An Analysis of the Effect of Regulator Designation of Auditors on Independence in Not-for-Profit Organizations in Saudi Arabia
Abstract
<h2>Conceptual and Contextual Foundations of Auditor Independence in Regulatory Environments</h2> <p>All countries have laws in place to protect the auditors' right to impartiality, which is crucial to the practice of public accounting (Mansouri, Pirayesh and Salehi, 2009). Despite the public's trust in auditors, studies have shown that they often have conflicts of interest that make it difficult for them to be truly objective. Management's influence over auditor employment and compensation is seen as a basic danger to auditor independence among other threats.</p> <p>Financial reliance between auditors and clients has long been a source of concern for regulators and users of financial statements, who fear a lack of auditor independence. A succession of accounting scandals, most notably Enron and World-Com, have increased skepticism about the reliability of audits (Bhasin, 2013). Regulators in a number of nations have implemented remedies aimed at promoting auditor independence in an effort to restore public confidence. These remedies include shifting the responsibility for selecting auditors to the audit committee and making the audit committee itself more autonomous. Although the new rules may help reduce management influence on auditors, they will not eradicate it entirely. Management can still sway audit-related decisions thanks to the strong influence it maintains over the audit committee, as shown by a number of empirical studies (Dickins and Skantz, 2010). Therefore, even in the post-Sarbanes-Oxley period, auditors believe that management is the primary influence behind auditor appointment and salary.</p> <p>Some scholars have looked into different ways to strengthen auditor independence by altering the institutional structure guiding the auditor appointment processes in order to reduce the influence of management on auditors. Some recent research, for instance, has looked at different ways in which auditors can be appointed, such as through investor selection of auditors or through the designation of auditors by regulators. While earlier archival research began to look at how regulators choose their auditors, it yielded mixed results. For instance, while some research has indicated a positive correlation between regulator designation of auditors and audit quality Cheng, Liu and Chien (2009), other studies have not found any such correlation at all. Therefore, the full implications of regulators assigning auditors remain obscure. Moreover, it is challenging for historical research to isolate confounding factors Leuz (2018) from regulator designation of auditors in such methods.</p> <h2>Research Objective and Intended Analytical Focus</h2> <p>The main objective of this research will be to analyze the effect of regulator designation of auditors on independence in not-for-profit organizations.</p> <h2>Scholarly and Practical Contributions to Auditor Independence Discourse</h2> <p>This research will be useful for academics, policymakers, practitioners, and businesses alike. Since Saudi Arabia is one of the few countries with specialized auditing and accounting standards and rules in place to monitor the work in the nonprofit sector, the results of this study will be useful to the researcher in that they will shed light on how the sector is now seen. The findings of this study will add to the existing body of knowledge regarding the impartiality of auditors and the length of their careers in auditing. Second, the findings will aid policymakers, such as the management of organizations and governmental bodies of nonprofit and for-profit organizations, in taking the appropriate actions in a timely manner to avoid unfavorable outcomes by providing a deeper understanding of the factors that influence auditor independence. Thirdly, professionals like auditors and accountants will have access to greater knowledge that will enable them to maintain their independence.</p> <h2>Evaluation of Litigation Risk as a Determinant of Auditor Objectivity</h2> <p>Auditor objectivity is encouraged by the possibility of legal action, which could result in significant financial and reputational implications (Beaulieu, 2001). Due to the high expense of litigation, auditors have to think about how well they can defend their conclusions (Francis, 2004). It has become increasingly clear to auditors that they may have to defend their conclusions in court as the likelihood of lawsuit rises. Therefore, they are less likely to accept their customers' aggressive financial reporting and more likely to err on the side of caution. It has been shown in the past that auditors pay closer attention to the possibility of financial performance overstatements when lawsuit risk is high.</p> <p>The effect of lawsuit risk on fostering auditor independence has been studied in the existing literature. For instance, Piot and Janin (2007) present an analytical model that demonstrates how legal culpability boosts auditor independence, reducing the likelihood that auditors will concur with aggressive management tactics. Church et al. (2020) examine how concerns about legal action and losing a client influence auditors' tolerance for clients' aggressive financial reporting. They discover that when the danger of lawsuit is low and the risk of losing the customer is high, auditors are more tolerant of aggressive financial reporting by clients. Krishnan and Krishnan (1997) analyze the impact of lawsuit risk on auditors' going-concern reporting choices and conclude that auditors are more likely to lower their final going concern evaluation and recommend a changed audit report when the risk of litigation is high.</p> <p>In the event that an auditor's independence is challenged, the threat of being classified as such by a regulatory authority or of being sued by a client can act as a de facto control mechanism and provide the auditor with more bargaining power in contract negotiations. The extent to which regulator nomination of auditors aids in enhancing auditor independence is likely to be influenced by legal uncertainty.</p> <h2>Regulatory Appointment Mechanisms and Their Implications for Audit Quality</h2> <p>While auditing firms typically recruit their own auditors, certain nations have been investigating the possibility of changing the auditor hiring method by having authorities appoint auditors to publicly traded corporations. The Financial Supervisory Commission modified the Act on External Audits in December 1989 in response to investors' growing concerns about the lack of auditor independence (Kim and Cheong, 2009). The FSC can now appoint auditors for troubled companies thanks to the new amendment.</p> <p>The appointment of auditors is common practice among public companies in Saudi Arabia. The Saudi Arabian State-Owned Assets Supervision and Administration Commission (SASAC) published rules in 2004 mandating the appointment of auditors by state-owned enterprises falling under its purview. SASAC Order No. 5 mandates that auditors be appointed by SASAC for all state-owned enterprises ultimately managed by the central government. State-owned enterprises under central government administration are required, per SASAC Rule No. 173, to keep their approved auditors on staff for a period of two to five years (Milhaupt and Pargendler, 2017).</p> <p>Academics in the accounting sector have devoted increasing attention to the issue of regulator designation of auditors in recent years. Ebert (2021), for instance, examined whether regulator-appointed auditors deter managers from manipulating earnings. Similarly, Wu and Ying (2016) found that audit quality improved after regulatory interventions. However, the use of proxies such as audit fees and discretionary accruals presents limitations in measuring audit quality.</p> <p>It can therefore be argued that auditors appointed by regulators will be less likely to yield to the audited corporations because of their increased independence. Regulator designation of auditors helps reduce the potential for auditors to be influenced by the management of the firm being audited.</p> <h2>Development of Hypothesis on Auditor Selection and Independence Outcomes</h2> <p>Our primary interest is in answering whether the selection of an auditor by the regulating body has any bearing on the auditor's independence. We hypothesize that auditors' inquiries into and conclusions about noncompliance will be influenced by regulatory designation.</p> <p>H1: Regulatory designation auditors make more independent decisions.</p> <h2>Conceptual Framework Linking Regulatory Designation to Auditor Independence</h2> <p>Independent variable: Regulatory designation of auditors</p> <p>Dependent variable: Auditor independence</p> <p>Control variables</p> <h2>Research Design and Philosophical Alignment with Deductive Inquiry</h2> <p>The research strategy can be thought of as the methodology and approach taken throughout the data collection, analysis, and interpretation phases. Researchers frequently have the option of employing either the deductive or inductive approach. Deductive research involves testing the hypothesis that a certain relationship exists between phenomena.</p> <p>Based on Maxcy (2003), it is essential that one's research philosophy and methods coincide. Because of the similarities between positivism and the deductive method, the latter was chosen to analyze the research problem and achieve the study's objective.</p> <h2>Quantitative Data Collection Strategy Using Structured Questionnaires</h2> <p>This research is based on a quantitative research approach. To gather the research data, the researcher will use questionnaires developed based on the research objectives containing both closed and open-ended questions. The closed-ended questions will be based on a Likert scale of 1–5, enabling analysis using SPSS software.</p> <p>The questionnaires will be distributed online, and respondents will be given sufficient time to complete them.</p> <h2>Definition and Scope of the Study Population in Auditor-Based Research</h2> <p>Target population refers to the subset of the overall population that is the major subject of the research question. In this research, external auditors are the study population. The research will target a total of 70 respondents.</p> <h2>Statistical Techniques for Data Analysis and Interpretation</h2> <p>After data collection, the data will be verified for accuracy and entered into SPSS for analysis. Descriptive statistics will be used to calculate percentages and averages. Regression and correlation analysis will be performed to establish relationships between variables. Results will be presented using tables and graphs.</p> <h2>Integrated Synthesis of Research Purpose and Methodological Direction</h2> <p>The main objective of this research is to analyze the effect of regulator designation of auditors on independence in not-for-profit organizations in Saudi Arabia. The research will be guided by one independent variable (Regulatory designation auditors) and one dependent variable (Independence). The research will rely on primary data collected through questionnaires and analyzed using SPSS software.</p>