Audit firm, corporate governance, and audit quality: Evidence from Bahrain

Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74

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Advances in Accounting, incorporating Advances in International Accounting j o u r n a l h o m e p a g e : w w w. e l s ev i e r. c o m / l o c a t e / a d i a c

Audit firm, corporate governance, and audit quality: Evidence from Bahrain Jasim Al-Ajmi ⁎ Department of Economics and Finance, College of Business Administration, University of Bahrain, P. O. Box 32038, Bahrain

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a b s t r a c t The aim of this research is to document the perceptions of credit and financial analysts with regard to the relationship between the effectiveness of audit committee, size of the auditing firm and audit quality in the context of Bahrain, which is characterized by a developed financial sector, low-liquidity stock market, low turnover in board of directors of listed firms, an inactive merger and acquisitions market and almost non-extent litigation. A survey of 300 credit and financial analysts shows that analysts considered auditors' opinion useful. Both credit and financial analysts see the credibility of financial statements to be a function of the size of the auditing firm. Both groups assume that the characteristics of Big-Four firms allow them to produce better-quality reports than non-Big firms. Non-audit services were found to affect auditor's independence and hence impair audit quality. Both the groups of analysts believe that effective audit committee enhances the quality of audit reports. Financial analysts perceive financial statements to be more credible than do credit analysts. © 2009 Elsevier Ltd. All rights reserved.

1. Introduction Audit service is perceived to play an important role in reducing information asymmetry (Beatty, 1989; Willenborg, 1999) as well as in mitigating agency problems between managers and shareholders and between shareholders and creditors (Jensen & Meckling, 1976). Therefore, owners hire auditors to produce information used in contracting with managers (Antle, 1982; Watts & Zimmerman, 1986). Meeting these two roles depend on audit quality. While audit quality is considered an important element of corporate governance, it is unclear whether audit quality and other aspects of corporate governance (such as director knowledge and independence) are fundamentally complements or substitutes, according to Defond and Francis (2005). Audit quality is a concept that has different definitions for different people. DeAngelo (1981a) hypothesizes a two-dimensional definition of audit quality that has set the standard for addressing the issue. First, a material misstatement must be detected, and second, the material misstatement must be reported. Audit quality as such is the increasing function of the ability of an auditor to detect accounting misstatements and is related to the degree of auditor independence. Titman and Trueman (1986) propose that a good auditor provides precise information regarding the firm's value. Because the purpose of an audit is to provide assurance as regards the financial statements, audit quality is defined by Palmrose (1988) as the probability that financial statements contain no material misstatements. Davidson and Neu (1993) define

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audit quality as the ability of the auditor to detect and eliminate material misstatements and manipulations in the net income reported. Users of financial statements perceived audit reports to provide absolute assurance that company financial statements have no material misstatements and do not perpetrate fraud (Epstein & Geiger, 1994). However, auditors perceive audit quality in terms of strict adherence to GAAS/ISA requirements. Auditors working with a company also strive to reduce their business risk by minimizing auditees' dissatisfaction, avoiding litigation, and limiting the damage to their reputation, which could result from audit failure. The demise of Arthur Andersen in 2002 is an example of the ultimate results of audit failure. Regardless of any differences in the definition of audit quality, and even when users and providers of audit services question the quality of audit service, they agree on its importance. I acknowledge that measuring audit quality is problematic. The quality of an audit is not directly or immediately obvious, especially to creditors and investors. Audit qualitycontrol procedures are intended to maintain high standards of control over the process of an audit, but an audit failure usually becomes known only in the case of a business failure; witness Enron. An auditor's role is to assuage agency problems resulting from the separation of ownership and control (management). This role can be successful only if an audit opinion reflects the true findings of the audit engagement. According to the Statement of Financial Accounting Concepts No. 1 (SFAC No. 1, Paragraph No. 8, p. 9), “financial statements are often audited by independent accountants for the purpose of enhancing confidence in their reliability.” American Institute of Certified Public Accountants (AICPA) (1994) also acknowledges the importance of considering perceptions of investors on auditor independence. A former chairman of the AICPA, Elliott (2000)

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says “[The AICPA] believe[s] that appearances are very important and capital markets require confidence in financial statements and audit reports, and the member firms of the AICPA are basing their business of auditing on their reputations, and that is heavily affected by appearance.” Despite considerable research on audit quality, studies on audit quality in Bahrain are scarce. This might be due to the relatively low number of audit failures. Since the establishment of the first shareholding companies until 2008, there were only three reported cases of audit failure. These cases involve the General Trading and Food Processing Company (1994), the Bahrain Islamic Investment Company (2002), and the Bahrain Saudi Bank (2002). The fraud involved in the first case was carried out by the company's accountant, and the court ruled against the accountant. As for the second company, the case was settled out-of-court, and the partner involved in the case was asked to leave the firm, whereas the third instance resulted in replacement of the auditors without the auditors being taken to court. The low number of reported cases of audit failures does not ensure that audits of Bahraini listed firms are of good quality and should not mean that users of company reports should be complacent as to the quality of an audit. Therefore, this study investigates the way users of financial statements determine the quality of audit reports. Accordingly, a survey of the major users of financial statements (investors and lenders) with respect to their perceptions of the factors that determine audit quality, particularly with respect to the impact of corporate governance and size of audit firms on the quality of an audit report, is carried out. This research makes three contributions to the literature. First, although most of the research in the area uses different methodologies to investigate the determinants and the role of audit quality on integrity and quality of accounting information, studies on markets such as Bahrain, which is characterized by dominance of few accounting firms; largely uncommon cases of switching audit firms; weak enforcement of regulation reverent to audit industry, with exception of those related to financial institutions; low-liquidity stock market; and considerably less number of different institutional setup. Hence, this research provides additional insights to audit quality. Second, it responds to calls for empirical testing of the relationship between corporate governance and audit quality, according to Defond and Francis (2005). Third, Defond and Francis (2005) argue that research on the effectiveness of audit committee suffer from a number of problems such as weak statistical explanatory power and multi-colinearity problem. A survey method that asks respondents to state their perception of the effect of effective audit committee on audit quality overcomes these problems. The remaining part of the article is organized into four sections. The following section provides brief accounts of the audit market in Bahrain. Section 3 offers brief literature review on the relationship between effectiveness of audit committee, firm's size, and audit quality. Section 4 describes the data collection and research methodology. Section 5 presents the research findings of questionnaire survey. The final section provides conclusions of the study, its implications, and suggestions for future research. 2. Audit market in Bahrain1 Some important features of the audit market in Bahrain must be understood to perceive the context in which this study was undertaken. 1 Most of the contents of this section are based on interviews with the following persons: Adnan Yusuf, Chief Executive Officer of Albarka Banking Group; Ibrahim Zainal, Chairman of TRAFCO; Jamal Fakhro, CPA (US), Managing Partner of KPMG Fakhro and Ex-Chairman of the Bahrain Accountants Association (BAA); Elham Hasan, CPA (US), Managing partner of PWC-Bahrain; Abbas Radhi, CPA (US), a partner from BDO Jawad Habib, and Chairman of the BAA; Hameed Rahma, Assistant Undersecretary for domestic trade at the Ministry of Industry and Commerce; Jassim Abdulaal, CA (UK), Senior Partner, Grand Thornton-Gulf Audi-Bahrain; Yusuf Hassan, director of bank supervision at the Central Bank of Bahrain (CBB); Khalil Noor Eldeen, CFA, Exinvestment banker, Ex-director of BIBF, and a member of the audit committee of Ethmar Bank Group; and Waleed Bangash, CA (UK), Director, Financial Control (Strategic Planning), Unicorn Investment bank. The interviews took place between the 5th of January and the 4th of March, 2008.

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As of the end of February 2008, audit services in Bahrain are provided by 24 accounting firms. Five of these are considered local; four are operating as foreign branches; and the remaining are linked to international firms. The Big Four; i.e., Ernst & Young (E&Y), Deloitte & Touche (D&T), KPMG, and PricewaterhouseCoopers (PWC) have a strong presence in Bahrain. D&T and KPMG operate as a joint venture, whereas the other two operate as branches of international firms. BDO Jawad Habib and E&Y are the only two firms registered with the United States (US) Public Company Accounting Oversight Board (PCAOB). The Bahrain Stock Exchange (BSE) was established in June 1989. As of July 2007, there were 41 listed Bahraini incorporated firms (two of these have been de-listed and did not issue their reports of 2006). The majority of the companies are retail banks, wholesale banks, and investment companies. The Central Bank of Bahrain (CBB) requires financial institutions to be audited by one of the big audit firms. Audit services are regulated by the Amiri Decree Number 26 of 1996, which requires auditors to obtain a license to practice and set the minimum requirements for a license. In effect, audit firms got two licenses, one to practice auditing and the second specifically to offer auditing services to financial institutions. Appointments of auditors, as per article (205) paragraph (e) of the Bahrain Commercial Companies Law Number 21 of 2001, should be made on a yearly basis at firm annual stockholder meetings. However in practice, boards of directors are empowered by annual meetings to appoint auditors and to determine their remuneration. This practice is subject to criticism on the grounds that an auditor's role is to mitigate agency problems that might exist between the board and the shareholders. The CBB's authority is based on article, (61) paragraph (a), of The Central Bank of Bahrain and Financial Institutions Law Number 64 of 2006, which states: “Every Licensee shall appoint one or more qualified and experienced external auditors for its accounts for every financial year. Prior written approval by the Central Bank will be required before appointing an auditor.” This approval is needed annually. In cases wherein a decision has been taken to replace the external auditors before the end of the year, the respective financial institutions are also required to inform the CBB about the reasons for this decision. Since 2002, only three of the Big Four have been approved to audit the financial statements of the locally incorporated banks. Exclusion firm of the Fourth came after its audit failure of the financial statements of locally incorporated retail banks. CBB guidelines specify experience of the auditors, experience of the firm, and number of partners, among other requirements. Currently, only Big Four firms audit small financial institutions. The internal guidelines of the CBB allow non-big firms to audit small investment companies. As of September 2007, Bahraini incorporated financial and non-financial firms listed on the Bahrain Stock exchange are audited by five companies, the Big Four and one other company, which is connected with an international firm. The other two companies are a joint venture between a local audit firm and regional or international companies. Unlike some other countries in the region where listed firms are audited by two audit firms, all companies in Bahrain are audited by only one audit firm. Audit services industry is dominated by the Big Four. A total of 82.5% of the 41 listed companies on the BSE that published their annual reports in 2007 are audited by one of the Big Four, and the other 17.5% are audited by a non-Big Firm company. In Bahrain, it is not mandatory to switch audit firms. In fact, in 2006, the CBB took a position against a motion in the parliament to mandate such a requirement on the ground that small markets are distorted by such decisions. Experience has shown that switching of audit firms takes place in very rare cases and generally occurs only after an audit failure. The CBB does require auditors of financial institutions to switch auditing partners at least every five years. Auditing firms claim that

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they follow such a practice for other firms in accordance with their own internal policies. Auditors are not prevented from joining a client firm at any time, even immediately after formulating an audit opinion. The presence of multinational firms and international financial institutions in Bahrain, the government's long-standing policy of attracting foreign investment, the effect of globalization, and the size of the Bahrain economy are possible reasons for the nondevelopment of local accounting and auditing standards. As a result, companies in Bahrain are required to comply with international financial reporting standards (IFRS), whereas accounting firms must comply with the international standards on auditing (ISA). These requirements apply to all companies, including financial institutions. The latter are required to comply with the financial accounting standards issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI). However, in accordance with the requirements of AAOIFI, for matters on which AAOIFI standards do not exist, the respective institutions are required to comply with the relevant IFRS. This is also applicable to conventional bank licensee units. Requirement to comply with the IFRS and ISA are perceived by both the government and the accounting firms as the basis for the competitive advantage that Bahrain enjoys. As in many other countries, the practice in Bahrain is that accounting firms should sign the audit reports and not the partners who supervise the audit engagements. This is due to the lack of legal sanction for the auditors of companies operating in Bahrain to sign the audit report in their own names. Article (19) of the Amiri Decree No. 26 of 1996 gives auditors the choice to sign the audit reports using either their names or the name of the company. Chairmen and chief executive officers sign the company(ies)'s reports as representatives of the respective board(s) of directors. As such, they assume no more personal responsibility than other members on the boards. All listed and unlisted financial institutions are required to form independent audit committees. Listed non-financial firms are not required by law to form such committees. Members of the audit committees of financial institutions are nominated by the boards; however, they need to be approved by the CBB. However, whether the criteria that the CBB uses for its approval include an assurance of independence and knowledge or merely an affirmation of the latter is not clear. The principles of Auditor Oversight issued by the International Organization of Securities Commissions (IOSCO) in 2002 state that audit quality is an important requirement for the integrity of financial statements. However, Bahrain lacks a formal independent audit oversight regulating authority, similar to the PCAOB in the US. The establishment of such an institution is considered the best practice internationally, as it provides one of the mechanisms that increase confidence in the quality of an audit (International Audit Networks (IANs), 2006). IANs recognize that the establishment of independent audit oversight regimes have reinforced the independence of auditors, and in their view, improved the governance and regulation of the auditing profession. They state that independent audit oversight regimes have led to audit firms emphasizing on the quality of the audit. The need for having an audit oversight in Bahrain is a view that is shared by most of those interviewed for the purpose of writing this section. Furthermore, peer review for other companies is uncommon in Bahrain. The Ministry of Industry and Commerce (MIC) as per article (27) establishes a disciplinary committee composed of the Chairman, who should be a judge from the Civil High Court, appointed by the Minster for Justice, and two other members, who are specialists in auditing, appointed by the MIC. The disciplinary committee investigates the cases referred by the MIC for misconduct, violations of professional requirements, serious negligence, or violations of the Amiri Decree No. 26 of 1996. However, there are no public records available regarding the referred cases. Previous experience shows that litigation risk is very low in Bahrain. In the corporate history of Bahrain, there are neither publicly

announced out-of-court settlements between the auditors and their clients nor court judgments against erring auditors. However, there is one case pending against the auditors belonging to one of the non-Big Four firms. No decision has yet been arrived at, even though it dates back to the mid-1990s. Another case involving E&Y was settled out-of-court, and the partner involved in the case was asked to leave the firm. However, the low number of litigation cases should not be seen as an indicator of high audit quality in Bahrain. The fewer cases of litigation might be due to the high cost, weak regulation, less efficient court system, the difficulties of bringing such cases to the court, and passive investors. However, this situation changed after the audit failure of the Bahrain Saudi Bank. The role of the CBB in maintaining the stability of the financial system ensures the maintenance of a certain level of audit quality during the auditing of financial institutions. Furthermore, as the number of foreign investors increase, raising the awareness of investors, enhancing the efficiency of the judiciary system, increasing the probability of materialization of risk, increased government privatization programs, and reduction of government ownership in listed firms are likely to increase the probability of materialization of litigation risk. Restatements of earnings are uncommon in Bahrain. The only restatement between 1957 and 2007 in the financial statements of listed companies was in 1994 when the newly appointed auditors restated the profit figures of the General Trading and Food Processing Company. In Bahrain, it is common to outsource internal audit services to audit firms. Firms thus avoid the cost of creating an internal audit department with expertise that is not used during the year. The CBB prohibits external auditors from providing routine internal audit services to their clients. OM2.7.2 of the Operational Risk Management guidelines states that “The [CBB] will generally not permit licensees to outsource their internal audit function to the same firm that acts as their external auditors. However, the [CBB] may allow short-term outsourcing of internal audit operations to a licensee's external auditor, to meet unexpected urgent or short-term needs (for instance, on account of staff resignation or illness). Any such arrangement will normally be limited to a maximum of one year.” Universities in Bahrain use American textbooks in their business programs, including textbooks on accounting. Bahrain University, the biggest and the only public university, has a policy that dictates professors teaching at the college of business to have been educated in western universities. Furthermore, auditors and analysts are expected to seek professional qualifications from the US and the United Kingdom (UK). Advertisements on the websites of financial institutions and in newspapers seeking new staff state that applicants need to possess professional qualifications obtained from the US and the UK; this policy seems to be followed by both the government and the private sector. For example, the Labor Fund of Bahrain (www.lf.com), which is the government arm for training, awarded two contracts to BDO Jawad Habib and Earnest & Yong in 2007, worth 14.1 million Bahraini Dinars (US$37.4 million), to train 7200 Bahrainis for obtaining American and British accounting qualifications. The human resources development fund (HRD Fund) (www.hrdfund.org) and the Bahrain Institute of Banking and Finance (BIBF), the banks' arms for training their staff, offer funding for and provide training for their staff only for acquiring professional qualifications from the US and UK. This policy is also followed by audit firms that require their local staff to seek their professional qualifications from these two countries. Unlike in the US, there is no professional body in Bahrain to play a role similar to that of AICPA. The Bahrain Accountants Association (BAA), which was established in 1972 as a nongovernmental organization, has a very minimal role in the further development of the profession. Its activities are limited to workshops, seminars, and public lectures. Membership in the BAA is voluntary. Despite thousands of accountants qualifying for membership into the BAA, including all holders of an undergraduate degree in Accounting, the number of members at the end of January 2007 was only around 250, among whom, the active members were very few.

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3. Brief literature review Watkins, Hillison, and Morecroft (2004) summarize both theoretical and empirical work on audit quality from DeAngelo (1981b) through 2002. Francis (2004) offers an excellent review of published empirical attempts over a quarter century beginning in 1981. Defond and Francis (2005) offer a critical review of audit quality literature after 2002. Besides these three studies, a brief review that presents the salient feature of the relationship between firm size, corporate governance, and audit quality is imperative to set the ground for the stage for the author's survey results. The relationship between the audit-firm size and the quality of auditreporting decisions has been widely investigated; however, the results are not conclusive. Although extensive empirical evidence suggests that the Big Four firms provide higher quality audits (DeAngelo (1981b), Palmrose (1988), Deis and Giroux (1992), Mutchler, Hopwood, and McKeown (1997), Krishnan and Schauer (2000), Fuerman (2004), there is other evidence to suggest that no differences in quality exist between the Big and non-Big audit firms (Jeong and Rho (2004) and Khurana and Raman (2004). Krishnan (2005) comments that audit quality differs between and within the various audit firms. These results might have an important implication for the perception of investors and lenders about the quality of audit reports. A number of reasons are used to explain the positive effect of auditfirm size on audit quality. Audit quality is a function of how well an audit team functions, and presumably firms perform best based on the following criteria: 1. availability of adequate resources (human and technology) (DeAngelo, 1981b; Frantz, 1999); 2. control systems of high standard; 3. larger firms are more independent of their clients (DeAngelo, 1981b); 4. large firms have a considerable business at stake if they lose their reputations (DeAngelo, 1981b); 5. charging higher audit fees that allow them to spend more time and effort in each audit engagement (Francis, 2004; Goodwin-Stewart & Kent, 2006); and 6. high significant economic costs imposed on the auditor in the event of audit failure (DeAngelo, 1981b). Auditor independence from the client's management is considered as one of the prerequisites for a good-quality audit. Several definitions can be found for the independence of the auditor. Among them are the following: “the conditional probability of reporting a discovered breach” (DeAngelo, 1981a, p. 186); “the ability to resist client pressure” (Knapp, 1985); “a function of character—with characteristics of integrity and trustworthiness being essential” (Magill & Previts, 1991); and “an absence of interests that creates an unacceptable risk of bias” (Beattie, Fearnley, & Brandt, 2001). Several factors are found to have potential influence over the independence of the auditor. Among them are size of the auditing firm (Shockley, 1981); non-audit service (Shockley, 1981; Knapp, 1985); the client's financial conditions (Knapp, 1985); the nature of conflict of interest (Knapp, 1985); the tenure of the audit firm, (Shockley,1981); the degree of competition in the audit-service markets (Knapp, 1985); and the audit committee (Teoh & Lim, 1996). Eichenseher and Shields (1983) show that chief financial officers believe that audit quality is a function of 11 items. These are ethical standards, reputation, industry expertise, audit-team expertise, geographical coverage, audit fees, working relationships, meeting deadlines, technical qualifications, accessibility of the audit firm, and range of services offered. Shockley and Holt (1983) argue that bank chief financial officers rank the Big Firms in terms of 10 attributes. These are prestige, professionalism, expensiveness, competence, aggressiveness, conservativeness, impendence, reliability, helpfulness, and bureaucratic behavior. Carcello, Hermanson, and Mcgrath (1992) report 12 items that are perceived by auditors, preparers, and users of financial statements to

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determine audit quality. These are auditee size, audit team and firm experience with the client, industry expertise, responsiveness to client needs, compliance with GAAS, firm executive involvement, firm commitment to quality, involvement of audit committee, degree of personal responsibility, conduct of fieldwork, auditor's skeptical attitude and firm personnel maintain freshness of perspective. Corporate governance is defined as the system by which firms are directed and controlled (Cadbury, 1992). The principles of corporate governance formulated by the Organization for Economic Cooperation and Development (OECD) state that “An annual audit should be conducted by an independent, competent and qualified, auditor to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects,” (OECD, 2004)). KPMG (2006, p. 2) states that audit committees are responsible for oversight of the company's financial reporting process, including related risks and controls as well as the company's internal and external auditors. U.S. SEC (2003) states that the primary role of the audit committee is to oversee the financial reporting process with the ultimate objective of ensuring high-quality financial reporting. KPMG (2006) outlines five guiding principles for audit committee for playing an effective role. These are: 1) recognize that one size does not fit all, 2) have the “right” people in the committee, 3) monitor and insist on the right “tone at the top,” 4) ensure that the oversight process facilitates the committee's understanding and monitoring of key roles, responsibilities, and risks within the financial reporting environment, and 5) articulate and exercise the committee's direct responsibility for the external auditor. An effective independent audit Committee is seen as one of the determinants of audit quality, see for example Dhaliwal, Naiker, and Navissi (2006). Such a committee recommends external auditors and manages the relationship between them and the company, according to AICPA (2004) and OECD (2004). Zhang, Zhou, and Zhou (2007) report that firms with an ineffective audit committee are more likely to be identified with an internal control weakness. Krishnan (2005) finds that there is a positive relationship between audit committee independence and the quality of internal control prior to the enactment of SOX. However, others report that the role of audit committees in overseeing and strengthening the audit process is not significant, Carcello, Hermanson, Neal, and Riley (2002); Abbott, Parker, Peters, and Raghunandan (2003). Piot and Missonier-Piera (2007) report that audit quality, unlike quality of corporate governance, measured by firm size (Big and non-Big) does not have a significant influence on the cost of debt of non-financial French listed firms. These results are robust even after controlling for a set of auditees' characteristics such as firm size, profitability, asset structure, and interest coverage ratio. However, others report that one of the most important functions corporate governance can play is ensuring quality of financial reporting process (see for example, Blue Ribbon Commission, 1999)). Dechow, Sloan, and Sweeney (1996); Beasley (1996); Beasley, Carcello, and Hermanson (1999); Beasley, Carcello, Hermanson, and Lapides (2000); Carcello and Neal (2000); and Klein (2002) report an association between weaknesses in governance and poor financial reporting quality, earnings manipulation, financial statement fraud, and weaker internal controls. Audit quality might be impaired by a number of factors especially by the pressure on the accounting firms to increase profit, reduce costs, and increase fees. Otley and Pierce (1996) and Willett and Page (1996) report that it is not unusual for accounting firms to trim their time budgets and increase control over their staff so as to increase profits, which thus leads to the response of the audit staff to these pressures by resorting to dysfunctional behavior such as falsifying audit work. Otley and Pierce (1996) also argue that a performanceevaluation system might represent a threat to audit quality. Furthermore, the pressure to meet the time budget is found to lead to a reduction of audit quality (Kelley, Margheim, & Pattison, 1999).

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Additionally, the low probability of bringing in litigation cases against auditors and imposition of a limit for liabilities affect the economic incentives that deliver good audits. 4. Research methodology and sample characteristics This study was undertaken in two stages. The first stage involved the use of a mail-in questionnaire to seek the views of loan officers and investment analysts on the issues of the auditing firm's size and the attributes of audit quality. The second stage entailed a series of interviews with senior auditors of audit firms, banks, and investment companies on the issues of size of the auditing firms and audit quality, with the aim of more detailed analysis. The use of the questionnaire is motivated by an argument in Beattie and Fearnley (1998, p. 264) that “the questionnaire approach provides richer insights than is possible using secondary data analysis, which focuses on economic factors, because the questionnaire instrument includes both economic and behavioural factors.” They also point out that a behavioral or qualitative technique is important to clarify theories in accounting research because it can provide “new insights into buyers' behavior is offered by the ‘relationships approach’ to professional services developed in the service marketing literature, which classifies relationships (in the present case, auditor– client relationships) based on buyer type.” They note further that an “economic-based framework can be expected to provide only a partial explanation of auditor choice.” The corporate debt secondary market in Bahrain is thin, with only two issues, which means that companies seeking credit must rely on bank loans. There are also limited numbers of listed companies, so considerable equity investment in local companies is directed to nonlisted companies or to companies whose financial statements are not publicly available. Thus, a survey approach to examine the role of firm size in determining audit quality from the users' perception is the best approach in Bahrain. Moreover, some of the factors the author tests in the study (non-audit services and outsourcing internal audit services) are not disclosed even by listed companies, which are required by law to publish annual and quarterly reports. This makes a survey approach the only viable methodology. The survey instrument was developed upon review of literature and after consultation with five analysts with appropriate experience. It was comprehensively tested to improve its quality and to make sure it was applicable to current practices in Bahrain to generate the highest response rate. The questionnaire was then pretested on a sample of 20 credit and financial analysts whose comments were incorporated in the final version. The survey was administered during January and February 2007 to 150 credit analysts and to 150 financial analysts working in Bahrain for retail banks, wholesale banks, and investment companies. Out of the 300 questionnaires distributed, 175 questionnaires were returned, of which 164 questionnaires were useful for the analysis, resulting in a 54.7% response rate. Sixty percent response was obtained from financial analysts and 49.3% from credit analysts. One of the most common problems cited in a survey methodology is of non-response bias, when data from survey respondents may turn out to be invalid. To ensure the reliability and validity of the data, it is essential to examine the sample for the possibility of a non-response bias (see Bartlett & Chandler, 1997; Mallin & Ow-Yong, 1998). The author follows Oppenheim (1999) and Wallace and Mellor (1988), and the first 15 questionnaires were compared with the last 15 questionnaires, using t-test to investigate the differences. The results show that there is no significant difference between the 15 early and the 15 late responses, implying the absence of non-response bias. The questionnaire is divided into five sections. Section I requires respondents to provide information about the type of their institutions; the positions they occupy to determine whether their work

involves analysis of financial statements for credit and investment decisions; and their qualifications, age, and length of experience in decisions on investing and lending. Table 1 describes the respondents. Section II asks of a number of questions found in the accounting and corporate governance literature to determine audit quality; Section III asks respondents to state their perceptions on the important competencies of auditors that might affect the credibility of an audit firm; and Section IV asks two questions soliciting respondents' perceptions of the credibility of audit reports issued by Big Four and non-Big Four auditors. Finally, Section V requires participants to state their perceptions of the effect of effectiveness of audit committee on quality of audit. The respondents work for retail banks (38.4%), wholesale banks (42.1%), and investment companies (19.5%). Although the respondents hold a variety of positions in their organizations, the author wanted to reach those who analyze company reports for the purpose of obtaining decisions on investment and lending, and respondents were asked to indicate the purpose for which they analyze reports. Around 54.9% are investment analysts, whereas 45.1% are credit analysts. The majority of the respondents (74.4%) held graduate degrees or qualifications with respect to accounting or investment analysis. A majority of the respondents also had more than five years of experience, whereas around 60% of those with experience of less than five years had professional accounting qualifications. Hence, the information gathered ought to be reliable and could be generalized to the whole population. 5. Results and analysis The first question the respondents were asked to answer is about their confidence in the independence of the auditors performing their audit engagements. Auditor independence is seen by many as an important prerequisite for audit quality (DeAngelo, 1981b). Lack of auditors' independence indicates that clients may be exerting influence over the results of their audit. If this is the case, an auditor will be unable to carry out the necessary duties to reduce agency problems and ensure credible financial statements. The majority of the respondents seem to be confident (but not extremely confident) that the auditors are independent when they express their opinion. Table 2 shows the means and standard deviations

Table 1 Sample characteristics. Institutions

Frequency

Percent

Cumulative percent

Retail bank Wholesale bank Investment company (Bank) Total Position Financial analysts Credit analysts Total Highest qualification B.Sc. Graduate degree CPA/CA/ACCA/CFA Total Age of the respondents Less than 25 years 25 to 29 years 30 to 34 years 35 to 39 years 40 years and older Total Length of experience Less than 5 years 5 to 9 years 10 to 14 years 15 to 19 years 20 years and longer Total

63 69 32 164

38.4 42.1 19.5 100.0

38.4 80.5 100.0

90 74 164

54.9 45.1 100.0

54.9 100.0

50 67 47 164

30.5 40.8 28.7 100.0

30.5 71.3 100.0

8 34 36 54 32 164

4.9 20.7 22.0 32.9 19.5 100.0

4.9 25.6 47.6 80.5 100.0

52 28 46 14 24 164

31.7 17.1 28.0 8.5 14.6 100.0

31.7 48.8 76.8 85.3 100.0

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of the responses. The mean responses show that respondents perceive auditors in Bahrain as independent but not highly independent. This observation came from credit analysts as well as financial analysts, although financial analysts thought that auditors were more independent than credit analysts. To test whether this difference is significantly different from zero, the author applies a Levene test and t-test. The homogeneity of the variances of the responses of two groups is confirmed by the results obtained from the Levene test, so a t-test is performed to test the differences in the mean of the responses between credit and financial analysts. The results show that the mean difference is not significantly different from zero, indicating that both groups seem to agree that auditors in Bahrain are independent of their clients. Another measure of audit quality is that financial statements are free from unintentional misstatements or omissions of material information. Respondents were asked to indicate their confidence level with regard to whether the financial statements of Bahraini companies meet a standard using such a definition of audit quality. The mean rank of the responses shows that the majority of respondents (86.6%) are at least confident, and only 2.4% do not have any confidence at all in the financial statements. The results also show that, on average, financial analysts are more confident in financial statements than credit analysts (mean of response of 3.49, 5.00 being extremely confident compared with the mean of 3.38). The t-test results indicate that the mean difference is significantly different from zero, indicating that the two groups are homogeneous in their perceptions of the quality of audits. This can also be seen from the results of the Levene test, which shows that variances of the responses of the two groups do not differ significantly. The relatively high confidence of financial analysts in financial statements might be due to 1) their reliance on these statements as the main source of information, and therefore, they need to believe that such financial statements are more reliable than the credit analysts do; 2) financial analysts deal mainly with financial statements of listed firms which are audited by either the Big Four or BDO Jawad Habib, whereas credit analysts deal mainly with the small- and medium-sized firms, the accounts of which are audited mainly by small audit firms. This might imply that “audit quality” has been socially constructed to fit needs of financial analysts more than the users of financial statements. Credit analysts, on the contrary, have

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access to their clients facilitating the process of obtaining more information from clients whenever the need arises. Whether auditor reports influence credit and investment decisions is the third question in the questionnaire. The mean of the responses indicates that those reports do influence analyst decisions. The majority of respondents appeared to take auditors' reports into consideration to different degrees; only 8.5% of the respondents answered that the reports do not influence their decisions at all. Mean responses indicate financial analysts (3.49) appear to be influenced more by auditors' reports than credit analysts' reports (3.38). The results of Levene's test for the equality of variances indicate no significant difference between the variances of the responses of both groups, but the results of the t-test indicate the mean responses of the groups differ significantly from each other. These results might be explained by two reasons: 1) credit analysts can obtain additional information from clients who are seeking financing, and 2) bank–client relationships give creditors more leverage to know their clients, their financial positions, and their probability of defaults. Investors and financial analysts do not generally have these advantages. Financial analysts would be expected to rely more on financial statements and auditors' reports as one way to determine the credibility of a financial statement. The effect of non-audit services (NAS) by firms' external auditors is one factor cited in the literature as having an impact on auditor independence and audit quality. Such services tend to be regarded by regulators in the UK, the US, Australia, and various other countries as a threat to auditor independence (Craswell, 1999, p. 29). In fact, research findings on a connection between the joint provision of audit and NAS and auditor independence have been inconclusive and contradictory (Ashbaugh, 2004; Brandon, Crabtree, & Maher, 2004; Chung & Kallapur, 2003; DeFond, Raghunandan, & Subramanyam, 2002; Frankel, Johnson, & Nelson, 2002; Geiger & Rama, 2003; Kleinman, Palmon, & Anandarajan, 1998; Reynolds, Deis, & Francis, 2004). A review of the literature by Beattie and Fearnley (2002) shows no evidence to support the hypothesis that the joint provision of audit and NAS could threaten auditor independence; it is acknowledged that it might threaten the appearance of independence (but the audit quality will not be affected).

Table 2 Means and standard deviations of the responses, Levene's F test, and t-test. Questions

Stat.

1. How confident are you that the Qualified Accountants are independent in performing the audit?

Mean 3.440 Std 1.075

3.490 1.008

3.380 1.155

0.111

0.654

5 = Extremely Confident, 0 = No Confidence 2. How confident are you that the financial statements are free of unintentional (alternatively, intentional) misstatements Mean 3.440 or omissions? Std 1.075

3.490 1.008

3.380 1.155

0.111

0.654

Mean 3.650 Std 0.877

3.780 0.897

3.490 0.832

0.007

2.139a

Mean 3.730 Std 1.086

3.760 1.042

3.700 1.144

2.219

0.309

Mean 1.770 Std 0.928

1.870 0.927

1.650 0.911

0.041

1.401

Mean 2.680 Std 1.160

2.640 1.202

2.730 1.114

0.635

− 0.467

5 = Extremely Confident, 0 = No Confidence 3. The influence of the auditor's report on your decision-making process.

5 = Great Influence, 0 = No Influence 4. In your opinion, the provision of non-audit services by the audit firms will impair its independence and therefore its quality of services. 5 = Strongly Agree, 0 = Do Not Agree 5. In your opinion, outsourcing internal auditing activities to the external auditors will enhance the audit quality.

5 = Strongly Agree, 0 = Do Not Agree 6. In your opinion, long association of the relationship between auditors and their clients will enhance the credibility of financial statements 5 = Strongly Agree, 0 = Do Not Agree Std: Standard Deviation. a Significant at less than 5% significance level.

Sample Financial Credit Levene's t-test analysts analysts F test

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Antle, Griffin, Teece, and Williamson (1997) contended that auditor independence would not be affected by NAS because this client association would improve audit quality. The reasons are that an auditor's knowledge of the client company can be improved by the provision of NAS, resulting in increased objectivity (knowledge spillover); independence (Goldman & Barlev, 1974; Wallman, 1996); and economies of scope (Arrunada, 1999). Others, including Brandon et al. (2004), Frankel et al. (2002), Glezen and Millar (1985), Jenkins and Krawczyk (2002), Lowe and Pany (1995, 1996), Raghunandan (2003), and Wines (1994) argue that performing non-audit and audit services will pressurize auditors not to conduct the audit function objectively, impairing their independence. Auditors will end up auditing their own work, according to “Revision of the Commission's Auditor Independence Requirement,” 2001. Auditors will be weakened if they rely on NAS (Canning & Gwilliam, 1999). This will ultimately impair the quality of an audit. Elstein (2001) contends that high consulting fees negatively affect auditor independence and worsen audit quality; having provided NAS, auditors become more likely to give the client the benefit of the doubt, including more flexibility in recording and adjusting discretionary reserves that could lead to manipulation of earnings figures. The respondents of the survey conducted by the author were asked to determine how much they agree with the statement that “the provision of non-audit services by audit firms will impair auditor independence and therefore its quality of services.” The results show that the majority agreed that auditors offering non-audit along with audit services might compromise their independence, leading to a poorer quality of their audit. The Levene test and t-test results show that the perceptions of the two groups were similar. Abbott, Parker, Peters, and Rama (2007) argue that the effect of outsourcing internal audit services to external auditors will lead to economic bounding only if companies outsource routine internal audit tasks and also will result in a loss of internal auditors' independence, although outsourcing non-recurring internal audit tasks will not lead to economic bonding. In Bahrain, although some non-financial non-listed companies outsource their internal audit to non-external auditors, some companies do outsource such services to their external auditors. To test how credit and financial analysts perceive the effect on audit quality of outsourcing internal audit tasks to external auditors, respondents were asked to express their opinion of the role of outsourcing in the credibility of financial statements. The results show that the majority (more than 76%) do not look favorably on outsourcing internal audit tasks to a firm's external auditors. Levene's test on the variances of the responses shows that the variances are homogeneous. The mean difference is not significantly different from zero, indicating that credit analysts and financial analysts share similar opinion.

Auditor tenure is one among the factors that affect audit quality, although the relationship is complex. Auditors auditing a client for the first time generally need more time to understand the client's business, which increases the risk of missing material and misstatements. Yet, although a very long association may lead to a better understanding of the client's business and make it more likely that the auditor will detect misstatements and earnings management, it might also produce a poorer quality audit. Shockley (1981) and Deis and Giroux (1992) argue that long tenure has the potential to cause complacency, more relaxed audit procedures, too much dependence on management representations, and less skepticism and less diligence in gathering evidence. Myers, Myers, and Omer (2003) and Ghosh and Moon (2005) contend that long relationship improves audit quality and that mandatory limits on an auditor's term might put on unnecessary cost burden on investors. More recently, Knechel and Vanstraelen (2007) find that long associations between auditors and clients do not impair auditor independence; they do not find evidence to support the contention that long-term relationships will make auditors better at predicting bankruptcy. The author's survey results show that opinions of the respondents vary, although the largest group perceives tenure to have little effect on the quality of an audit. Levene's test for equality of variances shows that variances of the responses of the groups are homogeneous. The ttest shows no significant difference between the means of the responses of the two groups. Fourteen competencies (attributes) have been found in the literature to contribute to the quality of the audit service and ultimately the audit report: specialization; independence; industry expertise; technical competence in applying GAAP & GAAS/IFRS & ISA, a wide range of skills such as analytical skills; provision of real value for the audit fees paid by clients; proactiveness, taking initiative; due care; commitment to providing and maintaining quality service; professional audit expertise; reputation; high ethical standards; and possessing strong accounting and auditing knowledge. Survey respondents were asked to state their perceptions with regard to the level of importance of each of those competencies for the quality of audit, using a 6-point Likert scale, where zero indicates that the competency is not important in determining audit quality and 5 indicates that it is extremely important. Table 3 presents the summary statistics. Accounting and auditing knowledge is ranked first, followed by professional audit expertise (with a mean of 4.52). Auditor independence is ranked third with a mean of 4.49. Real value for the audit fees is ranked last by both groups of analysts with a mean of 3.46. The low ranking of this factor should come as no surprise because users of financial statement would be more concerned about the

Table 3 Descriptive statistics of competencies/factors, Levene's F test, and t-test. Competencies/Factors Specialization Independence Industry Expertise Technical competence in applying Wide range of skills (GAAP & GAAS/IFRS & ISA) Real value for fees Proactive Takes initiative Due care Quality commitment Professional audit expertise Reputation Ethical standards Accounting & auditing Knowledge a

Significant at less than 0.05 level.

Whole sample

Financial analysts

Credit analysts

Std. Deviation

Mean

Std. Deviation

Mean

Std. Deviation

Levene's F test

t-test

Mean 4.140 4.490 4.050 4.080 3.750 3.400 3.630 3.730 4.120 4.300 4.520 4.150 4.410 4.610

1.021 0.883 1.064 1.203 1.076 1.237 1.203 0.999 1.090 0.999 0.917 1.152 1.129 0.937

4.210 4.610 4.100 4.170 3.700 3.340 3.610 3.770 4.270 4.310 4.520 4.240 4.530 4.620

0.977 0.730 1.039 1.144 1.126 1.300 1.287 1.092 1.003 1.098 0.939 0.878 1.173 0.801

4.050 4.350 4.000 3.970 3.810 3.460 3.660 3.680 3.950 4.300 4.510 4.030 4.270 4.590

1.071 1.026 1.098 1.271 1.016 1.161 1.101 0.878 1.169 0.872 0.895 1.414 1.064 1.084

0.089 11.358a 0.000 0.057 0.000 0.903 4.220a 0.873 0.689 1.986 0.388 7.717a 0.108 0.603

0.981 1.830 −0.655 1.026 − 0.655 − 0.592 − 0.274 0.579 1.890 0.088 0.060 1.153 1.490 0.187

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Table 4 Respondents' perceptions of the credibility of audit reports. Credibility of audit reports The credibility of a report audited by one of the Big Four The credibility of a report audited by Non-Big Four a

Whole sample

Financial analysts

Credit analysts

Std. Deviation

Mean

Std. Deviation

Mean

Std. Deviation

Levene's F test

t-test

Mean 4.34 2.57

0.722 1.016

4.49 2.58

0.066 0.104

4.16 2.57

0.092 0.123

0.132 0.468

2.953a 0.064

Significant at less than 0.05 level.

quality of the reports than the value of money; reduced auditor fees might lead to a compromise on the quality of an audit. The four factors most important to financial analysts (mean is higher than 4.5) were accounting and auditing knowledge; independence; ethical standards; and professional audit expertise. Credit analysts rank only accounting and auditing knowledge and professional audit expertise as extremely important and rank auditor independence in third place. The Levene test and t-tests of the mean difference show no significant difference between the variances of the responses of all factors, except for independence, proactiveness, and reputation. The test results also indicate that the mean responses of the credit analysts and of the financial analysts do not differ significantly, indicating that the two groups perceive the importance of the factors similarly. To test respondents' perceptions of the effect of firm size on audit quality, they were requested to answer two questions on how they perceived the quality of audits performed by Big Four firms and the quality of audits by non-Big Four firms. The means of the responses show that both groups of analysts think financial statements audited by one of the Big Four as being more credible than those of firms that are not classified as Big Four. Financial analysts rank the credibility of financial statements audited by Big Four significantly higher than the rank of financial analysts. This difference should not be interpreted as that credit analysts favor statements audited by non-Big four firms, as both credit and financial analysts consider the quality of financial statements audited by non-Big firms as average. These results should be interpreted along with the respondents' perception of the importance of 14 factors that are likely to determine the quality of the audit service. These factors are shown in Table 4. Because these factors are likely to be characteristic of Big Four firms, these firms are more likely to be perceived as providing better-quality audit reports. These results would be consistent with those of many of the studies that find that Big Four firms produce better quality reports because they have better resources. This is also additional evidence supporting the current CBB policy that non-Big Four firms are not allowed to audit retail and wholesale banks and large investment companies. The results also justify the decisions of listed companies to demand audit services from companies with an international presence

because they can access the expertise needed even if it is not available in the auditor's local offices, providing assurance of a quality that meets the expectations of investors and creditors. Two regression models are used to test the effect of the 14 attributes on the perception of the credibility of financial statements. The dependent variable in the first model is the perception of the respondents of the credibility of reports audited by Big Four firms. The dependent variable in the second is the perception of the respondents of the credibility of statements audited by non-Big Four firms. In both models, the independent variable is the sum of the ratings of the 14 competency factors as perceived by respondents. Each model is run three times. The first assumes that the dependent variable is the perception of all the respondents; the second is the perception of the credit analysts; and the third is the perceptions of the financial analysts. Table 5 shows the regression results. The adjusted R2 in the first model is 17.9% and significant at less than 5%, and the coefficient of the competencies is 0.031 and significant at less than 5%, indicating that the total rating of the competencies is one of the determinants of the audit quality. When the dependent variable is replaced with the perceptions of credit analysts and then with those of financial analysts, the R2 changed to 9.40% and 51.90%, respectively. In both regressions, the coefficients of independent variable remain significant with a priori expected sign. The adjusted R2 in the second model is 0.8% and insignificant at the conventional level, and the coefficient of the competencies is 0.09 and insignificant. Similar regression results are obtained when the model is tested using the two subsamples (credit analysts and financial analysts). The outcomes of the six regression runs also indicate that both credit analysts and financial analysts perceived that the Big Four firms, unlike non-Big Four, are more likely to have the needed competencies to ensure audit quality from a user's perspective. These results lend further support to those reported by Carcello et al. (1992), Eichenseher and Shields (1983), Shockley and Holt (1983), and Frantz (1999). Subsequently, step-wise regression is carried out after replacing the independent variable with the individual values of the 14 competencies in the mode. For the entire sample, the dependent

Table 5 Regression results (Creditability of audit reporti = α + β competenciesi + εi). Dependent variable

Sample

Constant

Credibility of a report audited by one of the Big Four

Whole sample

2.566a (0.303) 1.068a (0.006) 0.807a (0.655) 0.2040 (0.469) 4.224a (0.416) 3.335a (0.653)

Coefficient

Financial analysts Credit analysts Credibility of a report audited by Non-Big Four

Whole sample Financial analysts Credit analysts

Standard errors are in parentheses. a Significant at less than 0.05 level.

Adjusted R2

F- value

0.423

17.90%

35.232a

0.720

51.80%

77.280a

0.307

9.40%

7.467a

0.09

0.80%

1.331

0.069

0.50%

0.415

0.015%

1.379

Independent variable (Competencies/Factors) 0.031a (0.005) 0.055a (0.006) 0.031a (0.011) 0.009 (0.008) 0.005 (0.007) − 0.015 (0.011)

Standardized beta

− 0.124

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variable is the credibility of a report audited by one of the Big Four; in addition to the constant, only professional audit expertise, reputation, and wide range of skills are included in the final model, with an R2 of 24%. The coefficients of the three variables are positive and significant at less than 2.8%. When the dependent variable is replaced with the perceptions of the credit analysts, the final model has an R2 of 62.7% and includes professional audit expertise, wide range of skills, reputation, and accounting-and-auditing knowledge. When the dependent variable is replaced with the perceptions of financial analysts, the final model has an R2 of 70% and includes professional audit expertise, real value for fees, wide range of skills, ethical standards, and accounting-and-auditing knowledge. When the dependent variable is replaced with the credibility of a report audited by one of the non-Big Four, for the entire sample, only two variables (proactive and takes initiative) remain in the final model, with a significant R2 of 8.9%. When the sample is limited to the credit analysts, the final model includes only one variable, “due care”, with a significant R2 of 5.1%. The final step-wise regression is carried out for the sample that is limited to financial analysts. The final model has a significant R2 of 34.9% and includes the following variables: due care, expertise in the industry, and commitment to quality. The audit committee is considered an important board committee that plays a role in implementing corporate governance guidelines. One of the most important functions of the committee is to oversee internal and external audit performance and to advise the board on audit matters. Therefore, an effective audit committee should enhance audit quality. Corporate governance principles (OECD, 2004) outline the importance of audit committee in enhancing audit quality. Abbott, Parker, and Peters (2004), Yang and Krishnan (2005), DeZoort and Salterio (2001), and Lin, Li, and Yang (2006) find a positive relation between audit quality and the effectiveness of audit committee. Banks and investment companies are required by law to have audit committees, but not non-financial companies listed on the Bahrain Stock Exchange. To measure the impact of an audit committee on perceived audit quality, respondents were asked about their reactions with regard to the role of an effective audit committee in audit quality. To test the effect of the role of the committee in improving audit quality, respondents were asked to state their perception of the importance of effectiveness of audit committee on the quality of audit, using a 6-point Likert scale, where 0 indicates not important in determining audit quality and 5 indicates that it is extremely important. The survey does not elaborate on the requirements for audit committee to be effective. This is attributed to the fact that practices “that work best for one organization may not be ideal for another—especially in a corporate governance environment where corporate culture, financial reporting risks, and governance needs can vary dramatically from company to company.” The mean of the responses of the whole sample is 4.15 and 0.82 standard deviation. The mean and the mode of the responses clearly show that these users of financial statements perceive that an audit committee affects the audit quality. Splitting the responses into the groups, the mean responses of the credit analysts is 4.12 and 0.76 standard deviation, whereas mean responses of the financial analysts is 4.17 and a standard deviation of 0.88. Levene's test (F = 3.056, p value of 0.082) on the variances of the two groups indicates no significant difference between the variances. The null hypothesis that the two groups of analysts view the effect of the role of audit committee in determining audit quality as equally important is accepted because the p value of 0.729 is more than the critical value of 0.05. 6. Concluding remarks The author has reported the results of a survey of credit and financial analysts on perceptions of audit quality and the factors that determine that quality. Consistent with the evidence in developed

markets, the bigger auditing firms are perceived to provide better quality audits and to be more independent of the management of companies they audit compared with smaller firms. Findings are similar in both the questionnaires and personal interviews. The conclusion is that the Big Four auditing firms have characteristics that place them in a better position to produce better quality audits than smaller firms. A review of the 2007 annual reports of 41 companies listed on the Bahrain Stock Exchange shows that 82.5% of the companies are audited by one of the Big Four. The author's interviews indicate that the Big Four auditors are better able to resist management pressure in cases of conflict. Their greater resources, technical knowledge, and global reach allow them to deal with clients more objectively without a fear of termination. Financial analysts rely more on the audited financial statements than credit analysts. This is likely because a bank–client relationship allows credit analysts to obtain more information from their clients; they are also in a better position to evaluate the financial position of their borrowers than financial analysts. Both groups of analysts think that provision of non-audit services will negatively affect auditor's independence and ultimately impair the quality of an audit. An effective audit committee is seen as one factor that should improve the credibility of financial statements. Regression results indicate that both groups of analysts perceive financial statements audited by Big-Four firms to be of better quality than those audited by non-Big firms. This is because of the characteristic of Big Four firms, which are not matched by other audit firms. This is an evidence supporting CBB's current policy that audit of retail and wholesale banks and large investment companies should be performed by Big-Four firms. Furthermore, credit analysts have found that the creditability of an audit report by one of the Big Four is determined by professional audit expertise, wide range of skills, reputation, and accounting-and-auditing knowledge. However, for financial analysts, the credibility of these reports is a function of professional audit expertise, real value for fees, wide range of skills, ethical standards, and accounting-and-auditing knowledge. Future research may be directed toward determining the effect of the actual role of an audit committee on audit quality. This can be carried out when companies start establishing such committees and ensure that they act in an independent and effective manner. This is likely to take place when Bahrain issues its corporate governance code. Acknowledgements I am grateful to the two anonymous reviewers for their time and efforts. I would like also to thank the Journal co-editor, Professor J. Timothy Sale, for his support and editorial assistance. The usual caveats apply. References Abbott, L., Parker, S., & Peters, G. (2004). Audit committee characteristics and restatements. Auditing: A Journal of Practice and Theory, 2, 69−87. Abbott, L. J., Parker, S., Peters, G. F., & Raghunandan, K. (2003). The association between audit committee characteristics and audit fees. Auditing: A Journal of Practice and Theory, 22, 17−32. Abbott, L. J., Parker, S., Peters, G. F., & Rama, D. V. (2007). Corporate governance, audit quality, and the Sarbanes–Oxley act: Evidence from internal audit outsourcing. Accounting Review, 82, 803−836. American Institute of Certified Public Accountants (AICPA) (1994). Professional standards. New York: Commerce Clearing House Inc. American Institute of Certified Public Accountants (AICPA) (2004). The AICPA audit committee toolkit. New York: AICPA. Antle, R. (1982). The auditor as an economic agent. Journal of Accounting Research, 20, 503−527. Antle, R., Griffin, P. A., Teece, D. J., & Williamson, O. E. (1997). An economic analysis of auditor independence for a multi-client, multi-service public accounting firm. Berkeley, CA: The Law & Economics Consulting Group Inc.

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