al-ajmi - 2009 - audit firm, corporate governance, and audit quality - evidence from bahrain

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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
abstractarticle info
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 qualityand otheraspects ofcorporate 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 informa-
tion 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
audit quality asthe 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 companyalso 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.
Reg ar d less 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 ackno wledge that measuring
audit quality is problematic. The quality of an audit is not directly or
immediately obvious, e specially to cr editors and in vest ors. Audit quality-
control procedures are intended to maintain high standards of control
over the process of an audit, but an audit failur e usual l y b ecomes know n
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 I nstitute o f Certiﬁed Public Accountants (AICPA) (1994) al so
ackno wled ges th e importanc e of consideri ng perc epti ons of inv est ors on
auditor
independence. A former chairman of the AICP A, Elliott (2000)
Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
⁎ Tel.: +973 39444284; fax: +973 17449776.
E-mail address:
0882-6110/$ – see front matter © 2009 Elsevier Ltd. All rights reserved.
doi:10.1016/j.adiac.2009.02.005
Contents lists available at ScienceDirect
Advances in Accounting, incorporating Advances in
International Accounting
journal homepage: www.elsevier.com/locate/adiac
says “[The AICPA] believe[s] that appearances are v ery important and
capital markets requir e conﬁdence in ﬁnancial statements and audit
reports, and the member ﬁrms of the AICP A are basing their business of
auditing on thei r reputations, a nd that is heavily affected b y appearance.”
Despite consider able r esearch o n audit q uality, studies o n audit q uali ty
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 inv olv e the G enera l T ra ding and F oo d Proc essing Company ( 1994),
the Bahrain Islamic Investment Compan y (2002), and the Bahrain Saudi
Bank (2002). The fraud involved in the ﬁrst case was carried out by the

company's a ccountant, and the court ruled ag ainst the accountant. A s for
the second company , the case was settled out-of-court, and the partner
invol v ed in the case was asked to leave the ﬁrm, whereas the third
instance resulted in replacement of the audit ors without the audit ors
being taken to court. The low number of reported cases of audit failures
does not ensure that audits of Bahr aini listed ﬁrms are of good quality and
should n ot m ean t h at user s of company r e ports sh ould be complacent as
to the quality of an audi t. Ther efor e, this study in v estigates the wa y u sers
of ﬁnancial statements determine the quality of audit reports. Accordingly ,
asurveyofthemajorusersofﬁnancial statem ents (in vest ors and lenders)
with respect to their perceptions of the factors that determine audit
quality, particularl y with respect to the impact of corporat e gov ernance
and size of audit ﬁrms on the q uality o f 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 Bahrain
1
Some important features of the audit market in Bahrain must be
understood to perceive the context in which this study was undertaken.
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 miti-
gate 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 incorpo-

rated 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 aninternational 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
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, Ex-

investment 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.
65J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
they follow such apractice for other ﬁrms in accordance withtheir 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. Require-
ment 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 iss ued by the International
Organization of Securities Commissions (IOSCO) in 2002 state that audit
quality is an important requirement for the integrity of ﬁnancial
statements. Howev er, Bahrain lacks a formal independent audit over-
sight 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
conﬁdenc e 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
hav e led to audit ﬁrms emphasizing on the quality of the audit. The need
for ha vi ng an au dit oversight i n Ba hr ain is aview that is shared b y m ost of
those interview ed 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 privatiza-
tion 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 institu-
tions and in newspapers seeking new staff statethat 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 720 0 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 anongovernmental 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.
66 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
3. Brief literature review
Watkins, Hillison, and Morecroft (2004) summarize both theore-
tical 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 betweenthe audit-ﬁrm sizeand the qualityof audit-
reporting 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 (1 99 7), 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 an d
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 audit-
ﬁrm 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. a v ailabil ity of adequat e reso urce s (human and technology) (DeAngelo,
1981b; F rantz, 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, 200 4; 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);“t
he 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 inthe audit-service markets
(Knapp, 1985); and the audit committee (Teoh & Lim, 1 996).
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, geogra-
phical co v er ag e, audit fees, working relationships, meeting deadlines,
technical qualiﬁcations, accessibility of the audit ﬁrm, and range of
services o ffered. Shockley and Holt (1983) argue t hat bank chief ﬁnancial
ofﬁcers rank the Big Firms in terms of 10 attributes. These are prestige,
professionalism, expensiveness, competence, aggressiveness, conserva-
tiveness, impendence, reliabili ty, helpfulness, and bureauc rat ic behavior.
Carcello, Hermanson, and Mcgrath (1 992) report 12 items that are
perceived by auditors, preparers, and users of ﬁnancial stat ements to
determine audit quality . These are auditee size, audit team and ﬁrm
experience with the client, industry expertise, responsiveness to client
needs, compliance w ith GAAS, ﬁrm executive involvement, ﬁrm comm it-
ment to q uality, invo lvement o f audit committee, degr ee of personal

responsibility, conduct of ﬁeldwork, auditor's skeptical attitude and ﬁrm
personnel maintain freshness of perspective.
Corporate governance is de
ﬁne
d 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 share-
holders 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 enact-
ment 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 ofcorpor at e gov ernanc e, m easur ed by ﬁrmsize (Big andnon-Big)
does not have a signiﬁ
cant inﬂue
nce on t he co st o f de bt of non-ﬁnancial
Fr ench listed ﬁrms. These results are robust even after contr olling for a
set of auditees' characteristics such as ﬁrm size, pr oﬁtability, asset
structure, and interest co v erag e ratio. However, others report th at 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, Car cello,
Hermanson, and Lapides (2000); Carcello and Neal (2000);andKlein
(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 performance-
evaluation 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).
67J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
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 o ffered 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 non-
listed 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 q uality fr om the use rs' percep tion is the b est appr oach
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 co mpanies, 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-Y ong,1998). The author
follows Oppenheim (1999)
and W
allace 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 institu-
tions; 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 compe-
tencies 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 63 38.4 38.4
Wholesale bank 69 42.1 80.5
Investment company (Bank) 32 19.5 100.0
Total 164 100.0
Position
Financial analysts 90 54.9 54.9
Credit analysts 74 45.1 100.0
Total 164 100.0

Highest qualiﬁcation
B.Sc. 50 30.5 30.5
Graduate degree 67 40.8 71.3
CPA/CA/ACCA/CFA 47 28.7 100.0
Total 164 100.0
Age of the respondents
Less than 25 years 8 4.9 4.9
25 to 29 years 34 20.7 25.6
30 to 34 years 36 22.0 47.6
35 to 39 years 54 32.9 80.5
40 years and older 32 19.5 100.0
Total 164 100.0
Length of experience
Less than 5 years 52 31.7 31.7
5to9years 28 17.1 48.8
10 to 14 years 46 28.0 76.8
15 to 19 years 14 8.5 85.3
20 years and longer 24 14.6 100.0
Total 164 100.0
68 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
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 indepen-
dent 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% donot 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
” ha
s
been socially constructed to ﬁtneedsofﬁnancial analysts more than the

users of ﬁnancial statements. Credit analysts, on the contrary, have
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. Sample Financial
analysts
Credit
analysts
Levene's
F test
t-test
1. How conﬁdent are you that the Qualiﬁed Accountants are independent in performing the audit? Mean 3.440 3.490 3.380 0.111 0.654
Std 1.075 1.008 1.155
5 = Extremely Conﬁdent, 0 = No Conﬁdence
2. How conﬁdent are you that the ﬁnancial statements are free of unintentional (alternatively, intentional) misstatements
or omissions?
Mean 3.440 3.490 3.380 0.111 0.654
Std 1.075 1.008 1.155
5 = Extremely Conﬁdent, 0 = No Conﬁdence
3. The inﬂuence of the auditor's report on your decision-making process. Mean 3.650 3.780 3.490 0.007 2.139
a
Std 0.877 0.897 0.832

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.
Mean 3.730 3.760 3.700 2.219 0.309
Std 1.086 1.042 1.144
5 = Strongly Agree, 0 = Do Not Agree
5. In your opinion, outsourcing internal auditing activities to the external auditors will enhance the audit quality. Mean 1.770 1.870 1.650 0.041 1.401
Std 0.928 0.927 0.911
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
Mean 2.680 2.640 2.730 0.635 − 0.467
Std 1.160 1.202 1.114
5 = Strongly Agree, 0 = Do Not Agree
Std: Standard Deviation.
a
Signiﬁcant at less than 5% signiﬁcance level.
69J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
Antle, Gr ifﬁn, 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 (20 02), 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 indepen-

dence. 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 aud itors'
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 misstate-
ments. Yet, although a very long association may lead to a better
understand
ing 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 Vans traelen (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 t-

test shows no signiﬁcant difference between the means of the
responses of the two groups.
Fourteen comp etencies (att ributes) 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 r ang e of skills
such as analytical skills; pro vision of re al v alue for the a udit fees paid b y
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 know ledge .
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 indepen-
dence 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 Whole sample Financial analysts Credit analysts Levene's
F test
t-test
Mean Std. Deviation Mean Std. Deviation Mean Std. Deviation
Specialization 4.140 1.021 4.210 0.977 4.050 1.071 0.089 0.981

Independence 4.490 0.883 4.610 0.730 4.350 1.026 11.358
a
1.830
Industry Expertise 4.050 1.064 4.100 1.039 4.000 1.098 0.000 − 0.655
Technical competence in applying 4.080 1.203 4.170 1.144 3.970 1.271 0.057 1.026
Wide range of skills (GAAP & GAAS/IFRS & ISA) 3.750 1.076 3.700 1.126 3.810 1.016 0.000 − 0.655
Real value for fees 3.400 1.237 3.340 1.300 3.460 1.161 0.903 − 0.592
Proactive 3.630 1.203 3.610 1.287 3.660 1.101 4.220
a
− 0.274
Takes initiative 3.730 0.999 3.770 1.092 3.680 0.878 0.873 0.579
Due care 4.120 1.090 4.270 1.003 3.950 1.169 0.689 1.890
Quality commitment 4.300 0.999 4.310 1.098 4.300 0.872 1.986 0.088
Professional audit expertise 4.520 0.917 4.520 0.939 4.510 0.895 0.388 0.060
Reputation 4.150 1.152 4.240 0.878 4.030 1.414 7.717
a
1.153
Ethical standards 4.410 1.129 4.530 1.173 4.270 1.064 0.108 1.490
Accounting & auditing Knowledge 4.610 0.937 4.620 0.801 4.590 1.084 0.603 0.187
a
Signiﬁcant at less than 0.05 level.
70 J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
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 stan-
dards; 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
co
mpetency 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 R
2
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 R
2
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 R
2
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 inde pendent variable with the individual values of the 14
competencies in the mode. For the entire sample, the dependent
Table 4
Respondents' perceptions of the credibility of audit reports.
Credibility of audit reports Whole sample Financial analysts Credit analysts Levene's
F test
t-test
Mean Std. Deviation Mean Std. Deviation Mean Std. Deviation
The credibility of a report audited by one of the Big Four 4.34 0.722 4.49 0.066 4.16 0.092 0.132 2.953
a
The credibility of a report audited by Non-Big Four 2.57 1.016 2.58 0.104 2.57 0.123 0.468 0.064
a
Signiﬁcant at less than 0.05 level.
Table 5
Regression results (Creditability of audit report
i
=α + β competencies
i
+ ε

i
).
Dependent variable Sample Constant Independent variable
(Competencies/Factors)
Adjusted R
2
F-value
Coefﬁcient Standardized beta
Credibility of a report audited by one of the Big Four Whole sample 2.566
a
0.031
a
0.423 17.90% 35.232
a
(0.303) (0.005)
Financial analysts 1.068
a
0.055
a
0.720 51.80% 77.280
a
(0.006) (0.006)
Credit analysts 0.807
a
0.031
a
0.307 9.40% 7.467
a
(0.655) (0.011)
Credibility of a report audited by Non-Big Four Whole sample 0.2040 0.009 0.09 0.80% 1.331

(0.469) (0.008)
Financial analysts 4.224
a
0.005 0.069 0.50% 0.415
(0.416) (0.007)
Credit analysts 3.335
a
− 0.015 − 0.124 0.015% 1.379
(0.653) (0.011)
Standard errors are in parentheses.
a
Signiﬁcant at less than 0.05 level.
71J. Al-Ajmi / Advances in Accounting, incorporating Advances in International Accounting 25 (2009) 64–74
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 R
2
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 R
2
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 R
2
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 R
2
of 8.9%. When the sample is limited to the credit
analysts, the ﬁnal model includes only one variable, “due care”, with a
signiﬁcant R
2
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 R
2
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.
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