult to give a recommendation on this subject.
For this study a number of limitations should be acknowledged. First, for companies listed on the London Stock Exchange, not all variables used in prior literature where available in ASSET4, severely limiting the options for the corporate governance index (CORP_GOV) used in this study. This could explain the fact that no results were found regarding the relation between corporate governance and accounting conservatism as prior literature has used different measures for corporate governance strength. Second, this study used a specific sample of companies listed on the London Stock Exchange, companies with a premium listing, which makes generalizability to all companies listed on the London Stock Exchange questionable. The last limitation involves the fact that the sample size was relatively small. Although the sample size had 524 firm year observations, there were only 49 female auditors in the sample. As the research timeline runs from 2011 up to and including 2014, this left the amount of unique companies audited by female auditors even lower.
A suggestion for further research is to perform this study with a larger sample. A sample with more female audit engagement partners might be more suitable to determine if the gender of the audit engagement partner is related to accounting conservatism. Subsequently, it is advisable for further research to measure corporate governance as prior literature, which found a significant relation between corporate governance and accounting conservatism (e.g. Ahmed and Duellman, 2007; Ahmed and Henry, 2012). Finally, different measures of conservatism can be used in further research such as the model employed by Basu (1997). The model of Basu (1997) measures the timeliness of earnings, which is also a measure for accounting conservatism.
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