Journal of Financial Reporting and Accounting
The effects of audit quality on the costs of capital of firms in Ghana
William Coffie, Ibrahim Bedi, Mohammed Amidu,
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The effects of audit quality on the Effects of auditquality
costs of capital of firms in Ghana
William Coffie
Business School, University of Ghana, Legon, Ghana
639
Ibrahim Bedi
University of Ghana, Legon, Ghana, and Received 20March 2017
Revised 26 September 2017
Mohammed Amidu 16November 2017
Accepted 19 January 2018
Department of Accounting, University of Ghana, Legon, Ghana
Abstract
Purpose – This paper aims to investigate the effects of audit quality on the cost of capital in Ghana.
Design/methodology/approach – Non-financial firms listed on the Ghana Stock Exchange (GSE) as
well as non-listed firms from the database of Ghana Club 100 were included in the sample. Series are yearly,
covering a sample of 40 firms during the six-year period, 2008-2013. The study employed the positivist
research paradigm to establish the relationship between audit quality and the cost of capital.
Findings – There is evidence to suggest that the cost of debt and the overall cost of capital of firms in Ghana
can be explained by the quality of the external auditors. The results also show that the large size of the board
is associated with low cost of debt.
Research limitations/implications – The fact that the choice of quality measure is based on firm size
only and other measurements of audit quality could not be measured. Future research may examine how
other approaches to measuring audit quality affect cost of capital.
Practical implications – The results significant for those charged with assurance and regulation, as well
as lenders andmanagers of companies.
Originality/value – The authors investigate how external auditing quality affects the cost of capital of
firms operating in Ghana.
Keywords Cost of debt, Cost of equity, Developing country, Audit quality
Paper type Research paper
1. Introduction
Audit quality improves the reliability of financial statements to users of accounting
information because it helps in confirming the companies’ activities and affairs by
management (Ali, 2008) and decreases the magnitude of users information risk (Fairchild,
2008). Audit quality improves the quality of earnings, makes financial statements
acceptable to the tax authorities, expedites disposal of businesses and raising of finance
both equity and debt (Azizkhania et al., 2010, 2013; Chen et al., 2011). Audit quality is the
ability of an auditor to detect material misstatement in the financial statements and
accounting system of a firm, and report the material misstatement (DeAngelo, 1981). The
probability of material misstatement detection by the auditor depends on his or her virtue
and the probability of material misstatement reporting by the auditor depends on his or her
independence. Journal of Financial Reporting andAccounting
Vol. 16 No. 4, 2018
pp. 639-659
© EmeraldPublishingLimited
1985-2517
JEL classification –M41, M42, G31, O55 DOI 10.1108/JFRA-03-2017-0018
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JFRA Research shows that the cost of capital decreases as the quality of information increases
16,4 and the auditor's reputation as one of the audit quality attributes can affect the cost of
capital (Ahmadzedeh, Nahandi and Hasanzadeh, 2013; Krishnan, Li and Wang, 2013;
Azizkhania et al., 2010). The relationship between audit quality and cost of debt or equity
have received attention in the accounting and finance literature. However, the intervening
influence of International Financial Reporting Standard (IFRS) on audit quality and its effect
640 on cost capital is under-researched. In Ghana, medium to large companies are required to
produce financial statements in accordance to the IFRS from 2007. It was expected that
adoption of IFRS would improve financial reporting and reduce information asymmetry.
There is lack of empirical evidence that test the effects of post IFRS adoption period audit
quality on costs of capital in Ghana. Therefore, it becomes very necessary to investigate
such phenomenon in the context of emerging market where stock market participation is
low and financial institutions rather play a critical role in raising business finance.
Prior literature has examined the relationship of audit quality on the cost of debts (Cano-
Rodríguez and Alegría, 2012; Gul et al., 2013; Mansi et al., 2004; Karjalainen, 2011; Fortin and
Pittman, 2007; Pittmana and Fortin, 2004); the impact of audit quality on the cost of equity
(Li, Stokes, Taylor andWong, 2009; Chen et al., 2011; Krishnan et al., 2013); and the impact of
corporate governance and cost of capital (Soh, 2011). These studies suggest that the quality
of audit decreases the cost of debt and equity.
Khlif, Samaha and Azzam, (2015) examined the effect of voluntary disclosure, ownership
structure attributes and timely disclosure on the cost of equity capital in emerging Egyptian
capital market by using content analysis of annual reports. The authors find a negative
relationship between the level of voluntary disclosure and cost of equity capital. They
demonstrate that the increased levels of voluntary and timely disclosure reduce the cost of
external finance and improve the marketability of firms’ equities, which may directly impact
growth opportunities, especially when information is communicated to investors in a timely
fashion. Iatridis (2012) investigates whether being audited by a big auditor would lead to
lower agency costs and lower cost of equity by focusing on emerging common-law South
Africa and code-law Brazil. Their results show that though firms may be audited by high-
quality auditors, their institutional differences influence significantly the firms’ agency costs
and cost of equity. For common-law South Africa, the presence of effective corporate
governance mechanisms reduces agency costs, and the firm-level performance, growth and
market determinants tend to lead to a lower cost of equity. Ramly (2012) examined the
impact of corporate governance quality on firm’s cost of equity of 101 listed firms on the
Main Board of the Malaysian Bourse from 2003 to 2007. Regression results indicate that
firms having high-quality corporate governance practices have lower cost of equity. Further,
this research finds that firms’ board structure and procedures, practices that promoted
shareholder rights and enhanced accountability and audit process have significant reducing
impact on the cost of equity.
In a study by Wahyuni (2013) from 2000 to 2010 in Indonesia, the author found that
auditor specializations influenced the firm’s bond rating by credit rating agencies and is
negatively and significantly related to the cost of debt financing. Overall, their result
suggests that auditor specialization matters to bond market investor in Indonesia. Hwang
et al. (2008) examined the relationship between substituting auditors and the response of the
bond market among listed companies in Korea. They investigated the direct relationship
between substituting auditors and the bond market response, as well as the impact of
substituting auditors on the bond market response to the quality of earnings. The evidence
show that external investors both respond to the substituting of auditors and also take into
account the switching behaviour when assessing the quality of earnings. The growth in
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impacts is prominent for companies whose audit quality has improved, which relates to the Effects of audit
fact that the investors’ concern regarding switching of auditors reduces when switching of quality
auditor causes an improvement in the auditing quality.
In Africa, Ghana is among the emerging economies with an increase in trade and foreign
direct investments for the past decade. However, according to the “global doing business”
report, the cost of doing business has been rising in Ghana. In spite of the rising cost of
doing business in Ghana, various studies have been silent on the relationship between the
cost of capital and other variables that determine it. Besides, in Ghana, stock market 641
participation by firms is low, making a study on the influence of quality audit on cost of
equity relevant to understand the phenomenon. Furthermore, debt financing constitutes a
high percentage of firm financing in Ghana but research has not contributed how audit
quality could reduce cost of debt to make doing business in Ghana cheaper to attract
investors and boost exports. From the foregoing, it is important to appreciate how investors,
both debt and equity, react to audit quality. This, we seek to unravel by investigating the
relationship between audit quality and costs of capital.
Our study contributes to the accounting literature in the following ways. Firstly, we
investigate the intervening influence of IFRS adoption on audit quality and its effect on
costs of capital by examining a post adoption period data. Secondly, our study is conducted
in a context, i.e. Ghana, where this kind of study is uncharted; however, equity and debt
financing form the main capital structure of firms. Thirdly, our study examines the audit
quality effects on costs of individual sources of funding (i.e. debt and equity separately) vis-
à-vis the combined cost of capital (i.e. weighted average) by focusing on the Ghana setting.
Finally, our paper unravel the importance of audit quality in reducing information
asymmetry and how it in turns reduce the costs of raising finance.
We position the current paper in post adoption of IFRS as literature suggests that using
IFRS improves accounting information quality. For example, Daske et al. (2008) opine that
IFRS adoption will lead to improved transparency and higher-quality financial reporting,
effectively enhancing firm information environment. Proponents such as Christensen (2012)
claim that the new accounting standards improves transparency over national accounting
standards. In the financial market, particularly in the banking sector, evidence exists that
the banks charge relatively lower loan rates and apply conditions that are more favourable
to IFRS adopters than to non-adopters (Kim et al., 2011).
Moreover, while some find improvement in the accounting information quality in some
countries that adopt international accounting standards (Meeks and Swann 2009; Chen et al.,
2010; Chua et al., 2012), others do not see any significant improvement in reporting quality
(Kao and Wei, 2014; Jeanjean and Stolowy, 2008). Another stream of research find
improvement in accounting quality but are quick to mention other factors that could
contribute to the improvement besides the adoption of international accounting standards
(Barth et al., 2006; Soderstrom and Sun, 2007). Amidu et al. (2016) suggest that the relatively
high-quality earnings among firms in Ghana is attributed to the adoption of IFRS and the
interaction of firm size to equity capital and the strategy of firms in Ghana to finance their
operations with debt. We therefore argue that adoption of IFRS improves accounting
information quality which subsequently reduces information asymmetry and eventually
lowers the cost of capital.
Our results demonstrate that audit quality reduces the cost of capital. This supports the
lending credibility theory that audit quality improves the credibility of financial reports
which leads to reduction in cost of capital. Furthermore, the results of the study suggest that
the size of the board, firm size, listed firms, tangible assets (PPE) and return on assets reduce
the cost of capital. This findings of the study suggest that lenders and investors consider the
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JFRA relevance of larger boards, listing status and tangible assets (PPE) as collateral and high
16,4 return on assets to reduce the required rate of return.
The rest of the paper is organized as follows. Section 2 provides the institutional and
theoretical review, of the Ghanaian economy and, literature respectively. Section 3 reviews
relevant empirical literature and hypotheses development. In Section 4, we present the data,
and estimable models, while Section 5 presents empirical estimation strategy and discusses
642 the results. Section 6 concludes the paper.
2. Background and literature review
2.1 Institutional and sectorial review of Ghanaian economy
Ghana in the face of the global recession has had a robust economic growth even though
since 2011 the rate has been declining. Three main sectors, namely, the service sector, the
industrial sector and the agricultural sector, are the chief drivers of economic growth in the
country. The service sector is the largest which in 2014 registered a growth rate of 5.6 per
cent, a fall from 10.0 per cent in 2013. This sector has 49.6 per cent share of the country’s
GDP in 2014, a decline from 49.8 per cent in 2013. The decline in the growth rate of the
service sector is as a result of fall in the growth rate of several sub-sectors. For instance, the
social, community and personal service activities’ sub-sector recorded a decline of 38.1 per
cent in 2014; the “hotels and restaurants”, “financial intermediation” and “trade, repair of
vehicles, household goods” also recorded a decline of 25.8 per cent, 23.5 per cent and 16.1 per
cent, respectively, in 2014. Even though other sub-sectors including “real estate,
professional, administrative and support service activities” and “information and
communication” sub-sectors recorded an increase of 16.0 per cent and 14.1 per cent,
respectively, in the same year.
The second largest sector is the industrial sector and it recorded a whooping fall in
growth rate of 0.8 per cent in 2014 from 6.6 per cent in 2013. Over the years, performance in
this sector has primarily been underpinned by growth in mining and quarrying, with
petroleum being the main contributor. However, with the exception of the manufacturing
and the water and sewerage sub-sectors which attained marginally higher growth rates
above their respective values in 2013, all other sub-sectors recorded more slowly growth in
2014.
The agricultural sector recorded a growth rate of 4.6 per cent, much higher than the
growth rate of industry but lower than that of services in 2014. All other sub-sectors of this
sector recorded positive growth, with the exception of “fishing” which decline significantly
in 2014. According to SGER (2014), this sector recorded an increasing growth rates since
2011, from 0.8 per cent to 1.3 per cent in 2012 and to 4.9 per cent in 2013. Thus, recently the
sector seems to have been making gains. However, it worth noting that the only sub-sector
recording a higher growth rate in 2014 than 2013 is cocoa, thus giving rise to the reduced
decline in the growth of the sector between the two years. In spite of the recent solid growth
of agricultural sector, its contribution to national output continue to decline. This has been
the trend since the sector in 2009 hit a peak of 31.8 per cent share of GDP, and experienced a
slight fall in its share of GDP to 22.0 per cent in 2014, as against 22.4 per cent in 2013.
Largely, this trend is as a result of the expansion of the service and oil sectors, which in
relative terms have shrunk the contribution of the agricultural sector, though in absolute
terms the sector has been expanding
2.2 Review of theoretical literature
Several theories can be used to explain the call for audit services. The lending credibility
theory proposes that the fundamental role of the audit is to enhance credibility of the
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financial reports and enhance the integrity of the services auditors are offering to their Effects of audit
clients (Hayes et al., 2005). The users benefit from the enhanced credibility in the audited quality
financial report and these benefits are naturally reflected in the quality of investment
decisions as these decisions are grounded on credible information (Chen et al., 2011;
Ahmadzedeh et al., 2013). Therefore, our study of examining the effects of audit quality on
costs of capital is underpinned by the lending credibility theory as we seek to establish the
extent to which quality audit can reduce costs of raising business finance in Ghana. The
preceding theory argues that shareholders would appoint competent auditors that will 643
provide quality audited financial and systems reports which in turn increase investor
confidence and corresponding lower required rate of return. This is conceptualized in
Figure 1.
As indicated in the conceptual framework, when a firm chooses high-quality auditors,
it improves the credibility of the information provided in the annual reports by
enhancing the accuracy in the company’s earnings (DeAngelo, 1981), decreases
contracting costs in competitive capital markets (Fortin and Pittman, 2007; Ali, 2008).
Given the significance of transparency of accounting information to lenders and
shareholders, capital markets continue to examine the role of auditor choice to decrease
the doubts that users of the financial statements may have about companies. Whether
firms receive cost of debt benefits from high-quality audit is a controversial question for
managers and capital market participants (Chen et al. 2011; Fortin and Pittman, 2007;
Balsam, Krishnan and Young, 2003; Karjalainen, 2011; Krishnan et al., 2013). If auditor
assurance reduces investors monitoring costs (Watts and Zimmerman, 1986), then
competition will push banks to pass along these cost reductions to lenders in the form of
lower interest rates. However, the relationship between auditor assurance and loan
interest rate is inconclusive (Li et al., 2010). Kim et al. (2007), find that the interest expense
paid by firms with prestigious Big 4 auditors is significantly lower than firms with non-
Big 4 auditors due to the integrity given by Big 4 audit firms to the audited financial
statements.
3. Review of empirical literature and hypotheses development
Various literature studies have used auditor’s characteristics to explain audit quality
because the size of an audit reflects auditor’s capability and objectivity. Audit firm size is so
important that capital market and its participants may evaluate audit quality using the size
of the audit firm (Chen et al., 2011) and not their ability to detect and report material
misstatements of the financial statements (Ahmadzedeh, et al., 2013). A big audit firm is
viewed as very reliable and a higher reputation costs will provide the motivations to convey
Figure 1.
Conceptual
frameworkSource:
Authors
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JFRA higher audit quality (DeAngelo, 1981). Empirical research has mostly used Big 4 as a proxy
16,4 for audit quality and this study also uses Big 4 as a measure for audit quality because Big 4
audit firms have higher professional competence (Francis, Maydew and Sparks, 1999);
greater independence in the course of their engagement (DeAngelo, 1981); are able to
specialize in a particular industry (Li et al., 2010); are able to charge high audit fees
(Dhaliwal, Gleason, Heitzman and Melendrez, 2008); and are able to have higher auditor
644 tenure (Boone et al., 2004; Kim et al., 2013; Mansi et al., 2004).
3.1 Audit quality and cost of equity
Fortin and Pittman, (2007) and Khurana and Raman (2004) argue that, higher audit quality
leads to more credible and reliable financial information and improves the accuracy of a
firms’ earnings and reduces information risk which reduces the cost of equity. Krishnan
et al. (2013) state that when investors are not privy to information, they will demand a higher
rate of return to reward them for the risk of the use of their resources by managers. When
companies change from industry low audit quality to high audit quality the market
responds to the change and this reaction could either be because of an increased
expectations of future cash flows or because of a decrease in discount rate (Knechel and
Vanstraelen, 2007; Krishnan, et al., 2013).
Azizkhania et al. (2010) found that audit quality are significantly related to a lower cost of
equity but only for firms audited by non-Big 4 audit firms whiles (Fernando et al., 2010) find
that Big 4 audit firms reduce the cost of equity in the USA and Australia. Research found
that non state own enterprises with high audit quality obtain insignificant decrease in the
cost of equity than their state-owned counterparts that employ high-quality auditors in
China (Chen et al., 2011). Embong et al., (2012) find that audit quality reduces the cost of
equity of listed firms in Malaysia. Baker and Al-Thuneibat (2011) find that low audit quality
is positively related to the equity risk premium. Boone et al. (2008) and Baker and Al-
Thuneibat (2011) argue that equity risk premium declines in the early years of tenure but
rises as the years prolong. However, Alastair et al. (2011) find that the cost of equity of Big 4
auditors are insignificantly different from those of non-Big 4 auditors. This means that there
is no significant association between audit quality and cost of equity and that investors’
value auditor presence rather than audit quality.
Prior studies used either public listed firms or private firms but this study combines both
listed and non-listed firms. Though, there are mixed findings on audit quality and cost of
equity in the previous studies, this study argues that audit quality can reduce the cost of
equity. Hence, our study hypothesizes that:
H1. There is a negative relationship between audit quality and cost of equity.
3.2 Audit quality and cost of debt
Previous studies have investigated the influence of specific characteristics of audit quality
on the cost of debt (Huguet and Gandia, 2014; Kim et al. 2013; Karjalainen, 2011; Li et al.,
2010; Dhaliwal et al., 2008; Pittmana and Fortin, 2004; Fortin and Pittman, 2007; Mansi et al.,
2004). Prior research (Gul, et al., 2013; Ke, Lennox and Xin, 2012; Karjalainen, 2011; Kim,
Tsui and Yi, 2011; Mansi et al., 2004; Francis andWang, 2008; Fortin and Pittman, 2007; and
Pittmana and Fortin, 2004) has studied audit firm size and cost of debt and had generated
mixed results.
Some studies found a negative association between audit quality and cost of debt
(Karjalainen, 2011; Mansi et al., 2004; Pittmana and Fortin, 2004; Kim et al., 2007), show that
private firms with high audit quality (external audit) pay a significant lower interest rate on
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their debt than do private firms with poor audit quality (without an audit) in Korea and Effects of audit
further state that the interest rate on loans is significantly lower for firms audited by Big 4- quality
audit firms compared to firms audited by non-Big 4-audit firms. Mansi et al. (2004) found a
negative association between audit quality and cost of debt for US listed firms. Causholli
and Knechel (2012) found that audit quality plays a significant role in reducing the cost of
debt in the USA. A similar study by Gul et al. (2013) finds a significant negative
relationship between audit quality (as measured by Big audit firms) and cost of debt across
the world; Karjalainen (2011) and Huguet and Gandia (2014) also find a significant negative 645
relationship between audit quality (Big 4) and cost of debt among private firms in Finland.
Gul et al. (2013) found that clients’ firms benefit from Big 4 auditors in terms of lower cost
of debt around the world is related to audits performed in stricter investor protection
regime. Again, Li et al. (2010) and Ali (2008) show that in the USA, firms that employ
quality audit enjoy significantly lower cost-of-debt financing. Ke et al. (2012) find a
negative association between audit quality and cost of debt for firms audited by Big 4
auditors. They argue that Big 4 auditors increase the credibility of private and young firms
financial statements which result in a fall in debt monitoring cost and finally to a reduction
in the interest rate.
Carmo et al. (2016) examined the relationship between earnings quality and the cost of
debt for Portuguese private companies. They employed ordinary least squares regression
technique to test the relationship between earnings quality and the cost of debt. The results
show that earnings quality has a greater effect on reducing the cost of debt in companies
having audited financial statements. This finding suggests that banks give greater
importance to audited financial information when deciding the interest rate. Aldamen and
Duncan (2012) investigated the relationship between corporate governance and whether or
not companies are able to access interest bearing debt in Australia. They found that debt
companies have better corporate governance suggesting that the likelihood of accessing
interest bearing debt is related to governance level.
Conversely, some other studies found no significant relationship between Big 4 and cost
of debt (Fortin and Pittman, 2007; Kim et al., 2011). Various research studies in Spain have
studied the association between the cost of debt and audit quality in public companies,
private companies and a combination of both groups and found no significant association
between audit quality and cost of debt (Huguet and Gandia, 2014). Kim et al. (2011) found no
significant relationship between voluntarily audited and non-voluntary audited firms, and
Fortin and Pittman (2007) did not find significant relationship among firms audited by Big 4
and smaller auditors and their cost of debt. Piot and Missionier-Piera (2007) found that the
presence of Big-5 auditors do not influence the cost of debt significantly and that the
financial reporting and accounting number quality are the prime interest to debt-holders in
French setting irrespective of whoever audits it. Dhaliwal et al. (2008) found no evidence that
the relationship between earnings and the cost of debt falls as audit quality (measured by
the size of audit fees) increase. Therefore, they suggest that lenders value auditor presence
more than auditor choice (Huguet and Gandia, 2014). Guided by our choice of theory and
conceptual framework, we hypothesize that:
H2. There is a negative relationship between audit quality and cost of debt.
3.3 Audit quality and cost of capital
The weighted sum of the cost of equity and the cost of debt are the cost of capital for a firm
(Modigliani and Miller, 1958). Francis et al. (2005) claim that the cost of capital helps to link
the company’s long-term investment decisions directly to its long-term financing decisions.
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JFRA The capital structure of a firm is often made up of debt and equity and a combination of
16,4 these sources of finance give the overall cost of capital of the firm (Soh, 2011).
Research found that low audit quality have higher cost of capital than firms with high
audit quality (Francis et al., 2005). Chen et al. (2011) and Khurana and Raman (2004) found
that audit quality significantly enhances the credibility of financial statements in the USA
and Australia and find that audit quality significantly affects the cost of capital in the USA
646 but found no evidence that audit quality affects cost of capital in Australia. They
demonstrated that firms audited by large audit firms significantly reduces cost of capital
compared to the firms which have not been audited by large audit firms. Auditors have the
mechanism of detecting information distortion, improving information quality and
consequently reducing investment risk and facilitating optimal decision-making (Ahmad
et al., 2014). Thus, audit reduces informational risk for the users of financial statements
which eventually results in the reduction of return rate expected by investors. Mansi et al.
(2004) examine the association between auditor’s characteristics and cost of capital and
found that there is a significant negative association between auditor’s tenure and cost of
capital. In other words, cost of capital is reduced by an increased auditor tenure. Other
studies also find that auditor size (Big X audit firms), auditor industry specialization and
auditor tenure are negatively associated with the client firm’s cost of capital, but this
findings is limited to only small client firms, reflecting the poor information environment
associated with such firms (Fernando et al., 2010).
Li et al. (2009) find that in addition to higher audit quality being associated with a direct
reduction in the cost of capital, there is also a significant mitigation of the positive impact of
high accruals on the cost of capital and therefore concluded that markets recognize the
importance of both the insurance and assurance dimensions of audit quality. Ahmed et al.
(2008) examined whether the use of industry specialist auditor reduces cost of capital for
firms using Big 4 audit firms. They found that firms that use industry specialists’ auditors
(Big 4 auditors) have significant lower cost of capital than firms that use non-specialist Big 4
auditors. They further show that using an industry specialist auditor is important when
alternative monitoringmechanisms, such as boards of directors or institutional shareholders
are weak. This means that using Big 4 audit firms is unnecessary when alternative
monitoringmechanisms are strong (Ahmed et al., 2008).
Alireza et al. (2014) reviewed empirical evidence over the past decades to assess what
researchers have done about the impact of audit quality on the cost of capital. The study
finds a stream of literature explaining that audit quality of external auditor mechanisms
such as auditor size, audit fees, non-audit services and auditor industry specialization are
able to contribute towards enhancing the firm’s performance and reducing information
asymmetry and the cost of capital raised by firms. Theoretically and empirically to some
extent, high audit quality of external auditors will lead to lower firm risk, information
asymmetry and subsequently, a lower cost of capital.
Given that limited research actually combined the two components of cost of capital (cost
of debt and cost of equity) despite the importance of these components to the capital market
(Soh, 2011), this study examines the influence of audit quality and cost of capital. Though,
there are few studies on audit quality and cost of capital (Pittmana and Fortin, 2004), they
seem to conclude that audit quality has a negative association with cost of capital. This
study then proposes its third hypothesis that:
H3. There is a negative relationship between audit quality and the weighted average
cost of capital.
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4. Data and measurements Effects of audit
This section seeks to address the source of data collection, sample and the criteria used to quality
select the sample from the population, measurement of estimation variables, descriptive
statistics and correlation analysis.
4.1 Data and sample selection
The population of this study consists of all the firms listed on the Ghana Stock Exchange
for the periods 2008 and 2013 and the Ghana Club 100 firms for the period 2008 to 2013 647
financial years. The data are obtained from the annual reports of the companies. The data
on the listed firms are obtained from the Ghana Stock Exchange’s library, while the annual
reports for Club 100 are obtained from Ghana Investment Promotion Council (GIPC)
library. The Ghana Club 100 (GC 100) is an annual compilation of the top 100 (i.e. 100 most
successful firms by size, profitability and growth) companies in Ghana to give due
recognition to successful enterprise and it was launched in 1998 by the Ghana Investment
Promotion Council (GIPC). Forty firms with sufficiently continuously available data for six
years are used in this study. Among the 40 firms used for the study, 20 (50 per cent) are
solely listed on the Ghana Stock Exchange, 8 (20 per cent) firms are solely Club 100
members and 12 (30 per cent) are both Club 100 members and listed on the Ghana Stock
Exchange. All the firms uses both debt and equity capital. In total, 240 firm-year
observations are obtained over the 2008-2013 period.
4.2 Measurement of estimation variables
The cost of equity (COE), is measured using the Gordon model as implemented in Ahmad
et al. (2014) and Ahmadzedeh et al. (2013). This was computed by deflating the expected
dividend by share price (see Table I). Growth rate (g) in the formula was computed by
multiplying the return on capital employed (ROCE) by the percentage of profit retained for
each year. Following the approach of Pittmana and Fortin (2004), Francis et al. (2005) and Gul
et al. (2013), we measured cost of debt (COD) as the annual interest expense after tax in year t
to the interest-bearing total debt (i.e. short and long term) outstanding during the year. Capital
cost of companies consist of two components: cost of debt and cost of common equity. In this
study, capital cost is obtained by computing weighted average cost of capital (WACC) of these
two components as implemented in Fernandes (2014), Brealey et al. (2013) and Soh (2011).
This study uses KPMG, Deloitte and Touche, PricewaterhouseCoopers and Ernst &
Young) as the evidence of Big 4 audit firms in Ghana. In Ghana, Big 4 firms practice
auditing and assurance alongside with small sole proprietorships, locally owned
partnerships and partnerships with some minimal international affiliation other than the
Big 4. Audit quality has been measured in different ways in the accounting literature. For
example, DeAngelo, (1981) used firm size as a measure for audit. Becker et al. (1998) and
Francis et al. (1999) provided evidence in support of Big 4 as a measure for audit quality as
they found that lower level of discretionary accruals can be observed for firms that appoint
Big 4 auditors. Lennox (1999) found that the size of audit firm and reputation has a direct
association with quality of report produced, however, Kaawaase et al. (2016) showed that
there are no audit quality differences amongst Big 4 and non-big 4 firms in Uganda. Besides,
Carcello et al. (2002) and Miettinen (2008) used audit fees as a measure of audit quality with
the argument that audit fees reflect the magnitude of audit effort. Furthermore, audit quality
has been measured using discretionary accruals (Ronen and Yaari, 2008; Pott et al., 2009), as
financial statements can be manipulated by management through the use of accruals to
influence reported accounting numbers to their own benefit. It is expected that quality
external audit should be able to identify and report such manipulations.
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JFRA
16,4 Variables Variable definitions
The dependent variables
Cost of debt (COD) The cost of debt in year t is measured as
Interest expenseCOD = (1 T)
Interest bearing debt
648 DPSþ 1Cost of equity (COE) Cost of equity is measured as COE = þ g
P
Cost of capital (WACC) This is measured as:WACC = (1 T) kd (D/V)þ ke (E/V)
The independent variable (test variable)
Audit quality (AQ) A dummy variable equal to 1 if the sample firm is audited by Big
4 audit firm, otherwise 0.
Control variables
¼ Total LiabilitiesLeverage (LEV) Measured as: Leverage
Total Assets
Plant property and equipment (PPE) Collateral available to support borrowings, measured as
¼ Net plant property and equipmentPPE
Total Assets
¼ net incomeReturn on assets (ROA) Measured as: Return on assets
Total Assets
Firm size (FS) Firm size is measured as: FS = LN (market value)
Board size (BS) It is measured as: BS = Number of directors on the board
Listed Measured as 1 if the firm is listed, otherwise 0.
Club 100 (C100) Measured as 1 if the firm is a member of the Club 100 from 2008
to 2013, otherwise 0
Beta (a) a = Constant coefficient (intercept)
Beta (b 1) b 1 = Coefficient of independent variable
Beta (b 2-b 8) b 2-b 8 = Coefficients of control variables
Notes: T = tax rate; DPS = dividend per share; g = growth rate; P = share price; kd = cost of debt; ke = cost
Table I. of equity; D = debt proportion which is the percentage of debt capital used by the firm; E = equity
Variables definition proportion which is the proportion of shareholders fund in the firm; V = value of firm is the total of debt
and measurement and equity finance employed by the firm
There have been few research studies on Big 4 audit firms and cost of capital (Krishnan et
al., 2013; Ahmadzedeh et al., 2013; Chen et al., 2011; Li et al., 2009; Ahmad et al., 2014). As in
Angelo (1981) and Lennox (1999), we measure audit quality using the size of the firm, as big
firms have concern for their reputation, greater ability to withstand client pressure, greater
resources and a more developed audit strategy and procedures. Besides, Libby et al. (2006)
found that Big 4 firms are more likely to demand for correction of misstatement of amounts
recognised in the financial statements. This suggests that the Big 4 firms demand stricter
compliance to reporting standards and regulations. Similar to that of Azizkhania et al.
(2010), we define audit quality as a dummy variable with a value of 1 if the firm is audited
by a Big 4 audit firm, otherwise 0.
Leverage refers to book value of debt leverage, measured as the ratio of book debt to total
assets (Azizkhania et al., 2013). Previous studies have established that smaller firms have
higher risk than larger firms, so firm size (FS) is controlled (Khurana and Raman, 2004;
Ahmadzedeh et al., 2013). Firm size is measured as the natural log of the firm’s market
capitalisation and defined as share price multiplied by number of common stock. Plant,
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property and equipment scaled by total assets is included as a control variable for the Effects of audit
collateral value of assets (Karjalainen, 2011). Return on assets (ROA) is included to quality
control for firm performance. It is measured as net income scaled by total assets. The
study includes listed as a control variable for the client’s listing status and measured as 1
if the firm is listed and 0 otherwise. The study includes club 100 as a control variable for
the top 100 firms and is measured as 1 if the firm is part of Club 100 firms and 0
otherwise. This study controls for the effect of board size. It is measured as the number of
directors on the board. 649
5. Empirical method and analysis
This section provides the empirical estimation strategy and analysis of results.
5.1 Empirical estimation strategy
Our discussion in Section 3 conditions costs of capital on audit quality. Taking guidance
from this and controlling for other variables as in Khurana and Raman (2004), Fernando
et al. (2010), Gul et al. (2013) and Francis et al. (2005), we model cost of equity, cost of debt
and weighted average cost of capital as a function of audit quality and relevant control
variables. Guided by our hypotheses, we employ three separate econometric models as
below.
The cost of equity is modelled using the following empirical model:
COEit ¼aþ b 1AQitþ b 2BSitþ b 3PPEitþ b 4FSitþ b 5ROAitþ b 6LEVit
þ (1)b 7Listeditþ b 8C100itþm iþ y it
m i is firm-specific fixed effects and y it is an idiosyncratic disturbance term.
In our estimation of equation (1), the assumption of cross-sectional independence of the
error terms in the panel regression was highly unrealistic and violated. For example,
O’Connell (1998) demonstrates the considerable size distortions that can arise when such
cross-sectional dependencies are present but not accounted for. Furthermore, the p-value for
the Hausman test is significant at 10 per cent level (i.e. 5.17 per cent), indicating that the
random effects model is inappropriate. Therefore, we execute, as in equation (1), the robust
fixed effects panel regression by employing the “panel corrected standard errors” (PCSEs)
which accounts for the cross-sectional dependencies of the error terms. The subscript i on
the intercept term suggests that the intercepts of the firms are different resulting from the
firm fixed effects.
Contrary to the cost of equity model, our estimation of equations 2 and 3 shows that
firm-specific effects are not of significance interest to the problem at hand, which made us
to select the random effects panel regression, that essentially allows for a different error
structure for each firm. A Hausman test is conducted and it shows that the random
effects model is valid, as the firm-specific effects (m i) are found not to be significantly
correlated with the explanatory variables. The p-value for the Hausman test is more than
10 per cent (i.e. 27.53 per cent and 70.86 per cent for cost of debt and weighted average
cost of capital, respectively), indicating that the random effects model is appropriate.
Furthermore, the cross-section random effects test comparisons between fixed and
randommodels demonstrate no significant difference between the two models. Therefore,
we execute the robust random effects panel regression as in equation (2) and (3) by using
White cross-section standard errors and covariance to account for cross-sectional
heteroscedasticity.
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JFRA The cost of debt model is specified as:
16,4 CODit ¼ a þ b 1AQit þ b 2BSit þ b 3PPEit þ b 4FSit þ b 5ROAit
þ (2)b 6LEVit þ b 7Listedit þ b 8C100it þ v it
Whiles the cost of capital model is specified as:
650 WACCit ¼ aþ b 1AQit þ b 2BSit þ b 3PPEit þ b 4FSit þ b 5ROAit
þ (3)b 6LEVit þ b 7Listedit þ b 8C100it þ v it
The composite error term v it consists of two components: « it , which is the cross-section, or
individual-specific error component, and m it , which is the combined time series and cross-
section error component and is called the idiosyncratic term.
5.2 Summary statistics and correlation analysis
We present the descriptive statistics of the variables for our empirical analysis in Table II, as
Table III displays the correlation between the estimation variables. The dependent variables
are the cost of debt, cost of equity and weighted average cost of capital. The mean cost of
debt, cost of equity and weighted average cost of capital are 10.6 per cent, 15.74 per cent and
14.45 per cent, respectively. However, elsewhere 5 per cent was the average (Pittmana and
Fortin, 2004; Cano- Rodríguez and Alegría, 2012, Mansi et al., 2004), making the cost of
raising business finance in Ghana high. The cost of raising equity capital in Ghana is
relatively high compare to debt, and this may explain why most Ghanaian firms rely on the
Variables Obs. Mean SD Min Max
Years 2008 2013
Dependent variables
Cost of debt (COD) 240 0.105927 0.121269 0 0.65495
Cost of equity (COE) 240 0.157431 0.155524 0 0.80001
Cost of capital (WACC) 240 0.144486 0.119274 0 0.78208
Independent variable:
AQ 240 0.7875 0.4099316 0 1
Control variables
BS 240 8.333333 2.356628 3 16
PPE 240 0.2772089 0.2610474 0.002935 0.9829656
FS 240 7.154974 1.004995 5.227022 19.84547
ROA 240 0.0596975 0 0.0914635 0 0.5960634
LEV 240 0 0.1857744 0.2211615 0 0.9294249
Listed 240 0.825 0.3807612 0 1
C100 240 0.50 0.5010449 0 1
Notes: The cost of capital is made up of weighted average cost of capital (WACC), cost of debt (COD) and
cost of equity (COE). AQ is audit quality and is measured as dummy variable with a value of 1 if a Big 4
audit firm audits the firm, otherwise 0. BS is the board size. It is measured as the number of directors on the
board. Club 100 (C100) is the top 100 performing firms and is measured as 1 if the firm is part of Club 100
firms and 0 otherwise. Firm size (FS) is measured as the natural log of the firm’s market capitalisation and
Table II. defined as share price multiplied by number of common stock. ROA is return on assets. LEV is the
Summary statistics Leverage of the firm and is measured as the ratio of book debt to total assets. LISTED is used to describe
on selected firm level the client’s listing status and measured as 1 if the firm is listed and 0 otherwise. The PPE is asset
variables tangibility, which measures the physical property of the firm
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Effects of audit
Probability BS AQ C100 FS LEV LISTED PPE ROA WACC COD COE quality
BS 1.0000
AQ 0.1653 1.0000
C100 0.3794 0.0956 1.0000
FS 0.6336 0.3533 0.5160 1.0000
LEV 0.0957 0.0899 0.0987 0.2516 1.0000
LISTED 0.1659 0.0306 0.4082 0.4050 0.0155 1.0000 651
PPE 0.0702 0.0305 0.4608 0.2711 0.2292 0.3378 1.0000
ROA 0.2763 0.2648 0.3779 0.3071 0.0314 0.1122 0.2648 1.0000
WACC 0.0970 0.1490 0.0932 0.1187 0.0492 0.1033 0.1006 0.0741 1.0000
COD 0.0024 0.3067 0.0181 0.2051 0.1414 0.2128 0.0370 0.2033 0.2769 1.0000
COE 0.1603 0.0093 0.0838 0.0117 0.0583 0.1523 0.1813 0.1164 0.6525 0.0493 1.0000
Notes: This table presents correlation coefficient estimated on sample of firms in Ghana. The cost of
capital is made up of weighted average cost of capital (WACC), cost of debt (COD) and cost of equity (COE).
AQ is audit quality and is measured as dummy variable with a value of 1 if a Big 4 audit firm audits the
firm, otherwise 0. BS is the board size. It is measured as the number of directors on the board. Club 100
(C100) is the top 100 performing firms and is measured as 1 if the firm is part of Club 100 firms and 0
otherwise Firm size (FS) is measured as the natural log of the firm’s market capitalisation and defined as
share price multiplied by number of common stock. ROA is return on assets. LEV is the Leverage of the
firm and is measured as the ratio of book debt to total assets. LISTED is used to describe the client’s listing
status and measured as 1 if the firm is listed and 0 otherwise. The PPE is asset tangibility, which measures Table III.
the physical property of the firm Correlation matrix
debt market to raise business finance. The appetite for debt financing for Ghanaian firms
promotes the banking sector, as there is the market to supply debt finance. The average
board size is about eight members and 27.72 per cent of PPE, constituting the total company
assets, while on average there is 18.58 per cent of leverage per firm but with maximum
leverage of about 93 per cent indicating that some companies mainly rely on debt as their
main source of funding.
The results in Table III displays the correlation between the estimation variables. As
expected, the correlation between audit quality and all three costs of capital variables are
negative supporting the notion that quality of audit reduces cost of capital, as the confidence
by investors in firms audited by the Big 4 is high and therefore will require lower rate of
return. Similarly, firm size negatively relates to all three costs of capital variables indicating
that larger firms enjoy lower cost of raising funding and this is consistent with existing
evidence that firms with large market capitalisation produce lower returns compare to firms
with smaller capitalisation (Fama and French, 1992, 1993). The evidence also indicates that
PPE is recognised as a collateral for demanding lower cost of capital whiles high return on
assets reduces overall cost of capital. Moreover, listed firms and larger boards attract lower
cost of capital in raising funds.
5.3 Analysis of regression results
Table IV reports the results of our three estimation models. The results uphold all of our
three hypotheses. As expected, audit quality has a negative coefficient with all the three
costs of capital variables suggesting that high-quality audit provides a more credible and
reliable information and improves firms reported earnings which reduces the cost of capital.
However, amongst the three costs of capital variables, the relationship between cost debt
and audit quality is statistically significant at the standard level, indicating that quality of
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JFRA
16,4 WACC COD COE
AQ 0.0291(0.6897) 0.0883 (1.9697)** 0.0054 (0.1889)
BS 0.0036 (0.3512) 0.0122 (2.1356)** 0.0180 (4.1245)***
C100 0.0633 (1.7640)* 0.0629 (1.6874)* 0.0065 (0.1999)
FS 0.0127 (1.4489) 0.0183 (2.1251)** 0.0007 (0.1178)
LEV 0.0021 (0.2217) 0.0185 (2.1003)** 0.0006 (0.0988)
652 LISTED 0.0499 (0.9816) 0.0765 (2.2421)** 0.0631 (1.5428)
PPE 0.0437 (0.6359) 0.0043 (0.0665) 0.0795 (2.0525)**
ROA 0.0666 (0.5746) 0.1238 (1.2646) 0.0021 (0.2217)
a 0.4774 (3.4704)*** 0.3077 (2.0565)** 0.3713 (2.9440)***
F-statistic 1.3467 (3.8330)*** (3.0006)***
Adjusted R2 0.0115 0.0866 0.0628
Observations 240 240 240
Notes: The dependent variables are cost of capital, which is made up of weighted average cost of
capital (WACC), cost of debt (COD) and cost of equity (COE). AQ is audit quality and is measured as
dummy variable with a value of 1 if a Big 4 audit firm audits the firm, otherwise 0. BS is the board
size. It is measured as the number of directors on the board. Club 100 (C100) is the top 100 firms and is
measured as 1 if the firm is part of Club 100 firms and 0 otherwise Firm size (FS) is measured as the
natural log of the firm’s market capitalisation and defined as share price multiplied by number of
common stock. LEV is the Leverage of the firm and is measured as the ratio of book debt to total
assets. ROA is return on assets. LISTED is used to describe the client’s listing status and measured as
Table IV. 1 if the firm is listed and 0 otherwise. The PPE is asset tangibility, which measures the physical
Determinants of cost property of the firm. ***, ** and * indicate statistical significance at the 1%, 5% and 10% levels,
of capital respectively, with t-ratios in parentheses
firms audit is an important factor to lenders for determining their lending rate. This
suggests that companies with a high audit quality (Big 4 external auditor) pay significant
lower interest rate on debt capital than do companies with lower audit quality (non-Big 4
external auditor). This finding is consistent with that of Kim et al. (2007), Mansi et al. (2004),
Huguet and Gandia (2014) who found that cost of debt is reduced with high audit quality in
Korea, USA and Finland, respectively.
Furthermore, our finding in respect to cost of equity is consistent with existing literature
as several studies have found that quality audit leads to lower cost of equity in Australia
(Azizkhania et al. 2010), in the USA (Fernando et al., 2010), in China (Chen et al., 2011) and in
Malaysia (Embong, et al., 2012). When firms avail their activities to high-quality audit and
investors become privy to this information, they will demand lower rate of return in
response, as quality audit reduces information risk which in turn reduces cost of equity.
When equity investors are privy to information, they will demand lower rate of return to
reward them for the risk of providing resources for the company.
Besides, our finding in respect to the weighted average cost of capital suggests that audit
quality enhances the credibility of financial statements and hence reduces the overall long-
term cost of capital. This evidence is consistent with findings elsewhere, such as Khurana
and Raman (2004), where it was established that in the USA and Australia, quality audit
reduces overall long-term cost of capital. Because the overall cost of capital links the
company’s long-term investment decisions to its long-term financing decisions, it is
expected that companies will benefit from lower discount rate for their project’s net present
valuation and calculating internal rate of return. It can therefore be concluded that the
capital markets (both debt and equity) recognise the importance of the assurance and
insurance dimensions of higher audit quality (Li et al., 2009)
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Our results suggest that audit quality reduces information risk which in turn leads to Effects of audit
lower cost of funds. This suggests that auditors have the mechanism of detecting quality
information distortion, improving information quality and consequently reducing
investment risk and facilitating optimal decision-making. Thus, audit reduces informational
risk for the users of financial statements which eventually results in the reduction of return
rate expected by all kinds of investors. Unaudited financial information is viewed as stained
with information asymmetry, and thus, does not improve the efficiency of capital markets. 653
Audit is therefore seen as a key contributor to trust and market confidence. This suggests
that audit firms must continuously endeavour to enhance the audit quality in achieving
higher trust and the level of market confidence.
It can be argued that if firms can benefit from raising cheaper cost of capital, value is
created for the investors. In view of the limited yet emerging literature on the connection
between audit quality and the cost of capital, more grounded external corporate governance
mechanism, for example, audit quality of external auditor, can alleviate information
asymmetry and the agency problems that features the capital markets. In an agency
relationship in which information asymmetry issues emerge, the preparers of financial
statements are thought to be unscrupulous in reporting financial information. As a
consequence, the users of financial statements are unequipped for recognizing legitimate
and untrustworthy financial information. In this circumstance, the interest for independent
audits can be believed to bring about the financial statements of users receiving legitimate
reports (Wallace, 1980). Subsequently, audit services inform the market that the financial
statements provided bymanagement are free frommaterial errors.
Turning to control variables, overall weighted average cost of capital shows a negative
relationship with board size, firm size, listed firms, PPE and return on asset variables, while
it shows positive association with Club 100 and leverage. Furthermore, we find negative
association between cost of debt and board size, firm size, leverage and return on assets,
while only board size and PPE show negative relation with cost of equity. The evidence
suggests that investors recognised the importance of larger boards, large capitalisation and
marketable (listed) firms, larger PPE as collateral and high return on assets as means to
reduce the required rate of return and this is line with exiting evidence as in Azizkhania et al.
(2013), Khurana and Raman (2004), Ahmadzedeh et al. (2013) and Karjalainen (2011).
Interestingly, the mean (intercept) variable for all three regression models are positive
and statistically significant at standard levels, indicating that there are other important
variables that may influence investors required rate of return. The F-statistic for both cost of
debt and cost of equity models are statistically significant at 1 per cent level indicating the
joint significance of the explanatory variables for the explained variable. In other words, the
independent variables are important for explaining the variation in costs of equity and debt.
However, the coefficient of determination shows a very low adjusted R-squared for all three
models. This shows that audit quality vis-à-vis these control variables are not the only prime
interest to market participants however, auditor presence is a sign that information
provided in the financial reports are credible and are not misleading to stakeholders (bond
holders, debt holders and shareholders) of firms in Ghana.
5.4 Robustness tests: sensitivity of audit quality and firm size to cost of capital
To test the robustness of the benchmark results, some variations are made to the results
reported on table IV. We interacted the size of the firm with our main variable, the audit
quality. This is to enable us ascertain the elasticity or the response of bigger firm to the level
of cost of capital if they are audited with Big 4 accounting firms. Similar to Table IV, the
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JFRA results are presented in columns. Column 1 is weighted average cost of capital (WACC), and
16,4 Columns 2 and 3 are cost of debt (COD) and cost of equity (COE), respectively.
The results are presented in Table V and these seek to explore the overall sensitivity of
the relationship between audit quality and firm size to cost of capital. The interaction
between audit quality and size has a positive influence on cost of capital. This implies bigger
firms who engage the services of Big 4 may seek to have or experience higher cost of capital
654 and they are more sensitive to the level of cost of capital. However, this is considered not
important given the statistically insignificant effect. The results of all other variables remain
unchanged despite the interaction with the firm size.
6. Conclusion
The study inspired by the lending credibility theory tested the relationship between audit
quality and cost of capital. There is a negative correlation between audit quality and all the
components and overall cost of capital, i.e. cost of equity, cost of debt and weighted average
cost of capital. This supports the lending credibility theory that audit quality improves the
credibility of financial reports which leads to reduction in cost of capital. The relationship
between audit quality and cost of debt is significant but not with cost of equity. In the case of
control variables, board size, firm size, listed firms, PPE and return on asset are negatively
related to cost of capital. However, cost of capital is positively associated with Club 100 and
leverage. This findings of the study suggest that lenders and investors consider the
relevance of larger boards, listing status and PPE as collateral and high return on assets to
reduce the required rate of return. Furthermore, we find negative association between cost of
debt and board size, firm size, leverage and return on assets whiles only board size and PPE
show negative relation with cost of equity.
Variable WACC COD COE
AQ 0.2609 (0.8003) 0.1110 (0.2563) 0.3309 (1.3134)
BS 0.0029 (0.3311) 0.0115 (1.5116) 0.0147 (2.3412)**
PPE 0.0411 (0.7216) 0.0025 (0.0374) 0.1211 (2.1282)**
FS 0.0237 (1.5885) 0.0092 (0.5164) 0.0175 (1.2807)
ROA 0.0565 (0.6069) 0.1282 (1.9713)** 0.2392 (2.7019)***
LEV 0.0010 (0.1038) 0.0178 (2.5310)** 0.0011 (0.1403)
LISTED 0.0490 (0.9055) 0.0752 (1.8208)* 0.0600 (0.9031)
C100 0.0707 (2.0916)** 0.0565 (1.7066)* 0.0022 (0.0461)
AQ*FS 0.0130 (0.7604) 0.0110 (0.4974) 0.0192 (1.3927)
A 0.6556 (2.6789)*** 0.1595 (0.4826) 0.6649 (2.5886)***
Adj. R2 0.0104 0.0810 0.0445
F-Stat 1.2799 3.3417*** 2.2375**
Observations 240 240 240
Notes: The dependent variables are cost of capital, which is made up of weighted average cost of capital
(WACC), cost of debt (COD) and cost of equity (COE). AQ is audit quality and is measured as dummy
variable with a value of 1 if a Big 4 audit firm audits the firm, otherwise 0. BS is the board size. It is
measured as the number of directors on the board. Club 100 (C100) is the top 100 performing firms and is
measured as 1 if the firm is part of Club 100 firms and 0 otherwise Firm size (FS) is measured as the natural
log of the firm’s market capitalisation and defined as share price multiplied by number of common stock.
LEV is the Leverage of the firm and is measured as the ratio of book debt to total assets. ROA is return on
Table V. assets. LISTED is used to describe the client’s listing status and measured as 1 if the firm is listed and 0
Sensitivity of audit otherwise. The PPE is asset tangibility, which measures the physical property of the firm. AQ *FS is the
quality and firm size interaction of audit quality with the size of the firm. ***, ** and * indicate statistical significance at the 1%,
to cost of Capital 5% and 10% levels, respectively, with t-ratios in parentheses
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The results of this paper give rise to three policy implications. First, the study confirms that Effects of audit
external audits add credibility to financial statement as envisaged by the International quality
Standards on Auditing. It increases the value of financial reports which reduces information
asymmetry and subsequently reduce cost of capital. Therefore, firms should negotiate
interest rate and cost of equity with reference to their financial statements. Secondly,
regulators and external auditors can use the result of this study to grow the audit industry
in Ghana. This is because the value of external audit on cost of capital can be deployed as a
sale strategy to encourage the numerous companies who do not conduct external audits to 655
begin, thereby expanding the industry. This can reduce lowballing and the intense price
competition which affects audit quality, a phenomenon associated with a small audit
market. Finally, regulators through workshops, conferences and supervision must promote
audit quality so the audit market can expand as a result of reduced cost of capital associated
with audit quality.
Our study is not devoid of limitation. The fact that our choice of quality measure is based
on firm size and we are unable to test other measurements of audit quality. Yet, our results
are significant to those charged with assurance, regulation as well as lenders and managers
of companies. Future research may wish to examine how other approaches to measuring
audit quality affect cost of capital. We further recommend future studies into how external
audit quality influence the pricing mechanism of banks.
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About the authors
William Coffie is a Senior Lecturer at the University of Ghana Business School. He has a PhD in
Finance, Economics and Econometrics from the UK. He has extensive editorial and reviewing
experience and currently the Case Editor at University of Ghana Business School. He has also edited
for Inderscience Publishers and published in highly reputable journals including International Review
of Financial Analysis, Global Business and Economics Review, Journal of Accounting and Finance,
Afro-Asian Journal of Accounting and Finance, International Journal of Economics and Business
Research, International Journal of Management Practice, Research in Accounting in Emerging
Economies and several peer review conference papers. He has published six textbooks of which five
have been published by the internationally reputable Pearson. Dr Coffie has won an Investigator-led
research grant in capital market offered by Ghana Stock Exchange to investigate on stock market
participation in Ghana. Dr Coffie has consulted for several reputable organisations including Bauchi
State Government in Nigeria, National Union of Local Government Employees in Nigeria, Ministry of
Finance/AfDB, etc. He has offered training in applied econometrics to institutions and groups for
nearly 10 years and developed and taught applied econometrics in several universities at both
undergraduate and postgraduate levels. Prior to University of Ghana, Dr Coffie was a Senior Lecturer
in Finance and Econometrics and Programmes Director for MSc Finance and Accounting and MSc
International Banking and Finance at University of Wolverhampton UK. William Coffie is the
corresponding author and can be contacted at: wcoffie@ug.edu.gh
Ibrahim Bedi is a Chartered Accountant and Faculty at the Department of Accounting, University
of Ghana Business School. He is a Fellow, the Association of Certified Chartered Accountants (UK);
Member, the Institute of Chartered Accountants, Ghana; Member, American Accounting Association;
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Treasurer, African Accounting and Finance Association; and member, International Association of Effects of audit
Accounting Educators and Researchers. He holds Doctor of Philosophy, Master of Business
Administration and Bachelor of Science in Administration in accounting degrees. In 2010, he was a quality
visiting scholar to the Open University, UK. He is Partner of Taylor, Folson and Associates
(Chartered Accountants). He has publications on Compliance to the International Financial Reporting
Standards, Earning Management, Tax Audit and Compliance, Impediments to Accountancy
Education Change and Corporate Governance. He has successfully managed a number of research
grants and has worked on several research teams. 659
Mohammed Amidu is a Senior Lecturer at the University of Ghana Business School. He is a
Researcher with African Economic Research Consortium, and his areas of research include:
accounting information quality financial inclusion and literacy, corporate governance, corporate tax
policy, development finance, banking market structure, regulation and stability. The DANIDA Centre
for International Business awarded him a research grant to conduct a study on “An Examination of
Corporate Governance Practices of the Non-Traditional Export Sector of Ghana: An Exploratory
Study” (With Kyereboah- Coleman, A, in 2007). In 2008 he successfully won a research grant to
conduct a study titled “What Influence Bank Lending in Sub-Saharan Africa? Dr Amidu is also a
Visiting Research Scholar to International Monetary Fund (IMF) US. In 2012 he was awarded
VolkwagenStiftung Junior Fellowship Scholarship grant to conduct a research on the measurements,
determinants and implications of competition in the African banking sector using new industrial
organization literature”. The same institution (i.e. VolkwagenStiftung) awarded him a grant in 2014
to conduct a study on “Corporate social responsibility in extractive sector”. 1n 2013/14, the Dr Amidu
won the ORID investigator led grant to undertake a research titled “Do firms manage earnings and
avoid tax for corporate social responsibility?” His publications have appeared in journals such as
Accounting Research Journal, European Journal of Finance, Review of Quantitative Finance and
Accounting, International Review of Financial Analysis, Review of Financial Economics; Journal of
Risk Finance, Investment Management and Financial Innovations, Journal of Africa Business and
Baltic Journal of Management. He is a referee in many of these and other journals.
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