Gender diversity in the audit committee, the key
audit matters and the risk section of the company
Master Thesis Accountancy
University of Groningen, Faculty of Economics and Business
June 2017 JANIEKE KRUITHOF Studentnumber: 2352052 Berkelstraat 51 9725 GW Groningen Tel: +31637162973 E-mail: janieke_kruithof@hotmail.com Supervisor
Prof. dr. D.A. de Waard RA MA Co-assessor
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Abstract
This research looks at the influence of the rate of women in the audit committee and the country of establishment on the number of similarities between the key audit matters in the audit report and the risks in the risk section of the annual report. The sample consists of 219 UK companies and 47 NL companies. It has been established that the number of women does not affect the rate of similarities between the key audit matters in the audit report and the risks in the risk section of the annual report. The country of establishment shows a negative relation, this is contrary to the hypothesis set out in this research. The results of this research will provide input for future research.
3 Table of contents 1. Introduction ... 5 1.1 Introduction ... 5 1.2 Problem statement ... 7 1.3 Relevance ... 8
1.4 Structure of the paper ... 9
2. Theoretical framework ... 10
2.1 The agency theory ... 10
2.2 Stakeholder theory ... 11
2.3 The (extended) audit report ... 11
2.4 The key audit matters ... 13
2.5 Risk section of the annual report ... 13
2.6 The audit committee and gender diversity ... 14
2.7 Hypothesis ... 15
3. Methodology ... 17
3.1 Sample & data ... 17
3.2 Variables ... 17
3.2.1 Dependent variable ... 17
3.2.2 Independent variable ... 18
3.2.3 Control variables ... 18
3.3 Statistical model ... 19
4. Analysis and results ... 21
4.1 Dataset ... 21
4.2 Descriptive statistics ... 21
4.3 Multicollinearity ... 23
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4.5 Results hypothesis 2 ... 25
5. Conclusion & discussion ... 27
5.1 Conclusion & discussion ... 27
5.2 Limitations and recommendations for future research ... 28
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1. Introduction
1.1 Introduction
“Call it the tragedy of the auditor: tens of thousands of audit hours reduced down to one standard piece of text, an auditor’s report on a company. The auditor does his work diligently, but the great majority of it is hidden from the stakeholders, the people he is doing it for” (PwC, 2014, p.4) Due to the recent financial crisis users of the annual report are not only interested in the conclusions of the auditor. A simple ‘agreement’ is too simplistic. (PwC, 2014). According to many users the standard audit report has limited information value (Bos & Strating, 2014). Auditing is a heavily regulated activity and there has been a large increase in auditor regulation in the last decade (Köhler et al., 2016). Regulators and standard setters have recently focused substantial attention on auditor communications to financial statement users (CAQ1, 2013; PCAOB2 2012, 2013b). One of the new regulatory elements is linked to the transparency of audit engagements, the enhanced auditor’s report (Köhler et al., 2016). Stakeholders are dissatisfied because of limited transparency regarding the auditor’s actual activities. The society, politics, stakeholders and also the audit profession ask for an extended audit report. An audit report includes reporting important key points of control (NBA3, 2014a). In response, the International Auditing and Assurance Standards Board (IAASB) is working on a new model that provides much more information (Bos & Strating, 2014). The IAASB tries to make the audit report more transparent and also tries to reach an increase in confidence in the audit report and financial statements. The standards of the IAASB are effective for years ending on or after 15 December 2016 (Deloitte, 2015). For the book year of 2013 the new extended audit report was voluntary in the Netherlands and it has been tested by a number of external auditors (NBA, 2014b). Since the book year of 2014 the auditor is required to give an extended auditor’s report for Public Interest Entities (PIE) in the Netherlands (NBA, 2014a). In 2013 the UK was the first country who implemented a new extended audit report which was compulsory for listed companies in the UK. Together with the United Kingdom (UK) The Netherlands was the first country with a new extended audit report (Eimers & De Groot, 2015). The complexity of business increased over the last years. Until now the audit report has been a standard pass/fail report with limited information and providing no indication of the complexities relating to the entity or audit (Deloitte, 2015). The new extended auditor’s report is an answer to the
1 Center for Audit Quality
2 Public Company Accounting Oversight Board
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information needs of stakeholders. In the new extended auditor’s report the auditor starts with the judgment, gives key audit matters of the control, the continuity of the entity, the used materiality and the scope of the group audit (NBA, 2014). Main changes compared to the standard auditor’s report are the key audit matters and the used materiality. This study focuses on the key audit matters. The key audit matters have to give a description of the most significant issues of material misstatement, including issues of material misstatement due to fraud and a description of the response of the auditor to those risks (European Union, 2014). The key audit matters makes sure that there is more clarity for the users of the annual report over the most important work carried out by the auditor. Also the relationship between the risks reported by the company are considered to be relevant (PwC, 2014). The new extended audit report causes that the risk section and the report of the supervisory will receive additional attention. Criticism in the area of risks and risk management also comes from stakeholders. Among stakeholders is a demand for more informative information in the area of risks (Van Daelen & De Groot, 2014). Research of van Daelen & de Groot (2014) mentioned four recommendations for the supervisors of a company to improve the risk section:
1. Pose critical questions about the width, sharpness and trend over time of the risks. 2. Note that external reporting is consistent with the internal reporting on risks and risk
management.
3. Check the discussion about what deficiencies are identified and reasons why/or why not to appoint in the risk section.
4. Naming in the report of the supervisory board/audit committee the main risks related to financial reporting and also that these are discussed with the external auditor.
The key audit matters are designed to improve the communicative value of the audit report and is not assumed to provide original information that should have been disclosed by the management (Köhler et al., 2016). Also DeLaurell & Burbage (2014) indicate that it is not the responsibility of the auditor to provide openness to the investors, but that this is the responsibility of the company. The management and the auditor need to align the key points in time in order to prevent undesirable imbalance between the information that the auditor reports in the audit report and the information of the audited company (NBA, 2014a). An analyses of PwC shows that in the Netherlands a third of the key audit matters is not direct or indirect described in the risk section of the company’s annual report. That is not illogical because the risk section oversees the wide range of key business risks and focuses, compared to the auditor's report, less specific on just the financial reporting risks. It is not unlikely that users of the annual
7 report will asks why auditors report risk areas in the auditor’s report which are not mentioned by the management in the risk section of the company. The question is if the management and the supervisory board are aligned with the auditor (PwC, 2014). According to De Bos & Strating (2014) the new auditor’s report also influences the division of roles between the auditor, the management board and the supervisory board members and the reporting of management and audit committees in the management report. In the UK the audit committee has to mention the significant issues related to the financial statement in their report. The key audit matters in the audit report therefore are complementary to the description by the audit committee (PwC, 2014).
The new extended auditor’s report will encourage a more robust dialogue between the external auditor and the persons charged with governance in the company, this will improve audit quality as well as financial reporting (Deloitte, 2015). The audit committee, part of the supervisory board, plays an important role in the financial reporting process as communication intermediary between different parties such as the board of directors, internal auditors and external auditors. The audit committee also has to protect the interests of investor’s and other stakeholders (Collier & Gregory, 1999; Goodwin, 2003).
Recently there is a growing stream of research on the effects of gender diversity.The presence of women in audit committees or board of directors could bring better corporate monitoring and oversight what could result in better financial reporting quality (Stewart & Munro, 2007; Ittonen et al., 2010). Gender diversity could possibly play a role in the amount of similarities between the risk section in the annual report of the company and the key audit matters mentioned by the auditor.
1.2 Problem statement
The composition of the audit committee could possibly be important by balancing the divergent views of management and external auditors, which influences the quality of reporting. As mentioned above the stream of research on the effects of gender diversity in audit committees grows. There is a growing debate about the number of women in top positions within a company. The Dutch government tries to get at least an amount of 30% of women in the board of listed companies (FD, 2016). Previous studies have also demonstrated that gender diversity causes an increase in the degree of supervision within companies (Adams & Ferreira, 2009; Erhardt et al., 2003; Huse & Solberg, 2006). This research tries to study what the influence of the composition of the audit committee is on the similarities between key audit matters stated
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in the audit report and the risk section of the annual report. Therefore, the research question is formulated as followed:
What is the relation between the rate of women in the audit committee and the similarities between the key audit matters of the audit report and the risk section of the annual report of the company?
To answer this research question, a number of sub questions are established. These sub questions will provide help in answering the main research question. The sub questions are stated as followed:
1. Which theory underlies this study?
2. What is an audit report and to what extent differs the new extended audit report from the standard audit report?
3. What are the key audit matters of the audit?
4. What kind of information is provided by the risk section of the annual report and what is the impact of the new auditor’s report on this section?
5. What is the role of the audit committee and what is the impact of gender diversity within the audit committee?
1.3 Relevance
Research in the area of the new extended report is limited because this is only active for a few years and only in the UK and Netherlands compulsory for PIE’s. Research of Bos & Strating (2014) shows that the new extended audit report contains more information value than the standard audit report. Brouwer et al. (2016) have studied to what extend the key audit matters in the extended auditor’s report match with the risks reported in the management report and with the significant accounting policies and estimates in the notes. The results from this study show that the key audit matters in the extended auditor’s report often match with significant accounting policies and estimates identified by the management in the notes. As mentioned above, PwC (2014) found that a third of the key audit matters is not described as risk in the risk section of the company. This is an undesirable situation since the information provided by the external auditor can never be a substitute for the information primarily provided by the management and the supervisory board (Brouwer & Groot, 2014). This research examines if gender diversity in the audit committee causes difference in the rate of similarities between the reported key audit matters by the auditor in the audit report and the risks mentioned in the risk
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section of the annual report and thus also responds to the needs of the stakeholder in the field of the risks of the company.
A lot of research has been done on the association between audit committee characteristics and the relation with the quality of financial reporting (Abbott et al., 2012; Bédard et al., 2004). This study is the first in focussing on the relationship between gender diversity in the audit committee, the risk section of the annual report and the key audit matters in the extended audit report.
1.4 Structure of the paper
The next chapter mentions the main concepts and theory of the study. Chapter 3 explains the research method used in this research. Chapter 4 represents the analyses and the results of the research. At last chapter 5 gives an answer to the research question.
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2. Theoretical framework
This chapter discusses relevant concepts and theories that underlie the central research question. First of all, section 2.1 and 2.2 describe the theories underlying this study, the agency theory and stakeholder theory. Section 2.3 mentions the role of the audit report and the differences between the standard audit report and the extended audit report. Next, section 2.4 focuses on the key audit matters of the new extended audit report. Section 2.5 discusses the risk section of the annual report and section 2.6 focuses on the function of the audit committee and the role that gender diversity can play within the audit committee. Finally, section 2.7 displays the hypothesis for this research.
2.1 The agency theory
This research fits within the agency theory. The agency theory describes the relation between the shareholders and the management of the firm. This relationship is caused by the separation of ownership and capital of a firm. Within the agency theory the management can be seen as the agent of the principal, which are also known as shareholders. The principal admits the authority of the agent and makes the agent responsible for acting in his or her name (Jensen & Meckling, 1973). Furthermore, the agency theory helps to explain the development of the audit. Principals hire agents and give some authority to them in the form of decision-making. Principals have a certain amount of trust in their agents to let them act in the name of the principal. The basic principles of the agency theory is the belief that the interests of principals and agents differ. Agents could have different motives, principals may miss trust their agents and possibly need a mechanism, such as the audit report, to strengthen this trust. Information asymmetry between the agent and principal causes the need for disclosure of financial information (Healy & Palepu, 2001). The presence of information asymmetry makes it difficult for shareholders to monitor management (Eisenhardt, 1989; Hooghiemstra et al., 2015). Information asymmetry occurs because there are differences between the information the management of the company has and the information available to the shareholders. The management has more knowledge about the resources and activities of the company than the shareholders (Eisenhardt, 1989; Ndofor et al., 2013). The new extended audit report could decrease the information asymmetry problem because the new audit report gives more information about the company (Bos & Strating, 2014). This can reduce the agency problems between management and the shareholders. Also the risk section of the annual report is meant to reduce the information asymmetry between the management and outsiders (Linsey &
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Shrives, 2006).The risk section informs outsiders about the main risks for the company and the control measures taken by the company to reduce this risks.
Corporate governance systems are designed to align the interests of managers and shareholders and to prevent agency problems. The audit committee, as part of the supervisory board, plays an important role in monitoring the interest of managers. Through better monitoring managers will be less inclined to pursue his/her own interests at the expense of other stakeholders. This reduces agency costs and improves shareholders efficiency (Nicholson & Kiel, 2007). Agents can adopt accounting policies that give favourable accounting results which improves their own wealth. Having an audit committee can reduce the agency problem, an effective audit committee can enhance the quality and credibility of the financial statements. The audit committee also plays a role in assisting the work of the board of directors with safeguarding and advancing the interests of shareholders, which causes better alignment of the interest of shareholders and management. (Alchian & Demsetz, 1972; Fama & Jensen, 1983).
2.2 Stakeholder theory
Firms have stakeholders, which can be described as: “any group or individual who can affect or is affected by the achievement of the activities of an organization” (Freeman, 1984, p. 46; Freeman et al., 2007, p. 6). The stakeholder theory is an expansion of the agency theory. The agency theory only observes shareholders as stakeholder, the stakeholder theory focuses on all stakeholders. In addition to shareholders also customers, employees, suppliers and environment are part of the stakeholder theory (Hill & Jones, 1992).
As previously mentioned, not only the shareholders but also society, politics, the audit profession itself and other stakeholders ask for an extended audit report (NBA, 2014a). Also for other stakeholders as the shareholders the new extended audit report could be useful.
2.3 The (extended) audit report
The audit report is the output of an audit engagement. In the audit engagement the accountant controls if the financial statements give a fair presentation of the financial situation of the organization (NBA, 2016). Auditors give an independent and professional opinion if the information given by the organization provides a true and fair view of the financial statements. Audited financial statements do not mean that it is the duty of the auditor to ensure that the accounts are totally free from misstatements (European Commission, 2010). The purpose of the audit is to obtain reasonable assurance that the financial statements does not contain any inaccuracies of material importance (NBA, 2002). Materiality is the set of abnormalities,
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including omissions, which are considered individually or collectively to have material impact on the economic decisions of users taken on the basis of the financial statements (IAASB, 2009).
For years the audit report is a subject of discussion (Duréndez Gómez-Guillamón, 2003). The audit report is used by investors to make decisions, which promotes efficient capital markets (Boolaky & Quick, 2016). Investors and also other users of the annual report have demanded more transparency and insight into the audit (Deloitte, 2015). The original audit report was short and standardized. It was only giving standard wordings and provided no other information than the confirmation of the auditor if the financial statements give a true and fair view (Brouwer, et al., 2016). Auditors communicated their opinion in a standard manner, not firm-specific. From society, politics, stakeholders and the audit profession itself demand for an extended audit report increased. The limited transparency regarding an auditor’s actual activities has contributed to the dissatisfaction concerning the functioning of auditors (Brouwer et al., 2016). The werkgroep toekomst accountantsberoep (2014) states that society has received too little information on what auditors actually do. Therefore, it cannot be expected that society bases their trust only on the standard auditor’s report. Since 2014 the new extended audit report is compulsory for PIE’s in the Netherlands (NBA, 2014b). In 2013, the UK was the first country with a new compulsory extended audit report (Bos & Strating, 2014).
The new extended auditor’s report starts with the judgment, gives key points of the control, the continuity of the entity, the used materiality and the scope of the group audit (NBA, 2014a). The IAASB (2015a, 2015b) argues that the main objective of the extended audit report is to improve their informational value and relevance. To create more transparency throughout the audit the confidence in the financial statements increases, which is in public interest. This study focuses on the information about the key audit matters in the auditor’s report.
In the UK, together with the new extended audit report, also the requirements of reporting for the directors and supervisory board are tightened. The audit committee should include the key audit matters mentioned by the auditor in their report (FRC4, 2012). The matters mentioned in the report of the supervisory board should be complementary to the key audit matters mentioned by the auditor. This way the board would be better in line with the auditor (PwC, 2015a). The next section further discusses the key audit matters of the new extended auditor’s report.
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2.4 The key audit matters
As mentioned above, one of the new aspects of the extended audit report are the key audit matters. The part of the key audit matters in the new audit report will report on areas that were significant in the audit, report why they were significant and how the auditor audited this significant areas (PwC, 2015b). In determining the key audit matters, the auditor also will report areas in which the auditor encountered significant difficulty and things that required significant modification of the auditor’s approach (Boolaky & Quick, 2016). ISA5 Standard 702N par. 18a explicitly states that when key audit matters are communicated in the auditor’s report this is not a substitute for disclosures in the financial statements which the management has to make to achieve a fair presentation. The auditor will refer to the key audit matters of control in his statement to information provided by the financial statements and the management report. The auditor and the management have timely discuss the key audit matters. However, this does not take away that the auditor himself determines which he reports (NBA, 2014a). In this case the auditor’s report can give more information to financial statement users than the users received form the annual report of the company (PwC, 2015a). This could cause an undesirable imbalance between the information that the auditor reports in the audit report and the information of the audited company (NBA, 2014a). Also Eumedion (2015) found that in some cases the auditor’s report gives more information about the financial situation of the company than the annual report.
2.5 Risk section of the annual report
The law requires that the annual report includes a description of the principal risks and uncertainties for the company. The risk section consists of three elements (De Groot, 2010):
1. Risk profile: the main operational, strategic, financial and compliance risks.
2. Description of the risk management system: mention the characteristics of the organization-specific risk management system that control business risks.
3. In-control statement: statement of the organization in charge of the design and / or operation of the risk management system.
In the risk section of the annual report the direction describes the main strategic, operational, compliance and financial risks facing the organization. The new extended audit report causes that the risk section and the report of the supervisory board get more attention. Readers of the annual report will look at the relationship between the key audit matters in the new auditor’s
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report and risks mentioned in the management report and supervisory board (Van Daelen & De Groot, 2014). As mentioned in the introduction the stakeholders ask for a more informative risk section. The growing attention to the risk section is largely caused by the new auditor’s report.
2.6 The audit committee and gender diversity
There are two main sets of legal rules on the supervision of corporate management: one-tier boards and two-tier boards. The UK is a prominent country with a one-tier board. A one-tier board consists of executive and non-executive directors (Jungmann, 2006). The executives have the daily management of the company and the non-executives the supervisory role6. In the UK the audit committee consists of three or, when it is a smaller company, two outside independent non-executive directors (FRC, 2016). The Netherlands employs the dualism of a management board and a separate supervisory board, a two-tier board (Jungmann, 2006). The management board has the daily management of the company and a separate supervisory board oversees the management1. The audit committee is part of the separate supervisory board.
The last years the role of the audit committee developed from a voluntary mechanism used in situations with high agency costs to a compulsory mechanism. Today shareholders see the audit committee as the main mechanism for monitoring and there is also a lot social and legalisation attendance for audit committees (Aldamen et al., 2012). Audit committees have to oversee the financial reporting process of an entity. The board should establish an audit committee of at least three, or in the case of smaller companies, two members (FRC, 2012). The audit committee plays an important role in the financial reporting process as communication intermediary between different parties such as the board of directors, internal auditors and external auditors (FRC, 2012). The function of the audit committee is to meet the internal and external auditor regularly. In this meetings they have to discuss the financial reporting of the company (DeZoort, 1997).They have to meet at least annually with the internal and external auditors, without the managers. In this meetings they have to discuss matters relating to its remit and any issues arising from the audit (FRC, 2012). The audit committee also has to protect the interests of the investors and other stakeholders. They have to ensure that there is a high quality of disclosed financial information and that there is compliance with the requirements, monitoring and oversight of the internal audit function and at the same time maintaining the independence of the external auditor (Collier & Gregory, 1999; Goodwin, 2003). Through the interaction between the auditor and the audit committee the composition of the audit committee possibly
6 https://www.recht.nl/nieuws/ondernemingsrecht/archief/25066/ondernemingsbestuur-one-tier-vs-two-tier/
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effects what the audit committee reports in the annual report. This research focuses on what the company reports in the risk section of the annual report. While risk management is the responsibility of the management, overseeing risk management is the responsibility of the audit committee. The audit committee is responsible for discussing the risks with the greatest financial consequences and the approach of the management to these risks (NYSE, 2004). Psychology literature and management literature have already demonstrated that there are significant differences between sexes, differences in leadership styles, decision making, cognitive function and communication skills. Also corporate finance literature noted that gender diversity in boards and committees may have important complications for corporate governance (Carter et al., 2003; Erhardt et al., 2003; Huse & Solberg, 2006; Rose, 2007; Adams & Ferreira, 2009; Huse et al., 2009). Research suggests that women have a comparative advantage over men because they have better communicative capabilities within and among different groups (Wood et al., 1985; Fondas, 1997). According to Gul et al. (2011) the presence of female board members leads to higher quality of disclosures and fewer accounting restatements (Abbott et al., 2012). Female attendance at the board or committees will prevent taking excessive risks. Females are conservative and more risk averse as males. This has a positive effect on the integrity of financial reporting (Ittonen et al., 2010). Finally, there is evidence that boards with both males and females are more likely to discuss tough and sensitive issues than boards with only males (Clarke, 2005; Huse & Solberg, 2006; Stephenson, 2004). Gender diversity can cause more communication about issues that have not been treated or where not thought of. Various directors renew and broaden the focus of the organization. In addition, gender diversity improves the processing of information and advice (Carter et al., 2010). This suggests that the composition of the audit committee also influences the extent to which the risks identified by the company corresponds to the key audit matters of the external auditor.
2.7 Hypothesis
Following previous theory, the researcher of this study expects that the number of women in the audit committee has an impact on the number of similarities between the risk section of the annual report and the key audit matters mentioned by the external auditor. According to this theory the following hypothesis is formulated:
16 Hypothesis 1: Gender diversity in the audit committee has a positive impact on the rate of
similarities between the key audit matters of the audit report and the risk section of the annual report.
Audit committees in the UK are compulsory to give an explanation in the annual report about the key audit matters mentioned by the external auditor, in the Netherlands audit committees are not compulsory to give an explanation about the key audit matters. The audit committees in the UK should be more aware of the risks mentioned by the auditor. This could cause more similarities between the risk mentioned in the risk section and the key audit matters mentioned by the auditor. According to this the following hypothesis is formulated:
Hypothesis 2: In the UK there are more similarities than in the Netherlands between the risk
section of the annual report and the key audit matters mentioned by the external auditor.
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3. Methodology
To test the hypotheses established in the previous chapter, an empirical study is conducted. This chapter will describe how the research is conducted. First of all, section 3.1 describes the sample and the data used in this research. Section 3.2 gives a description of the dependent, independent and control variables used in this research. Finally, section 3.3 sets out the statistical model.
3.1 Sample & data
This study examines the key audit matters in the extended audit report, the risk section and the audit committee of 77 Dutch listed companies and 253 UK companies from the year 2015. The Dutch companies are all listed on the AEX, AMX or AScX. The UK companies consists of all companies in the FTSE7 100 and the 150 largest companies in the FTSE 250, selected based on the market capitalization measured at the beginning of 2015. In the UK this are the leading listed companies.
The required data is collected manually using of the annual reports and new extended audit reports from the year 2015. To the limited study period, this study looks only to the risk section and the audit report for the year 2015. Of the total of 330 companies, the following companies have been retrieved from the dataset for one of the following reasons:
- There is a standard auditor’s report included - No clear risk paragraph present in the annual report
- The audit statement has been issued by a non-big4 accountant - Data required for the relevant variables are not present
The final sample consists of 266 companies, consisting of 219 UK companies and 47 NL companies.
3.2 Variables
The next sections give a description of the dependent, independent, and control variables that are part of this research.
3.2.1 Dependent variable
The dependent variable is the rate of similarities between the key audit matters mentioned in the audit report and the risks mentioned in the risk section of the annual report
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(SIM_RIS_KAM). The rate of similarities is measured by dividing the number of key audit matters who are also mentioned by the company in the risk section by the total number of key audit matters mentioned in the audit report. Each key audit matter can get 0, 1 or 2 points. 0 points if the key audit matter is not mentioned in the risk section of the company, 1 point if the key audit matter is partially mentioned in the risk section of the company and 2 points if the key audit matter completely corresponds a risk in the risk section of the annual report. Therefore, the total number of key audit matters is multiplied by 2.
3.2.2 Independent variable
The conceptual model in chapter 2 (figure 1) shows that there are two independent variables, gender diversity in the audit committee (DIV_AC) and the country where the company is located, the UK of NL (COUNTRY). Gender diversity is measured in accordance with the research of Carter et al. (2010) by dividing the number of women by the total number of members of the audit committee. For the variable COUNTRY the companies are divided in two groups, for which a dummy variable is created. Where a UK company is coded with 1 and a company from NL with 0.
3.2.3 Control variables
This study looked at the relation between the gender diversity in the audit committee and the rate similarities between the risks mentioned by the company in the risk section and the key audit matters mentioned by the external auditor in the audit report. Moreover, it looked at the impact of the country where the company is located on the rate of similarities between the risks and the key audit matters. However, there exist more variables that may affect the dependent variable, but are not considered in this study. The control variables included in this study are: size of the company and the Big4 audit firm which performs the audit.
The first control variable is the size of the company. According to the research of Aldamen et al. (2012) the size of the company has impact on the financial statements of a company. Larger companies have better internal controls that ensure better financial reporting. The size of the company may have an impact on the number of similarities between the reported key audit matters and the risks indicated in the risk section of the company’s annual report. In accordance with the study of Aldamen et al. (2012) the size of the company will be determined by taking the logarithm of the total assets. Also Li (2008) shows that larger companies publish longer and more complex annual reports, what could cause a better alignment between the risk section and the key audit matters.
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The second control variable is the Big4 audit firm which performs the audit. The Big4 audit firms are PwC, Deloitte, KPMG and EY. Based on research of Francis & Yu (2009) the audit firm could possibly affect the similarities between the risks in the risk section and the key audit matters in the audit report. Research of Francis & Yu (2009) shows that audit quality may vary within Big4 audit firms. Also for this variable a dummy is created, where PwC is used as a frame of reference. Table 1 shows how the dummy-coding is applied.
Table 1 – Dummy coding
Dummy-variable 1 Dummy-variable 2 Dummy-variable 3
PwC 0 0 0
Deloitte 1 0 0
EY 0 1 0
KPMG 0 0 1
3.3 Statistical model
This quantitative research is carried out on the basis of a multiple regression analysis. Table 2 gives an overview of the variables that are part of this study. For the regression analysis, the following formulas can be established:
Hypothesis 1: SIM_RIS_KAM = β0 + β1* DIV_AC + β2* SIZE + β3 * BIG4 + εi Hypothesis 2: SIM_RIS_KAM = β0 + β1* COUNTRY + β2 * SIZE + β3 * BIG4 + εi
In this formula is the constant β0, βì represents the different coefficients, and εi represents the distortion term.
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Table 2 – Description of variables
Variables Measure
Dependent
SIM_RIS_KAM
Percentage of similarities between risks and key audit matters
Independent
DIV_AC COUNTRY
Percentage of women in the audit committee The country of the company (UK or NL)
Control
SIZE BIG4
Natural logarithm of total assets
The Big4 audit firm which performs the audit (PwC, Deloitte, KPMG and EY)
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4. Analysis and results
This chapter covers the analysis and the results according to the hypotheses addressed in chapter 2. Section 4.1 will elaborate on the dataset, section 4.2 provides descriptive statistics and multicollinearity is discussed in section 4.3. The results of both hypotheses will be discussed in section 4.4 and 4.5.
4.1 Dataset
Before the data is analyzed, the data is checked for observations that are outside the normal distribution of the data. Observations beyond the normal distribution can affect the results and thereby give a distorted view. This process is called winsorizing. The observations that fall outside the boundary of the average plus / min three times the standard deviation, get the value of the average plus / min three times the standard deviation (Field, 2013). This has resulted in the adjustment of 2 values to 27.7426 and the adjustment of 1 value to 16.3888 for the variable SIZE.
The variable SIZE is converted to the natural logarithm of the total assets, with the aim of reducing the impact of a skewed distribution in the observations.
4.2 Descriptive statistics
Table 3 shows the descriptive statistics of this research. This table shows the sample size, minimum, maximum, average and standard deviation of each variable. The descriptive statistics are only a summary of the results of the data collection and say nothing about the hypotheses to be tested.
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Table 3 – Descriptive statistics
Variables N Min. Max. Mean St. dev.
Dependent SIM_RIS_KAM 266 0,00% 100% 31,82% 23,51% Independent DIV_AC 266 0,00% 100% 27,46% 19,75% COUNTRY1 266 0 1 0,82 0,382 Control SIZE 266 16,39 27,74 22,07 1,85 BIG 41 266 0 3 1,33 1,20 1 = dummy variable
It is remarkable that on average only 27,46 % of the audit committee members are women. This shows that women are still in the minority in the audit committee. The mean of the similarities between the key audit matters in the audit report and the risks mentioned in the risk section is 31,82%. This shows that on average, only about 30 percent of the key audit matters are mentioned by the company in the risk section.
Table 4 shows an explanation of the dummy variable BIG 4 audit firm. Most observations in the sample apply to PwC with 92 annual reports and the least for EY with 42 annual reports. Deloitte and KPMG have respectively 63 and 69 annual reports in the sample.
Table 4 – Dummy variable Big 4 audit firm Organization Frequency Percentage
PwC 92 34,6%
Deloitte 63 23,7%
EY 42 15,8%
KPMG 69 25,9%
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4.3 Multicollinearity
Table 5 shows the correlation between the different variables. To calculate these correlations, the Pearson correlation test has been performed. This Pearson correlation test provides the ability to test for multicollinearity. Multicollinearity shows the degree to which two or more independent variables correlate. If multicollinearity is detected, this may affect the results of the regression analysis. Multicollinearity reduces the reliability of the results (Field, 2013). Also in the following two paragraphs, multicollinearity is discussed, but then on the basis of the VIF value.
Table 5 – Correlation matrix
Variables 1 2 3 4 5 6 7 Dependent SIM_RIS_KAM 1 Independent DIV_AC -0,061 1 COUNTRY 0,236** 0,287** 1 Control SIZE 0,072 0,123* 0,088 1 DELOITTE1 -0,022 0,139* -0,043 -0,074 1 EY1 0,021 -0,078 -0,124* 0,035 0,241** 1 KPMG1 0,047 0,047 0,094 -0,070 -0,330** 0,256** 1 1 = dummy variable
* Correlation is significant at the 0,01 level (2-tailed) ** Correlation is significant at the 0,05 level (2-tailed)
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Blumberg et al. (2014) state that when the correlation is higher as 0,7 or 0,8 multicollinearity is possible. Table 5 shows that there are some significant correlations between the variables. However, these are not large enough to assume that there is multicollinearity.
4.4 Results hypothesis 1
This section gives an explanation of the results following the first regression analysis. This regression analysis analyzes the extent to which gender diversity within the audit committee affects the rate of similarities between the key audit matters in the audit report and the risk section of the annual report (hypothesis 1). Table 6 shows the results of the first regression analysis. Model 1 shows the relationships between the control variables and dependent variable. Model 2 shows the relationships between the control variables, dependent variable and the independent variable: rate of female in the audit committee.
Table 6 – Results regression analysis 1
Variables Model 1 Model 2
Intercept 0,089 0,093 DIV_AC -0,086 SIZE 0,010 0,011 DELOITTE1 0,009 0,002 EY1 0,026 0,019 KPMG1 0,036 0,035 Adjusted R-squared -0,006 -0,005 F-value 0,603 0,744 Highest VIF 1,310 1,332 1 = dummy variable
First, Table 6 shows that there is no multicollinearity, there is only multicollinearity when the highest Variation Influence Factor (VIF) value is greater than 10. The highest VIF values in this regression analysis are 1,310 and 1,332. The adjusted R-squared in Table 6 shows the variance between variables. Model 1, shows that 0,6% of the variation of the dependent
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variable can be explained by the control variables. Model 2 gives an adjusted R-squared of 0,5 %. That means that 0,5% of the variation of the dependent variable can be explained by the control variables and the independent variable, the rate of female in the audit committee. The remaining 99,4% and 99.5% respectively are explained by variables not included in the model. Model 2 indicates a negative relation (β = -0,086) between the rate of females in the audit committee and the rate of similarities between the key audit matters in the audit report and the risks in the risk section of the annual report. This relationship is not significant, which means that hypothesis 1 could not be accepted. The rate of females in the audit committee has no impact on the rate of similarities between the key audit matters in the audit report and the risks in the risk section of the annual report
4.5 Results hypothesis 2
This section gives an explanation of the results following the second regression analysis. This regression analysis analyzes the extent to which the country of establishment of the company affects the rate of similarities between the key audit matters in the audit report and the risk section of the annual report (hypothesis 2). Table 7 shows the results of the second regression analysis. Model 1 shows the relationships between the control variables and the dependent variable, the dependent variable is the same within hypothesis 1 and hypothesis 2, model 1 in Table 7 is therefore similar to model 1 in Table 6.Model 2 in Table 7 shows the same variables as in model 1, but additionally the independent variable: COUNTRY.
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Table 7 – Results regression analysis 2
Variables Model 1 Model 2
Intercept 0,089 0,154 COUNTRY -0,155* SIZE 0,010 0,101 DELOITTE1 0,009 0,962 EY1 0,026 0,005 KPMG1 0,036 0,043 Adjusted R-squared -0,006 0,052 F- value 0,603 3,931* Highest VIF 1,310 1,312 1 = Dummy variable
* = Significant at the 0,01 level
Table 7 shows that also in the second regression analysis there is no multicollinearity, the VIF value is not higher as 10. The highest VIF values in this regression analysis are 1,310 and 1,312. The adjusted R-squared in model 2 of Table 7 shows that 5,2% of the variation of the dependent variable can be explained by the control variables and the independent variable: country of the company. The remaining 94,8% are explained by variables not included in the model.
Model 2 indicates a negative relation (β = -0,155) between the variable country where the company is located and the rate of similarities between the key audit matters in the audit report and the risks in the risk section of the annual report. This relationship is significant, however, contrary to the hypothesis that is set out in chapter 2, also hypotheses 2 could not be accepted.
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5. Conclusion & discussion
The first part of this chapter focuses on answering the main question mentioned in the introduction. Finally, the last section is dedicated to the limitations of this study and recommendations for future research.
5.1 Conclusion & discussion
The new extended auditor's report was central in this study and in particular the key audit matters that are part of this new auditor's report. Additionally also the risk section of the annual report plays a role in this study, since this also received extra attention by the introduction of the new auditor’s report. This research focused on the impact of gender diversity on the rate of similarities between the key audit matters in the audit report and the risks mentioned in the risk section of the annual report. This research focused on the annual reports and audit reports for the year 2015 and for companies from the UK and NL. The main question for this study was: What is the relation between the rate of women in the audit committee and the similarities between the key audit matters of the audit report and the risk section of the annual report of the company?
In addition, this study looked if the country of establishment of the company has impact on the rate of similarities. The following hypothesis have been prepared:
Hypothesis 1: Gender diversity in the audit committee has a positive impact on the rate of
similarities between the key audit matters of the audit report and the risk section of the annual report.
Hypothesis 2: In the UK there are more similarities than in the Netherlands between the risk
section of the annual report and the key audit matters mentioned by the external auditor. Both hypothesis have been tested by performing a regression analysis. The first regression analysis (hypothesis 1) shows a negative relation (β= -0,086) between the rate of females in the audit committee and the rate of similarities between the key audit matters in the extended audit report and the risks mentioned in the risk section of the annual report. The second regression analysis (hypothesis 2) also shows a negative relation (β= -0,155) between the country of establishment of the company and the rate of similarities between the key audit matters in the extended audit report and the risks mentioned in the risk section of the annual report. This relationship is significant, however, it is contrary to the hypothesis that is set out. Neither of the
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hypotheses can be accepted. So the rate of females in the audit committee has no effect on the rate of similarities between the key audit matters and risks and the country of establishment of the company has a negative instead of a positive effect on the rate of similarities between the key audit matters and risks. Different reasons can underlie these results. Possible reasons will be listed below.
This study assumes that the audit committee is influenced by the interaction with the accountant and the key audit matters that the auditor attaches. However, this interaction may not be present as assumed in this study. In addition, the audit committee is not required to take over the key audit matters that the auditor imposes. This could be a reason for a relationship other than expected between the rate of females in the audit committee and the rate of similarities between the key audit matters in the audit report and the risks mentioned in the risk section of the annual report.
A reason that the relationship between the company's country of establishment and the similarities between the key audit matters and risks is negative can be because the audit committee in the UK already reports in their report on the key audit matters mentioned by the accountant, this is required in the UK, and therefore this is not reported again in the risk paragraph of the annual report. This study looked at a difference in reporting by the audit committee, but there are still more differences between the regulations in the UK and NL, such as the differences in the board (one-tier vs. two-tier). Also these other aspects could cause other results as set out in the hypothesis.
5.2 Limitations and recommendations for future research
There are some limitations that may affect the results, this section gives a list of the restrictions for this study. These restrictions could give input for further research, possible further research is discussed in this section.
The data used in this study is gathered in collaboration with another student, this could affect the degree of subjectivity. There can be some differences in the interpretation of the similarities between the risk section in het annual report and the key audit matters in the audit report. Difference in interpretation among researchers could affect the results, this could reduce the reliability of the results.
In this study, only a comparison was made between the key audit matters and the risk paragraph of the annual report. However, the company's annual report consists of many more components. Also in other parts of the annual report, the company could provide information about the key
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audit matters mentioned by the auditor in the audit statement.It would be better to analyze the entire annual report to determine to what extent the company is aware of the key audit matters submitted by the accountant. Further research could also focus on other parts of the annual report and information provided in these other parts of the annual report.
This research focused on the annual reports and audit reports of the companies for one year, the year 2015. This may be a limitation for the results, this can impair the reliability and generalizability of the research. An analysis over several years would be better and could also pay attention on any developments in the key audit matters and risk paragraph over different years after implementation of the new extended audit report. As the new extended audit report is relatively new, these developments can be important for the future, to improve the audit report, but also improve the information given in the risk section of the annual report.
This research looked at the effect of the rate of females in the audit committee on the rate of similarities between the key audit matters in the audit report and the risks mentioned in the risk section of the annual report. However, the interaction between the audit committee and the auditor has been ignored. This research assumed that there is an interaction between the audit committee and the auditor. However, the extent to which this interaction actually exists is not included in this research. Future research could look at the extent to where there is interaction between the auditor and the audit committee and to what extent this impacts the similarities between the key audit matters and the risks in the risk section.
The sample consisted of 266 companies, but only 47 companies from the Netherlands. The distribution of companies from NL and UK is not optimal, this could influence the reliability of the results.
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