Audits are very expensive and therefore auditors are expensive too. A number of models have been developed to explain the role of the auditors. A mathematical model of the financial reporting process has been developed by Ng. He established that managers can increase the value of their reward/pay and reduce the variability of their income by selecting a reporting function which is biased towards overstated profits. An audit should ensure that any of the information produced by managers, is not misleading.
Thus, the owners benefits as it reduces the cost of management reward. Ng and Stoeckenius extended the agency model to consider the effects of the truthfulness of reporting of different methods of rewarding managers. The model suggested the only method of remuneration, which was not biased for reporting, was a fixed salary. Fixed salaries are regarded as unsatisfactory because very little profit to owner.
Chow’s study examined the effects of four hypothetical factors which could have an effect on the decision for a company to have an audit. Chow’s hypotheses are: H1 The smaller is the manager’s ownership share in the firm, the higher is the probability that the firm voluntarily engages external auditing. H2 The higher the proportion of debt in a firm’s capital structure, the higher is the probability that the firm voluntarily engages external auditing. H3 The greater the number of different accounting measures in a firm’s debt covenants, the higher is the possibility that the firm voluntarily engages external auditing.
H4 The larger a firm’s total size, the higher is the probability that it voluntarily engages external auditing. (John Dunn 1996) The first three hypotheses are based on the assumption that the need for an audit will increase with the potential for the conflict of interest. This could be due to owners/lenders will insist on an audit. The fourth hypothesis is based on the assumption that the cost of an audit is not directly related to the size of the company. An auditor as mentioned earlier would come into conflict with the directors, because the directors can affect the auditors’ fee income by removing them from the audit or from other activity. Replacement and public criticism of an audit can affect the auditors’ reputation.
Auditors are considered independent if they resolve the conflict honestly, without avoiding their responsibility to the shareholders. If auditors are not supported against the directors then they could be penalised for their honesty. To achieve my research objectives I would refer to the Research Design and Data Collection. In the Research Design I would be using the four layers of the ‘Onion’ and in the Data Collection I would be using the fifth layer of the ‘Onion’.
The Research Process ‘Onion’ (Saunders 2000). Research Question What are accountants (external auditors) accountable to? Research Design According to my research question, the research philosophy that will be undertaken is the positivism philosophy. “A theoretical framework is a collection of theories and models from the literature which underpins a positivistic research study” (Hussey et al., 1997). My research philosophy is a positivism philosophy (first layer of the ‘onion’) this is because it is closely related to a hypothesis. Whereas a “phenomenological study, a theoretical framework may be less important or less clear in its structure” (Hugges et al., 1997). This philosophy does not match with my research question.
My research approach is a detuctive approach (second layer of the ‘onion’) instead of an inductive approach. Detuctive research is a study, which is based on concepts, and theoretical structure is developed and then tested by an empirical observation. Basically it’s where theory is developed and hypothesis and a research strategy is designed to test the hypothesis. E.g. Ng and Chow have developed models and hypotheses. To prove Ng’s model and Chow’s hypothesis I would give out questionnaires and have face-to-face interviews and I would meet some accountancy firms if had enough time. This will be discussed later in the assignment in the Data Collection.
I did not choose inductive approach, because according to Saunders 2000 detuctive approach owes more to positivism and the inductive approach to phenomenology. Inductive approach is a study where theory is developed from the observation of empirical reality. The research strategies I choose are survey and case study (third layer of the ‘onion’). This is because the survey method is associated with the deductive approach, which I have chosen. Survey is a common and popular strategy in business and management research. Surveys allow the collection of a large amount of data from sizeable population in a high economic way. Mainly based on questionnaires, because it is easily understood and can easily come to a conclusion.
I have also chosen case study. This is because I have gained a rich understanding of the context of the research and the process being authorized. The case study usually answers he questions to ‘why’, ‘what’, and ‘how’ questions. Robson (1993:40) defines case study as the development of detailed intensive knowledge about a single “case” or a small number of related “cases”.