Audit Committee Impact on Cosmetic Accounting
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Audit committee quality and cosmetic accounting: an examination in an
emerging market
Article in Corporate Governance · January 2024
DOI: 10.1108/CG-05-2023-0181
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Audit committee quality and cosmetic
accounting: an examination in an
emerging market
Abbas Ali Daryaei, Afshin Balani and Yasin Fattahi
Abstract Abbas Ali Daryaei, Afshin
Purpose – The literature on the influence of audit committees (AC) and cosmetic accounting (CA) is Balani and Yasin Fattahi are
scarce. AC plays a unique and vital role in boosting earnings reliability in countries with weaker all based at the Department
application of accounting standards or weaker legal protection for investors. AC, therefore, are of Accounting, Imam
considered to be one of the essential tools available to directors in supervising management decisions Khomeini International
regarding financial reporting. This paper aims to examine the influence of AC characteristics (ACC) on
University, Qazvin, Islamic
CA and how this relationship is moderated by the audit fee.
Republic of Iran.
Design/methodology/approach – This study used probit regression to analyze 1,218 firm-year
observations of listed companies in Tehran Stock Exchange from 2014 to 2020.
Findings – The results show that AC financial accounting expertise, AC independence, female AC
membership and AC tenure were negatively related to CA. The negative relationship is highly
pronounced when a firm incurs higher audit fees, and audit fees moderate the relationship between ACC
and CA. Results for the robustness checks show that only AC independence was significant, and the
results of other characteristics were not significant.
Research limitations/implications – This research was conducted in an Iranian setting where the
formation of ACs is on the verge of regulation; therefore, the data used for the study only contains the
seven-year period of ACs’ statutory activity. In addition, a lack of consensus on the precise measures of
an AC’s effectiveness could be considered as a restrictive factor.
Originality/value – The findings provide an initial insight into the effect AC on CA and moderating effect
of audit fee on the relationship between ACC and CA.
Keywords Audit committee, Cosmetic accounting, Audit fee, Iran
Paper type Research paper
1. Introduction
Ideally, the purpose of financial reporting is to provide reliable information about a
company’s financial position and performance to a wide range of users that will be useful in
their economic decisions (Barth et al., 2018). Financial reporting quality is the extent to which
financial reporting conveys information about the company’s operations, in particular its
Received 3 May 2023
expected cash flows (Biddle et al., 2009). Earnings are one of the most important indicators Revised 24 September 2023
that users of financial statements consider when evaluating a company’s financial reporting 25 December 2023
Accepted 30 December 2023
quality and performance (Leong et al., 2015). However, the global financial crisis has put the
The authors are grateful to the
spotlight on accounting and financial reporting. Following a series of high-profile financial three anonymous reviewers for
scandals, the confidence of the investors and creditors in financial reporting has been their time and efforts. The
authors would also like to thank
undermined, and earnings quality has become a major factor in the credibility and reliability the Journal editor-in-chief,
of financial reporting (Ahmadpour and Ahmadi, 2008). Earnings management, also known in Professor Eweje Gabriel, for his
support and assistance.
the literature as cosmetic accounting (CA), income smoothing and creative accounting, is a
Disclosure statement: No
measure of low earnings quality (Dechow et al., 2010). Existing studies on earnings potential conflict of interest was
management are mostly based on the agency theory (Albersmann and Hohenfels, 2017). reported by the authors.
DOI 10.1108/CG-05-2023-0181 © Emerald Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j
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According to this theory, information asymmetry and conflicts of interest between the
management and shareholders enable managers to mislead investors by using judgment in
financial reporting (Healy and Wahlen, 1999). In this regard, internal and external monitoring
mechanisms can deter managers from opportunistic reporting by increasing the risk of
detection and potential penalties, thus reducing information asymmetry (Albersmann and
Hohenfels, 2017). The audit committee (AC) is recognized as an important corporate
governance mechanism for improving financial reporting quality (Mili and Alaali, 2023;
Sarbanes and Oxley, 2002). Through continuous monitoring of managers’ opportunistic
behaviors, the AC plays a major role in improving the quality and accuracy of financial
information and reducing information asymmetry between managers and shareholders, thus
reducing agency costs (Archambeault et al., 2008). In listed companies, an effective AC is
expected to improve stock market transparency (McMullen and Raghunandan, 1996;
DeZoort et al., 2002) and improve the quality of accounting information (Beasley, 1996;
Abbott et al., 2004; Pucheta-Martı́nez and De Fuentes, 2007). Financial scandals and
successive losses of shareholders and investors erode trust in financial reporting, and it is
the duty of the management, including the AC, to improve the quality of information for the
benefit of all stakeholders, especially the shareholders (Alavi and Ghaemi, 2017).
ACs have a unique and vital role in increasing earnings reliability in countries with weak
accounting standards (Poretti et al., 2018). Over the past two decades, the AC has become
one of the most important corporate governance mechanisms worldwide. Legislative and
regulatory bodies in many countries have required the establishment of the AC and the
expansion of its roles and responsibilities (Firoozi and Magnan, 2022). In Iran, the Audit
Committee Charter (2013) approved by the Securities and Exchange Organization (SEO)
requires the establishment of the AC and specifies its responsibilities for companies listed
on the Tehran Stock Exchange (TSE). Numerous studies have highlighted the role of ACs in
reducing opportunistic behaviors and increasing financial reporting quality (e.g. Baxter,
2010; Abbadi et al., 2016). Regarding the relationship between the AC and earnings
management, various characteristics such as financial expertise (Tajvidi and Ghaempanah,
2021; Be dard and Gendron, 2010; Karamanou and Vafeas, 2005; Sharma and Kuang,
2014), independence (Beasley et al., 2000; Abbott et al., 2000; Baxter and Cotter, 2009:
Tajvidi and Ghaempanah, 2021), female membership (Bala et al., 2019; Khlif and Achek,
2017), and tenure (Tamoradi et al., 2020; Adeyemi, 2006; Yang and Krishnan, 2005;
Schrader, 2017) have been investigated. Among these characteristics, financial expertise
and independence have been examined more frequently, but female membership has
received less attention, especially in Iran as an emerging country.
The AC comments upon and approves the accounting practices of a company, and thus it
can influence the company’s approach to financial reporting, level of disclosure and
compliance. Both scholars and professional bodies have argued that the AC can improve
financial reporting (e.g. Marsh and Powell, 1989; Auditing Practices Board, 1994). However,
the Enron scandal is evidence that the financial expertise of AC members does not necessarily
improve its effectiveness (Benston and Hartgraves, 2002); rather, other characteristics such as
independence, female membership and tenure can also play a role. Article 9 of the Audit
Committee Charter of TSE-listed firms specifies the responsibilities and powers of the AC in
relation to the independent auditor (Berkman and Zuta, 2018). Among other things, the AC is
responsible for the appointment, compensation and oversight of the independent auditor.
From the users’ point of view, the existence of an AC improves auditor independence and thus
increases the quality of financial reporting (Gwilliam and Kilcommins, 1998). In this study, the
independent auditor fee is included as a moderator variable and a proxy for audit effort in the
relationship between AC characteristics (ACC) and creative accounting.
The rationale for examining abnormal audit fee is that it reflects the special relationship between
the auditor and the client. According to the literature, abnormal audit fee occurs in the form of
economic rent or bribes related to audit services and increases the auditor’s dependency on
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the client (Kinney and Libby, 2002; Choi et al., 2010). The results of this research can provide
insights into the effect of certain ACC on financial reporting quality, which can be helpful for
boards’ AC appointment decisions. Moreover, the moderating role of audit fee is investigated
as a proxy for auditor effort, which can be useful for increasing the effectiveness of the AC and
its relationship with the independent auditor. The contributions of this research are threefold:
䊏 The AC is relatively new in Iran, and extensive investigation is needed into the
characteristics that improve its performance and effectiveness. According to Alavi and
Ghaemi (2017), various factors such as insufficient oversight by the SEO, revision of the
Audit Committee Charter and insufficient compensation challenge AC effectiveness in
Iran. Therefore, the present research explains an important role in identifying the
consequences of the AC and examining its relationship with the companies’ reporting
approaches. This research deals with the ambiguous relationship between the AC and
CA in Iran’s economic environment, which introduces this important variable (CA) as one
of the creative methods in financial reporting and one of the methods of profit
management, which is partially in the literature related to the reporting environment. Iran’s
finance has been neglected, and the present study intends to improve the literature of this
field to some extent and to show the role of the AC in this regard in an experimental way.
䊏 This study focuses on nonfinancial information and the internal control system, which
are two of the areas within the purview of the AC as per Articles 13 and 17 of the Audit
Committee Charter.
䊏 In this study, the effect of the interaction between the AC and the independent audit fee
on the quality of financial reporting is investigated. In other words, by examining the
moderating role of audit fees in the relationship between ACC and CA, this research
depicts the efforts of independent auditors to help the AC to improve the status and
quality of financial reporting of companies.
As the entity responsible for overseeing the work of the auditors, the AC not only has a say
in the volume and scope of audit procedures but also determines audit fees in accordance
with the Audit Committee Charter (Abbaszadeh et al., 2020). In Iran, unlike in developed
countries, the corporate governance structure is weak and requirement to establish ACs in
Iranian firms has been carried out by TSE in recent years. In the late 2012, TSE approved
the AC charter to establish the corporate governance system. Therefore, these unique
socioeconomic features mentioned above along with other foreign and political factors such
as economic and trading sanctions against Iran that differentiate this capital market from
other countries make Iranian capital market as a unique context for our study and with
considering the nascent formation of ACs in Iran as well as the role of effective ACs in
alleviating the agency problems, protecting the investors’ interests and increasing the firms
value, we investigate the effect of effective AC on CA in Iranian firms. Therefore, our study
attempts to fill the gap and extend the literature on AC and CA in emerging markets. Hence,
the focus of our study is to acquire an understanding of whether the dimensions of AC affect
the CA among Iranian firms. So, we selected a sample of 1,218 firm-year observations from
companies listed on the TSE. Because of the unavailability of AC data, our study period
encompasses only seven years (2014–2020).
This paper proceeds as follows. Section 2 discusses relevant literature and develops the
hypotheses. Section 3 provides details of the data and methodology adopted. Section 4
presents the primary analysis. Section 5 provides additional analyses, and Section 6 concludes.
2. Background and hypothesis development
2.1 Audit committee characteristics and cosmetic accounting
Corporate governance is a system that enables a company to balance the interests of
managers and shareholders, reduce agency costs, minimize earnings management, add
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value and prevent financial distress (Soleimani and Moghadasi, 2014). As an internal
corporate governance mechanism, ACs have a unique and vital role in increasing earnings
reliability in countries with weak accounting standards (Poretti et al., 2018). There is
sufficient empirical evidence of the relationship between the AC and financial reporting
quality (e.g. Dechow et al., 1996; Beasley et al., 2000). The present research focuses on
creative accounting as a measure of financial reporting quality. The concept of creative
accounting has been defined in various ways. Jameson (1988) defined it from an
accountant’s perspective as follows: “The accounting process consists of dealing with
many matters of judgement and of resolving conflicts between competing approaches to
the presentation of the results of financial events and transactions [. . .] this flexibility
provides opportunities for manipulation, deceit and misrepresentation. These activities—
practiced by the less scrupulous elements of the accounting profession—have come to
be known as ‘creative accounting’” (Setayesh and Gholami, 2012). Following the
Sarbanes–Oxley Act, monitoring financial reporting quality has become a major concern for
ACs and the main focus of corporate governance reforms (Shankaraiah et al., 2017). By
closely monitoring the accounting practices of the company, the AC can improve the quality
of financial reporting and information disclosure and deter the management from
aggressive accounting practices (Alavi and Ghaemi, 2017). The AC is an essential
mechanism for monitoring management decisions regarding financial reporting. It can curb
opportunistic behavior of managers and align their interests with those of stakeholders to
enhance the company’s earnings quality (Jahanian, 2016). Research shows that ACCs
have a significant effect on its ability to reduce opportunistic behaviors and enhance
financial reporting quality (Bala et al., 2019). In fact, the effectiveness of the AC is a function
dard and Gendron, 2010; Li et al., 2012). For example, larger ACs
of its characteristics (Be
consisting of members with diverse expertise can oversee financial reporting practices
more effectively (Vafeas, 2005). The literature on AC effectiveness is extensive, and the
results have been mixed. However, several factors that influence AC effectiveness have
been identified, including stock ownership, power, financial expertise and industry
expertise (DeZoort, 1998; Kalbers and Fogarty, 1993; DeZoort et al., 2002; Abbott et al.,
2004; Carcello et al., 2002; Beasley, 1996). The present research focuses on ACCs such as
financial expertise, independence, tenure and female membership. Based on these
discussions, the first hypothesis is developed as follows:
H1. There is a negative significant relationship between audit committee characteristics
with cosmetic accounting.
2.2 Financial expertise and cosmetic accounting
Because of the possibility of distortions and its effects on financial reporting quality, it is
necessary for companies to have an oversight function that provides assurance of the
quality of financial reporting. The board of directors assigns this oversight role to the AC.
According to Article 7 of the Audit Committee Charter of the Securities and Exchange
Organization of Iran (SEO), one of the main responsibilities of the AC is to ensure financial
reporting quality. The financial expertise of the members has a positive effect on earnings
quality and thus improves the quality of financial reporting (Karamanou and Vafeas, 2005).
Proponents of the resource dependence theory argue that ACs provide critical resources,
including expertise and skills that help the firm gain competitive advantages, mainly related
to financial reporting quality. Consequently, resource dependence theory explains AC as
provision of resources, providing expertise and experience in order for firms to gain
competitive advantage, especially in financial reporting quality (Nelson and Devi, 2013).
From the perspective of RDT, it is assumed that the multiple abilities, knowledge and
expertise of ACs lead to superior corporate results (Dakhlallh et al., 2020). AC expertise is a
vital component of corporate governance that helps companies achieve their strategic
goals (Cohen et al., 2007; Pfegger, 1972). According to the RDT, the expertise of the AC
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plays a key role in ensuring the control of financial reports that leads to improved
performance of the company (Oroud, 2019). According to the agency theory, members with
financial expertise improve the AC’s ability to evaluate auditors’ judgment and can be
effective in creating a strong internal control system (Sultana, 2015). Financial expertise
allows AC members to discuss a wide range of topics related to financial reporting quality
with the management and independent auditors (Be dard and Gendron, 2010). It is
expected that the financial expertise of AC members will improve financial reporting quality
and transparency. Article 5 of the Audit Committee Charter states that “the audit committee
should be made up of three to five members, with the majority being independent and
having financial expertise.” As such, Iranian companies are required to have financial
experts on their AC, which is expected to minimize agency conflicts caused by managers’
opportunistic behaviors (Umar et al., 2023). Based on this, the existence of financial
expertise among the committee members is a basic prerequisite. According to Be dard and
Gendron (2010), the financial expertise of AC members allows them to ask demanding
questions from the management and independent auditors and be demanding in the quality
of answers provided. ACs with financial expertise can control accrual management more
effectively (Dhaliwal et al., 2010). Prior research has shown ACs with financial expertise can
better understand technical accounting procedures and standards, allowing them to
perform the responsibilities more competently (DeZoort and Salterio, 2001; Cohen et al.,
2002). In addition, AC expertise is associated with lower levels of earnings management
(Albersmann and Hohenfels, 2017; Krishnan et al., 2011; Naiker and Sharma, 2009; Soliman
and Ragab, 2014; Nasirzadeh et al., 2018). Accordingly, the first subhypothesis is
developed as follows:
H11. There is a negative significant relationship between audit committee financial expertise
with cosmetic accounting.
2.3 Audit committee independence and cosmetic accounting
The independence of the AC is widely considered a key factor in the effective monitoring of
the financial reporting process. Independence means that the AC members should have no
financial or family ties to the chief executive officer (CEO) or the firm (Bruynseels and
Cardinaels, 2014). According to the SEO, independent members are those with no direct or
indirect ties to the firm or interests that would affect their decision-making or cause them to
favor the interests of a specific individual or group over others. Independent directors are
well positioned to monitor the financial reporting process and are better able to withstand
pressures for earnings manipulation (Bazrafshan et al., 2015). To be effective, the AC must
be independent from the company and be made up of nonexecutive or outside directors
(Lari and Oradi, 2017; Yousefiasl et al., 2018). Prior research has shown that an
independent AC enhances financial reporting quality (Hundal, 2013; Takhtaei et al., 2013;
Firnanti and Karmudiandri, 2020), earnings quality (Baxter and Cotter, 2009) and timeliness
of financial reporting (Heydari, 2016), while reducing real (Soleimani and Fasihi, 2015) and
accrual earnings management (Klein, 2002). Companies with fraudulent financial reporting
tend to have less independent ACs (Beasley et al., 2000). In Iran, a study by Alavi and
Ghaemi (2017) showed that ACs are heavily influenced by the CEO and are not
independent enough to perform their oversight responsibilities effectively. Therefore, it is
important to examine the impact of AC independence on the quality of financial reporting in
Iran. In general, an independent AC is expected to provide effective oversight of the
financial reporting process and the reliability of financial statements (Juhmani, 2017).
Therefore, the second subhypothesis is developed as follows:
H12. There is a negative significant relationship between audit committee independence
with cosmetic accounting.
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2.4 Audit committee tenure and cosmetic accounting
Independent directors with longer tenure have more experience and expertise in overseeing
the financial reporting process (Fiedler, 1970). They are more likely to acquire conceptual
knowledge as a result of their work experience and have more reputation-based capital that
has developed over time. Long-tenured directors care more about their performance because
poor performance damages their reputation (Chan et al., 2012). Some studies have shown
that the tenure of AC members is linked to earnings management (e.g. Mishra and Malhotra,
2018; Chen and Komal, 2018). That is, longer tenure is expected to result in a decrease in
earnings management and an increase in financial reporting quality (Adeyemi, 2006; Nikulin
et al., 2022). The longer a director has served on the board, the more knowledgeable they are
about the firm’s practices, and this accumulated knowledge and experience enables them to
be more effective (Yang and Krishnan, 2005). AC members with longer tenure are more likely
to hire large audit firms to increase their transparency and the credibility of their financial
reports through higher-quality audits (Schrader, 2017; Tamoradi et al., 2020). Several studies
have provided evidence of a positive relationship between directors’ tenure and their
monitoring effectiveness. Beasley (1996) investigated the relationship between board
characteristics and the likelihood of fraudulent financial reporting and found that fraud is less
likely in companies where the average tenure of independent directors is higher. Similarly, Liu
and Sun (2010) found that longer tenure of AC members is associated with more effective
monitoring and reduces earnings management. However, the role of AC members’ tenure has
received less attention in the Iranian context, and the present research aims to fill this gap.
Hence, the third subhypothesis is developed as follows:
H13. There is a negative significant relationship between audit committee tenure with
cosmetic accounting.
2.5 Female audit committee membership and cosmetic accounting
According to social feminist theory, the inherent differences between men and women do
not mean that one is superior to the other and that men and women may develop different
traits that are equally effective. According to this theory, females are more responsible for
caring for family, and males are more accountable for earning money from jobs and work.
Under this classification, females spend more time and energy on homework (Tahir et al.,
2021). Social feminist theory emphasizes equality of opportunity and access to equal
resources between women and men. The presence of women in audit committees can be
justified according to the principle of gender balance and measuring the diverse
experiences and perspectives that each gender can provide to a committee. This theory
critiques the power structures that lead to gender differences. The presence of women in
ACs can help critique the power structures in this area and contribute to gender balance in
audit-related decisions. As a result, it can be said that the presence of women in ACs is not
only justified from the perspective of social feminist theory, but it can also help to improve
organizational performance and promote women’s economy. On the contrary, an emerging
issue in corporate governance is gender, racial and cultural diversity in committees and
boards of firms (Green and Homroy, 2018). Therefore, some alternatives to promote firms’
ethical behavior are proposed, including the feminist ethics lens. Based on the feminist
ethical theory, women have different perspectives in communicating their thoughts that will
affect their policies (Ardillah, 2022). Based on these theories, the role of women in the AC
can be highlighted as in other departments of organizations.
On the contrary, liberal feminist theory suggests that, if given equal opportunity, men and
women will use their potentials rationally and equally, and hence, psychological
differences will decrease and eventually disappear (Fisher et al., 1993). Accordingly, the
theory of liberal feminism requires that women be totally integrated in all roles, equal to
men and do not want any role differences. This theory can mean that women do not
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always have a risk nature and can also have a risk-taker character (Budi, 2019).
Justifying the presence of women in ACs according to the principle of gender balance
and measuring the diverse experiences and perspectives that each gender can bring to
a committee. This diversity in decisions and opinions can help improve the reporting
process. According to the liberal feminist point of view, emphasizing the power of joint
decision-making and the sharing of authority between women and men in ACs, as an
example of gender equality, can have a positive effect on the quality of decision-making
and the implementation of appropriate procedures based on reporting standards.
According to the liberal feminist approach, emphasis on audit ethics and the importance
of avoiding gender discrimination in the audit process can justify the active presence of
women in this field. Organizational structures and market mechanisms can reduce
agency conflicts (Fama and Jensen, 1983). According to Bathala and Rao (1995),
outside (nonexecutive) directors improve supervision and thus mitigate agency
problems. Female nonexecutive directors with financial expertise can transfer different
experiences, knowledge and ideas to the boards they are serving (Hillman et al., 2002).
Diverse backgrounds and other personality traits of female directors and AC members
can enhance the committee’s ability to manage risks and prevent financial distortions.
According to institutional theory, gender-diverse boards conduct higher-quality deliberations
and discussions on tough issues that may be considered unsavory in all-male boards (Huse
and Solberg, 2006). Institutional theory expands the traditional agency–theoretic view of
corporate governance by recognizing that boards and AC serve not only to monitor
management but also to provide symbolic legitimacy to the firm (Cohen et al., 2008).
According to the institutional theory, the presence of women in ACs can be considered as an
institutional change compared to the traditional and institutional structures of corporate
management. This institutional change may lead to increased transparency, the importance
of audit ethics and improved corporate governance. The presence of women with different
views and values can lead to diversity in decisions and optimal implementation of
conservative procedures in financial reporting. Female representation on board committees
has been shown to be positively associated with firm performance (Green and Homroy,
2018). This includes the AC, and examining the effect of female representation on this
committee can be useful. Regarding ACs, prior research has shown that gender diversity is
associated with better oversight and less earnings management (Lara et al., 2017; Zalata
et al., 2018). According to Srinidhi et al. (2011), female representation on the board of
directors and the AC can enhance earnings quality through better oversight. Moreover,
research has shown that female auditors are more sensitive to risks than male auditors (Gold
et al., 2009). In the Iranian context, Kazemi Olum and Abdi (2019) showed that AC gender
diversity is positively associated with earnings quality. Abdi et al. (2019) found that female
representation on the AC is negatively associated with information asymmetry. Oradi and
Izadi (2020) found a positive relationship between female membership on the AC and the
reliability of financial statements. Sepasi and Abdoli (2016) showed that companies with
female board members or female CEOs exhibit a higher degree of conditional conservatism;
that is, women tend to require a higher degree of verification to recognize good news as
gains than to recognize bad news as losses.
Prior research has also documented that the presence of female directors on the AC
reduces aggressive accrual management and the likelihood of receiving a going concern
opinion (Dobija et al., 2018; Firoozi et al., 2016; Ittonen et al., 2016; Martinez et al., 2016).
Abdullah and Ismail (2016) found a negative relationship between female membership on
the AC and discretionary accruals management. Therefore, female membership is expected
to increase AC effectiveness and have a positive effect on financial reporting quality, and the
fourth sub-hypothesis is developed as follows:
H14. There is a negative significant relationship between female audit committee
memberships with cosmetic accounting.
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2.6 Audit committee characteristics, audit fee and cosmetic accounting
According to the agency theory, an agency relationship is “a contract under which one or
more persons (the principal) engage another person (the agent) to perform some service on
their behalf which involves delegating some decision-making authority to the agent.” This
relationship always involves conflicting interests that arise as a result of the separation of
ownership from management, divergent management and shareholder objectives, and
information asymmetry between managers and shareholders (Mahdavi and Monfared
Maharlooyi, 2011). Consequently, the owners need to establish mechanisms to monitor
managerial activities and limit opportunistic managerial behavior (Pakmaram and Mayan,
2017). Financial statement audit is one such mechanism that can prevent agency conflicts.
Auditor’s opinion on financial reports can increase users’ confidence in the company’s
financial reporting. According to theories, auditors act in the interest of shareholders and
reduce agency problems between the agent and the principal. When agency costs are
greater, there is increased demand for higher-level audit quality (Francis and Wilson, 1988).
Audit fee is one of the main indicators for evaluating an auditor’s activity. As the volume and
quality of audit procedures increase, so does the amount of fee demand by the auditor.
Schroeder et al. (1986) showed that large audit firms are more likely to disclose material
errors than other firms. These firms also demand higher fees.
The present research investigates the moderating role of audit fee in the relationship
between ACC and creative accounting (as a proxy for financial reporting quality). The effect
of abnormal audit fee on this relationship is also investigated. Normal audit fee is
determined based on factors such as client size, client complexity and client-specific risk
(Simunic, 1980). Abnormal audit fee is determined based on the special relationship
between the auditor and the client (Choi et al., 2010). More specifically, it is a form of bribe
or economic rent and increases the auditor’s dependency on the client (Kinney and Libby,
2002). Based on these discussions, the second hypothesis and related subhypotheses are
developed as follows:
H2. Audit fee moderates the relationship between audit committee characteristics and
cosmetic accounting.
H21. Audit fee moderates the relationship between audit committee financial expertise
and cosmetic accounting.
H22. Audit fee moderates the relationship between audit committee independence and
cosmetic accounting.
H23. Audit fee moderates the relationship between audit committee tenure and cosmetic
accounting.
H24. Audit fee moderates the relationship between female audit committee membership
and cosmetic accounting.
The conceptual model is presented in Figure 1.
3. Methodology
3.1 Sample
The present study adopts a quantitative, ex-post-facto research design to investigate the
relationships between variables. The data derives mainly from audited financial statements
and board’s reports of the TSE and Rahavard Novin software. The population of the study
encompasses all TSE firms for the period 2014–2020. However, the study compiles a
purposive sampling; Following these criteria, the study includes 174 firms (1,218 firm-year).
To select a representative sample, purposive sampling is used with the following four
inclusion criteria (see Table 1). In this research, the data is first analyzed using Excel
software and then using Eviews software, 11th version.
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Figure 1 Conceptual framework
Table 1 Sample computation for firms
Sample computation for year 2014–2020 Firms Firm-year observations %
Total population 536 3752 100
Less:
Firms inactive between 2014 and 2020 (188) (1316) (35)
Financial services firms (52) (364) (9)
Firms that did not provide complete information (45) (315) (9)
Firms that were admitted to the stock market from 2014 (77) (539) (14)
Final sampled firms 174 1,218 33
Source: Created by authors
3.2 Model specification
The hypotheses of the study were tested using the following probit models:
X
SCAit ¼ b0 þ b1 ACCit þ b2 CONTROLit þ «it
X
SCAit ¼ b0 þ b1 ACCit þ b2 ACC AUFEE it þ b3 CONTROLit þ «it
The description of the variables of Models 1 and 2 is presented in Table 2.
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Table 2 Variable measurements
Variable Acronym Definition Source
Dependent
Cosmetic accounting SCA CV of change in income divided by CV of change Ashari et al. (1994), Carlson and Bathala
in sales. A firm is categorized as income smoother (1997)
if it is CVDI/CVDS < 1 (smoothers coded as 1 and
otherwise 0)
Independent (ACC)
AC financial accounting ACFAE Proportion of AC members with recognized Abernathy et al. (2014), Krishnan et al.
experts professional accounting qualifications (2011) and Bala et al. (2019)
AC independence ACINDP Measured as proportion of independent direction Bala and Kumai (2015), Krishnan et al.
in AC to the total number of AC members (2011) and Sultana (2015)
Female AC membership FACM Measured as proportion of female direction in AC Martinez et al. (2016) and Thiruvadi and
to the total number of AC members Huang (2011)
AC tenure ACTTN Mean tenure on the AC Schrader (2017) and Majiyebo et al. (2018)
Moderator
Audit fee AUFEE Natural logarithms firm audit fee Carcello et al. (2002)
Control
AC size ACSZ Total number of AC members Sultana (2015) and Sun et al. (2014)
Board financial expertise BFE Proportion of financial expertise on the board Bala and Kumai (2015) and Baxter and
Cotter (2009)
Board independence BI Percentage of independence directors on the Krishnan et al. (2011) and Sultana (2015)
board
Firm age AGE Natural logarithms firm age of start
Firm size FSZ Natural logarithms of total assets Krishnan et al. (2011) and Sultana (2015)
Leverage LEV Long-term debt to total assets Jizi and Nehme (2018) and Krishnan et al.
(2011)
Sales growth SGROW Change in sales divided by previous sales
Source: Created by authors
4. Empirical results
4.1 Descriptive statistics of continuous and dichotomous continuous
Table 3 reports the descriptive statistics of the quantitative variables. To ensure the normal
distribution of the data, the data are winsorized at the 1% confidence interval to reduce the
effect of outliers. Table 3 shows that, on average, 0.732 of the AC members had financial
expertise, with a minimum value of 0.2 and a maximum value of 1. This finding indicates
the high proportion of members with financial expertise on Iranian ACs. The mean value
of AC independence is 0.362, with a minimum value of 0.2 and a maximum value of 1.
This finding suggests that compared to financial expertise, less importance is placed
on independence when selecting AC members. Regarding female membership, the
results show that 0.036 of AC members are female, with a minimum value of 0 and a
maximum value of 0.67. This indicates that female representation on the ACs is low,
which is a major weakness, especially given that there are companies without any
female AC members. According to the literature, gender diversity in the board of
directors and its committees, especially the AC, can strengthen supervisory and
governance mechanisms and help improve financial reporting quality. The mean tenure
of the AC members is 3.062, with a minimum value of 1 and a maximum value of 7.33.
The relatively high mean obtained for tenure suggests that the sample firms seek to
create stability in their ACs, taking into account the benefits of longer tenure. Audit fee
as the moderator variable has a mean value of 5.324, with a minimum value of 0 and a
maximum value of 8.52. The high mean value obtained for audit fee observations can
be attributed to the tenure and financial expertise of AC members. That is, AC members
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Table 3 Descriptive statistics of continuous variables
Variable Mean Median Maximum Minimum SD
ACFAE 0.732 0.67 1 0.2 0.241
ACINDP 0.362 0.33 1 0.2 0.161
FACM 0.036 0 0.67 0 0.103
ACTTN 3.062 3 7.33 1 1.455
AUFEE 5.324 6.881 8.52 0 3.276
ACSZ 3.143 3 5 1 0.539
BFE 0.155 0.2 0.6 0 0.141
BI 0.666 0.6 1 0.2 0.183
AGE 3.627 3.714 4 3 0.339
FSZ 14.83 14.592 19 12 1.489
LEV 0.067 0.04 0.624 0 0.082
SGROW 0.340 0.204 4 1 0.638
Descriptive statistics of dichotomous variables
Variable Obs Frequency Percentage
0 1 0 1
SCA 1,218 618 600 0.51 0.49
Total 1,218 100%
Source: Created by authors
with longer tenure and more financial expertise pay more attention to the existing
agency relationships and are more likely to hire higher-quality auditors, which leads to
higher audit fees. The minimum value of 0 is reported because of the wide range of
audit fees and the low audit fees of some firms to avoid reducing the number of
samples.
Among the control variables, board financial expertise has a mean value of 0.155, with a
minimum of 0 and a maximum value of 0.6. Given the structure of the board of directors and
its relationship with the AC, the results indicate the relatively low level of financial expertise
among the board members of Iranian firms, and in some cases, the board of directors has
no members with financial expertise. High financial expertise is necessary for the board to
support the AC and act on its recommendations, which lack of financial expertise can
undermine the quality of financial reporting. Board independence has a mean value of
0.666, with a minimum value of 0.2 and a maximum value of 1. The mean values obtained
for firm size and age are also 14.830 and 3.627, respectively. The results indicate that
boards of directors in the sample firms have a higher ratio of independent directors than
directors with financial expertise. The mean value of financial leverage (0.067) suggests that
the investigated companies are less willing to finance through debt. Sales growth has a
mean value of 0.34. AC size has a mean value of 3.143, with a minimum value of 1 and a
maximum value of 5. A larger AC is expected to have better results, provided that other
influential characteristics of the AC are also considered in the selection of members. The
smallest observations mainly belong to the early years of the establishment of ACs in Iran
(around 2014).
The second part of Table 3 reports the descriptive statistics of the qualitative (dichotomous)
variable, creative accounting, which takes the value of 1 for firms that engage in creative
accounting, and 0 otherwise. For variables with nominal and ordinal scales, it is not
appropriate to use measures of central tendency and dispersion and instead frequency
distribution is used to describe these variables. The results in Table 3 show that out of a
total of 1,218 observations, 600 firms (49%) engage in creative accounting. Also, Table 4
shows the correlation coefficient between the variables .
Subhypotheses H1.1–H1.4 are tested using a probit regression model, and the results are
provided in Table 5. For H1.1, a significant negative relationship is observed between AC
financial expertise and creative accounting. The coefficient of financial expertise is
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Table 4 Correlation matrix
SCA ACFAE ACINDP ACTTN FACM AUFEE ACSZ AGE BFE BI FSZ LEV SGROW
1 SCA 1
2 –
ACFAE 0.407 1
0.000 –
ACINDP 0.255 0.174 1
0.000 0.000 –
ACTTN 0.115 0.072 0.038 1
0.000 0.012 0.180 –
FACM 0.045 0.067 0.012 0.026 1
0.114 0.019 0.672 0.361 –
AUFEE 0.063 0.017 0.032 0.112 0.044 1
0.029 0.554 0.272 0.000 0.122 –
ACSZ 0.039 0.054 0.034 0.007 0.014 0.061 1
0.176 0.059 0.239 0.811 0.620 0.035 –
AGE 0.110 0.050 0.058 0.033 0.099 0.038 0.037 1
0.000 0.083 0.044 0.252 0.001 0.184 0.197 –
BFE 0.029 0.197 0.091 0.100 0.001 0.031 0.010 0.069 1
0.315 0.000 0.001 0.001 0.961 0.273 0.722 0.017 –
BI 0.097 0.044 0.011 0.014 0.033 0.071 0.055 0.120 0.011 1
0.001 0.121 0.700 0.619 0.249 0.013 0.053 0.000 0.700 –
FSZ 0.162 0.062 0.023 0.114 0.108 0.232 0.263 0.000 0.038 0.078 1
0.000 0.030 0.427 0.000 0.000 0.000 0.000 0.989 0.185 0.006 –
LEV 0.070 0.024 0.057 0.027 0.072 0.056 0.034 0.049 0.015 0.036 0.009 1
0.015 0.409 0.046 0.340 0.012 0.049 0.237 0.090 0.593 0.204 0.750 –
SGROW 0.241 0.134 0.106 0.030 0.007 0.046 0.016 0.014 0.031 0.004 0.101 0.017 1
0.000 0.000 0.000 0.297 0.795 0.105 0.570 0.617 0.275 0.883 0.000 0.561 –
1 Correlation
2 p-value
Source: Created by authors
2.319706 with a p-value of 0.0000, which is significant at the 95% level. Consistent with
the theoretical framework, this finding indicates that greater financial expertise in the AC
leads to lower levels of creative accounting as a measure of poor financial reporting quality.
An AC with greater financial expertise can better mitigate agency conflicts arising from
management’s opportunistic behavior and will have a positive effect on earnings quality and
financial reporting quality. According to Article 7 of the Audit Committee Charter of firms
listed on the TSE, AC financial expertise plays a vital role in effective corporate governance,
internal control and financial monitoring. The results also indicate that firm age, sales growth
and firm size are negatively associated with creative accounting, while financial leverage
and board independence are positively associated with creative accounting. For H1.2, a
significant negative relationship is observed between AC independence and creative
accounting (Table 5). The coefficient of independence is 2.57858 with a p-value of 0.0000,
which is significant at the 95% level. This finding indicates that as AC members become
more independent, the company will be less likely to engage in creative accounting. In fact,
because of the distinct position of independent members and their greater ability to
withstand management pressure for earnings manipulation, they are more effective in
curtailing opportunistic management behaviors and enhancing the quality of financial
reporting. The results also show that firm age, sales growth and firm size are negatively
associated with creative accounting, while board independence and financial leverage are
positively associated with creative accounting.
For H1.3, a significant negative relationship is observed AC tenure and creative accounting
(Table 5). The coefficient of tenure is 0.093626 with a p-value of 0.0004, which is
significant at the 95% level. This finding indicates that as the average tenure of AC
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Table 5 Panel data probit regression between AC characteristics and cosmetic accounting
H1
Variable H11 H12 H13 H14
ACFAE 2.319 (13.054) – – –
ACINDP – 2.578 (7.791) – –
ACTTN – – 0.093 (3.528) –
FACM – – – 0.802 (2.213)
ACSZ 0.087 (1.155) 0.014 (0.194) 0.019 (0.274) 0.006 (0.092)
AGE 0.387 (3.304) 0.337 (2.970) 0.389 (3.498) 0.374 (3.352)
BFE 0.437 (1.540) 0.048 (0.176) 0.205 (0.766) 0.307 (1.152)
BI 0.538 (2.503) 0.658 (3.122) 0.574 (2.797) 0.600 (2.922)
SGROW 0.439 (6.795) 0.470 (7.468) 0.501 (8.163) 0.493 (4.799)
LEV 1.330 (2.774) 1.101 (2.370) 1.313 (2.890) 1.415 (3.119)
FSZ 0.108 (3.902) 0.132 (4.916) 0.108 (4.101) 0.127 (8.038)
C 4.597 (7.030) 3.777 (6.001) 3.086 (5.071) 2.990 (4.930)
N 1,218 1,218 1,218 1,218
LR statistic 317.7142 211.8483 143.2692 135.5839
Prob(LR statistic) 0.0000 0.0000 0.0000 0.0000
Notes: Sig. at 0.10; sig. at 0.05; sig. at 0.01
Source: Created by authors
members increases, the firm will be less likely to engage in creative accounting. Longer
tenure is associated with more experience and expertise in monitoring the financial
reporting process, as well as long-term commitment and reputation capital that have been
developed over time, which can mitigate factors that undermine financial reporting quality.
Moreover, longer-tenured directors are more likely to hire higher-quality auditors because of
their greater knowledge of the firm’s operations, which can improve financial reporting
quality and reduce creative accounting. The results also show that firm age, sales growth
and firm size are negatively associated with creative accounting, while board
independence and financial leverage are positively associated with creative accounting.
For H1.4, a significant negative relationship is observed between female membership on
the AC and creative accounting (Table 5). The coefficient of female membership is 0.8027
with a p-value of 0.0269, which is significant at the 95% level. This finding indicates that
higher female representation on the AC decreases the likelihood of the firm engaging in
creative accounting. Based on the institutional theory, gender diversity enables the
committee to conduct higher-quality deliberations. The results are consistent with the
theoretical framework in that because of their specific personality traits, higher
representation of women on the board of directors and the AC leads to greater
effectiveness in risk management and financial fraud prevention. More specifically, traits
such as greater sensitivity to issues and higher conservatism in gender-diverse ACs with
strong female presence can improve oversight mechanisms and reduce earnings
management. The results also show that firm age, firm size and sales growth are negatively
associated with creative accounting, while board independence and financial leverage are
positively associated with creative accounting.
Subhypotheses H2.1–H2.4 are also tested using a probit regression model, with audit fee
as the moderator variable (Table 6). For H2.1, the results show that audit fee moderates the
relationship between AC financial expertise and creative accounting. The coefficient of
audit fee is 0.169437 with a p-value of 0.0000, which is significant at the 95% level. Audit
fee is a measure of audit quality, and as noted earlier, the presence of members with
financial expertise on the AC increases the likelihood of hiring higher-quality auditors with
higher fees, thus helping the AC curtail creative accounting and improve the quality of
financial reporting. For H2.2, the results show that audit fee moderates the relationship
between AC independence and creative accounting (Table 6). The coefficient of audit fee is
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Table 6 Panel data probit regression between AC characteristics and cosmetic accounting with audit fee moderator affect
H2
Variable H21 H22 H23 H24
ACFAE 1.331 (5.859) – – –
ACINDP – 0.379 (0.830) – –
ACTTN – – 0.028 (0.915) –
FACM – – – 1.571 (3.020)
AUFEE 0.101 (5.418) 0.125 (6.455) 0.173 (9.545) 0.023 (1.968)
ACFAE AUFEE 0.169 (6.798) – – –
ACINDP AUFEE – 4.465 (8.539) – –
ACTTN AUFEE – – 0.071 (14.504) –
FACM AUFEE – – – 0.671 (7.060)
ACSZ 0.097 (1.293) 0.025 (0.339) 0.069 (0.927) 0.005 (0.077)
AGE 0.389 (3.270) 0.334 (2.871) 0.270 (2.228) 0.0327 (2.882)
BFE 0.481 (1.674) 0.060 (0.216) 0.154 (0.528) 0.2406 (0.884)
BI 0.458 (2.089) 0.603 (2.775) 0.427 (1.912) 0.659 (3.130)
SGROW 0.409 (6.201) 0.434 (6.682) 0.370 (5.491) 0.444 (7.145)
LEV 1320 (2.700) 1.124 (2.344) 1.144 (2.270) 1.399 (3.025)
FSZ 0.096 (3.398) 0.133 (4.720) 0.049 (1.682) 0.135 (4.913)
C 3.890 (5.611) 3.257 (4.751) 1.730 (2.476) 2.784 (4.314)
N 1,218 1,218 1,218 1,218
LR statistic 370.1303 300.384 426.2775 198.2575
Prob(LR statistic) 0.0000 0.0000 0.0000 0.0000
Notes: Sig. at 0.10; sig. at 0.05; sig. at 0.01
Source: Created by authors
0.465956 with a p-value of 0.0000, which is significant at the 95% level. According to the
agency theory, conflicts of interest arise from the separation of ownership from
management, and shareholders must incur costs to ensure that their interests and
objectives are aligned with those of the management. Agency cost is paid to the auditor
as audit fee to act as an independent agent and provide assurance of the reliability of
financial statements. The significant moderating effect indicates the greater ability of
independent directors to guide and support the independent audit process, which
reduces the likelihood of creative accounting and improves the quality of financial
reporting.
For H2.3, the results show that audit fee moderates the relationship between AC tenure and
creative accounting (Table 6). The coefficient of audit fee is 0.071997 with a p-value of
0.0000, which is significant at the 95% level. Longer-tenured members of the AC have more
experience and knowledge of the business, which can have a positive effect on the quality
of financial reporting. Given the fact that determining audit fee is one of the responsibilities
of the AC as per the Audit Committee Charter, longer-tenured members have a better
understanding of the company and are more likely to hire higher-quality auditors, which
entails a higher audit fee. Finally for H2.4, the results show that audit fee moderates the
relationship between female membership on the AC and creative accounting (Table 6). The
coefficient of audit fee is 0.6719 with a p-value of 0.0000, which is significant at the 95%
level. The literature on the personality traits of female AC members suggests that a gender-
diverse AC tends to be more sensitive to the oversight aspects of corporate governance
because of its higher degree of conservatism and lower risk tolerance, thus opting for
higher-quality audits as a means to mitigate agency problems, curtail creative accounting
practices and enhance financial reporting quality. Gender-diverse ACs are also better able
to establish an effective relationship with the independent auditor and pay more attention to
the scope and quality of audits, which leads to an increase in the audit fee, but reduces
creative accounting and improves the quality of financial reporting.
The results of the research hypotheses are summarized in Table 7.
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Table 7 Summary of hypothesis results
Hypothesis no. Hypothesis Confirmation Disapproval
H1 There is a negative significant relationship between audit committee characteristics
with cosmetic accounting
H1.1 There is a negative significant relationship between audit committee financial
expertise with cosmetic accounting
H1.2 There is a negative significant relationship between audit committee independence
with cosmetic accounting
H1.3 There is a negative significant relationship between audit committee tenure with
cosmetic accounting
H1.4 There is a negative significant relationship between female audit committee
memberships with cosmetic accounting
H2 Audit fee moderates the relationship between audit committee characteristics and
cosmetic accounting
H2.1 Audit fee moderates the relationship between audit committee financial expertise and
cosmetic accounting
H2.2 Audit fee moderates the relationship between audit committee independence and
cosmetic accounting
H2.3 Audit fee moderates the relationship between audit committee tenure and cosmetic
accounting
H2.4 Audit fee moderates the relationship between female audit committee membership
and cosmetic accounting
Source: Created by authors
5. Additional analysis
Audit fee is affected by the risk associated with the characteristics of the client such as size,
complexity and internal controls (Simunic, 1980; Francis, 1984; Palmrose, 1986) as well as
business risk (Bentley et al., 2013). When the risk of material misstatement is high, audit
standards require independent auditors to show greater effort and perform additional tests to
obtain more reliable evidence (Heninger, 2001; Patterson and Smith, 2003; Zhao, 2010). In
addition, as audit risk increases, the auditor will demand a risk premium to cover the potential
loss related to litigation risk, which results in higher audit fees (Heninger, 2001; Lyon and
Maher, 2005). Article 9 of the Audit Committee Charter discusses the responsibilities and
powers of the AC in relation to the independent auditor. These include the selection of
an independent auditor, the independent auditor’s fee and the independence of the
auditor. The interaction between the AC and the independent auditor has the potential
to improve earnings quality oversight (Yousefiasl et al., 2018). For additional analysis,
the effect of abnormal audit fee on the relationship between ACC and creative
accounting is investigated. Abnormal audit fee is the difference between the actual
audit fee paid to the auditor and the expected (normal) audit fee (Simunic, 1980; Choi
et al., 2009).
The rationale for investigating abnormal audit fee is that it is dependent upon the special
relationship between the auditor and the client. According to the literature, abnormal audit
fee can occur in the form of economic rent or bribes related to audit services and increases
the auditor’s dependency on the client (Kinney and Libby, 2002; Choi et al., 2010).
Numerous studies have examined the relationship between audit fees and financial
reporting quality (e.g. Chen et al., 2011; Ettredge et al., 2014; Asthana and Boone, 2012;
Blankley et al., 2012), but little research has been done on the different aspects of abnormal
audit fees that may be associated with different degrees of financial reporting quality.
DeFond and Zhang (2014) argued that abnormal audit fee can indicate additional audit
effort, which will increase the quality of financial reporting. On the contrary, it could reflect
auditors’ higher risk appetite or collusion between the client and the auditor (e.g. DeFond
and Zhang, 2014; Kinney and Libby, 2002), in which case the quality of financial reporting
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will be compromised. In this research, the regression model of Simunic (1980) is used to
measure normal and abnormal audit fees:
LAFEE it ¼ b0 þ b1 LTAit þ b2 CATAit þ b3 QUICKit þ b4 LDTAit þ b5 BANKRUPit þ b6 LOSSit þ «it
LAFEE = Natural logarithms actual audit fee;
LTA = Natural logarithms total assets;
CATA = Short-term assets to total assets;
QUICK = Cash flow to total assets;
LDTA = Long-term debt to total assets;
BANKRUPT = Net income to total assets;
LOSS = Loss coded as 1 and income 0; and
(ABFEE)/« = Abnormal audit fee (Model remainable).
In this model, actual audit fee comprises expected (normal) audit fee and unexpected
(abnormal) audit fee. Normal audit fee is determined based on the explanatory variables
model, while the residual denotes abnormal audit fee. The following model is used to
investigate the moderating effect of abnormal audit fee on the relationship between ACC
(financial expertise, independence, tenure and female membership) and creative accounting:
X
SCAit ¼ b0 þ b1 ACCit þ b2 ABFEEit þ b3 ACC ABFEE it þ b4 CONTROLit þ «it
The results of estimating this probit regression model are provided in Table 8. For the
relationship between financial expertise and creative accounting, the moderating effect of
abnormal audit fee is positive, but not statistically significant. This means that where there is
abnormal audit fee, increasing the number of members with financial expertise cannot
Table 8 Additional analysis panel data probit regression between AC characteristics and cosmetic accounting with
abnormal audit fee moderator affect
ACC
Variable ACFAE ACINDP ACTTN FACM
ACFAE 0.139 (0.888) – – –
ACINDP – 0.108 (0.453) – –
ACTTN – – 0.032 (1.260) –
FACM – – – 0.187 (0.525)
ABFEE 0.043 (1.141) 0.061 (1.435) 0.037 (1.353) 0.015 (1.357)
ACFAE ABFEE 0.036 (0.738) – – –
ACINDP ABFEE – 0.227 (1.886) – –
ACTTN ABFEE – – 0.006 (0.771) –
FACM ABFEE – – – 0.024 (0.161)
ACSZ 0.025 (0.718) 0.029 (0.415) 0.032 (0.458) 0.021 (0.306)
AGE 0.154 (1.429) 0.144 (1.341) 0.151 (1.400) 0.144 (1.332)
BFE 0.235 (0.876) 0.338 (1.300) 0.267 (1.032) 0.301 (1.167)
BI 0.287 (1.426) 0.264 (1.314) 0.281 (1.399) 0.273 (1.360)
SGROW 0.191 (3.365) 0.188 (3.305) 0.192 (3.381) 0.188 (3.324)
LEV 0.4444 (1.006) 0.434 (0.982) 0.407 (0.920) 0.447 (1.009)
FSZ 0.012 (0.502) 0.010 (0.393) 0.006 (0.251) 0.013 (0.510)
C 1.174 (1.934) 0.974 (1.615) 1.094 (1.850) 1.038 (1.750)
N 1,218 1,218 1,218 1,218
LR statistic 20.518 22.871 21.599 19.554
Prob(LR statistic) 0.0240 0.0112 0.0170 0.0337
Notes: Sig. at 0.10; sig. at 0.05; sig. at 0.01
Source: Created by authors
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increase the effectiveness of the AC. That is because in the presence of abnormal audit
fees, members with financial expertise can more effectively advance the objectives of the
management by virtue of their experience and expertise in financial reporting, which
diminishes the role of financial expertise in preventing financial statement manipulation and
creative accounting. Regarding tenure, the results are similar to those obtained for financial
expertise. That is, longer tenure in situations where there is abnormal audit fee has a
negative effect on creative accounting, and the long-term dependencies developed
between members and the management can reduce the effectiveness of the AC.
As for AC independence, the results indicate a significant negative effect at the 10% level.
According to the agency theory, conflicts of interest lead to misalignment of objectives,
which has an adverse effect on creative accounting as a measure of poor financial reporting
quality in case of abnormal audit fees. However, this relationship is moderated by the
presence of independent members on the AC and the corporate governance system.
Regarding female membership, a negative moderating effect is observed, but it is not
statistically significant. According to the literature, because of the conservatism, greater
sensitivity to financial statement manipulation and lower propensity for aggressive earnings
management, abnormal audit fee is expected to moderate the relationship between female
membership and accounting creativity. However, given the nature of the abnormal audit
fees and the low representation and influence of women in the ACs of Iranian firms, the
results indicate the ineffectiveness of the AC in case of abnormal audit fee payment.
In general, the results relating to the moderating effect of abnormal audit fee should be
interpreted with caution. According to the theoretical and empirical literature, characteristics
such as financial expertise, independence and tenure are negatively associated with
creative accounting, which are also robust when audit fee is used as a moderator variable.
However, the presence of abnormal audit fee challenges the effectiveness of the AC, with
only independence remaining significant.
6. Discussion and conclusion
The purpose of this research was to investigate the relationship between ACC and creative
accounting as well as the moderating role of audit fee. The results indicated a significant
negative relationship between financial expertise, independence, tenure and female
membership and creative accounting. Moreover, audit fee moderated these relationships.
According to the literature, the AC is a corporate governance mechanism that is established to
align the interests of managers and shareholders, reduce agency costs and curtail earnings
management. Regarding the relationship between AC financial expertise and creative
accounting, the results are consistent with Albersmann and Hohenfels (2017), Krishnan et al.
(2011), Soliman and Ragab (2014), Nasirzadeh et al. (2018). The financial expertise of the
members increases the ability of the committee in financial assessments and reporting, which
can improve the transparency and quality of financial reporting. Regarding the relationship
between AC independence and creative accounting, the results are consistent with Hundal
(2013), Baxter and Cotter (2009), and Yousefiasl et al. (2018). Independent directors are in a
better position to monitor the financial reporting process and are better able to withstand
management pressure for earnings manipulation, and which can have a positive effect on the
quality of financial reporting. Regarding the relationship between AC tenure and creative
accounting, the results are consistent with Mishra and Malhotra (2018), Chen and Komal
(2018), Schrader (2017), Tamoradi et al. (2020). The tenure of AC members is an indicator of
their experience, commitment and accumulated knowledge and expertise, which are
positively associated with AC effectiveness. Regarding the relationship between female
membership and creative accounting the results are consistent with Zalata et al. (2018), Green
and Homroy (2018) and Kazemi Olum and Abdi (2019). Female nonexecutive directors with
financial expertise can offer different experiences, insights and ideas to the committees of the
board of directors. Diverse backgrounds and special personality traits of female directors
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serving on the AC increase the committee’s effectiveness in risk management and financial
fraud prevention. According to Green and Homroy (2018), board gender diversity creates a
strong corporate structure that improves firm performance. Female representation on the
board of directors and the AC is an effective way to improve reporting quality and increase the
reliability of financial statements for users.
These findings can be analyzed from the perspective of different theories. According to the
agency theory, members with financial expertise improve the AC’s ability to evaluate
auditors’ judgment and can be effective in creating a strong internal control system.
Furthermore, from the perspective of RDT, it is assumed that the multiple abilities,
knowledge and expertise of ACs lead to superior corporate results.
According to the RDT, the expertise of the AC plays a key role in ensuring the control of
financial reports that leads to improved performance of the company. According to this
theory, appropriate expertise of AC members can reduce dependence on external sources
and create confidence in the financial reporting process. In addition, according to the
theory of social feminism, women spend more energy than they can find a special place in
society. Therefore, it can be said that the efforts of women in the AC have strengthened the
reporting environment as well as the supervisory role of the AC in this environment. Based
on the social feminist theory, it can be argued that these findings point to the presence of
women in the AC and their role in regulating the interests of managers and shareholders.
Therefore, it can be said that based on the ability of women in the AC, the amount of profit
has decreased. Also, according to the theory of liberal feminism, women mainly have a risk-
taking character and tolerate risk to some extent. Therefore, it can be said that the
conservative character of women has led to more discipline in the reporting environment
and played an important role in reducing CA. The liberal feminist theory interprets these
results to share the roles of responsibility and women’s participation in financial decisions in
the organization and highlights the independent role of women in accounting decisions and
providing financial reports free of any manipulation and bias. In general, the analysis of
these findings from the perspective of social feminist theory and liberal feminist theory can
confirm and explain the positive and effective role of women in the financial and accounting
complex and help improve the transparency and quality of financial reports. These
characteristics of women’s conservatism have helped to strengthen the credibility and
supervisory power of the AC in the financial reporting process and have had a positive
effect on increasing the honesty and accuracy of the company’s financial information.
Regarding the moderating effect of audit fee, it must be noted that audit fee is an agency
cost (monitoring fee) and a measure of auditor effort. Audit fee increases with the volume
and quality of audits. According to Schroeder et al. (1986), AC members believe that larger
audit firms with higher audit fees are more likely to detect material errors and misstatements.
Therefore, the effect of audit fee on the relationship between ACC and creative accounting
was tested, and the results indicated that these relationships are negatively moderated by
audit fee. This suggests that when the audit fee of a company increases, the likelihood of
engaging in creative accounting decreases, and the increase in audit fee can be viewed as
an indicator of audit quality. Given the roles and responsibilities of the AC and the board of
directors, we can conclude that independent auditors are largely responsible for ensuring
fair financial reporting (Cohen et al., 2008; Sulaiman, 2017). The results also support the
hypothesis that expert members of the AC demand greater effort from independent auditors
by paying higher audit fees (Goodwin-Stewart and Kent, 2006). These findings are in
accordance with the assumptions of the agency theory and show that the audit mechanism
and the greater effort of independent auditors lead to the reduction of agency problems.
Francis and Wilson (1988) also considered more demand for auditing as one of the ways to
reduce agency conflict. Therefore, these findings are a reaffirmation of agency theory.
In additional tests, the effect of abnormal audit fees on the relationship between ACC and
creative accounting was investigated. The results showed that this effect was only
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significant for AC independence, which can be in line with agency theory and the role of the
AC in reducing conflicts of interest and aligning divergent objectives. The moderating effect
of abnormal audit fee in relation to other ACC. Regarding financial expertise and tenure,
given the nature of abnormal audit fee as an indicator of the auditor’s dependency on and
special relationships with the client, such payments could mean that the AC is moving away
from its main role, which will undermine its effectiveness. In relation to female membership,
contrary to the literature, the results show that the effect of audit fee is not significant, which
can be attributed to the low proportion of female membership on Iranian ACs.
Based on the findings of the research, it is suggested that regulatory bodies and standard
setting organizations should encourage companies to form ACs with members with diverse
financial expertise, independence and relevant tenure, and emphasize on increasing the
presence of women in ACs. Because the findings of this research consistently highlight the
positive impact of financial expertise, autonomy and tenure on creative accounting restraint.
This recommendation is consistent with the literature showing that a well-formed AC is
effective in increasing the quality of financial reporting and reducing agency costs.
Therefore, policymakers should support policies that promote gender diversity in ACs. This
may include setting goals for women’s representation and creating incentives for
companies to actively involve women in these governance structures.
Our findings can help investors and other users of financial statements to understand the
role of the AC as a key corporate governance mechanism in enhancing financial reporting
quality, as well as the role of the independent auditor in AC effectiveness. The results are
also useful for accounting policymakers in promoting the role of the AC in reducing earnings
management, understanding the characteristics conducive to a dynamic AC and
developing guidelines that are tailored to the specific conditions of the country. These
findings allow investors to better understand the important role of independent auditors’
efforts on the effectiveness of the AC in increasing the credibility of financial information
disclosure, which in turn will increase investor confidence. This study can also be useful for
policymakers and regulators, as it enables them to understand the importance of these
distinctive characteristics of the AC in reducing financial opportunistic activities, which is one
of the most important elements of increasing the quality of financial reporting. In particular,
these findings help policymakers and regulators to understand the potential impact of
women members in the AC and make the position and absence of women in the economic
environment and Iranian companies, which still have a very low share in the board of
directors and corporate committees, fully felt. Therefore, it is recommended that
contemporary laws be updated and the presence of female expert members in the AC and
board structure of Iranian companies is mandatory in the new laws.
The present research investigated the relationship between ACC and creative accounting
with an emphasis on the moderating role of audit fees. Future research can explore other
oversight mechanisms such as internal audit as well as other moderators such as
ownership structure. One of the limitations of this research was the large variance in the
amount of audit fees paid by the sample firms, which forced us to give zero values to firms
with very low audit fees. Moreover, the establishment of ACs in Iran became mandatory in
2014, which limited the studied time period and the available data.
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Exchange”, Empirical Research in Accounting, Vol. 6 No. 4, pp. 69-94.
About the authors
Abbas Ali Daryaei received his PhD in accounting from University of Shiraz, Iran in 2015. He
is an Associate Professor in accounting at Imam Khomeini International University. He has
published many books and numerous articles in national and international academic
journals such as International Journal of Business Forecasting and Marketing Intelligence
(Elsevier), International Journal of Corporate
(Inderscience), Contadurı´a y Administracion
Social Responsibility (Springer), Corporate Governance (Emerald) and The Journal of
International Trade & Economic Development (Taylor & Francis Group). Dr Daryaei’s
j CORPORATE GOVERNANCE j
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[Link] [Link]
research interests are corporate governance, political economy and auditing. Abbas Ali
Daryaei is the corresponding author and can be contacted at: [Link]@[Link]
Afshin Balani lives in Iran. He is a PhD candidate at Imam Khomeini International University.
He is very interested in research in the field of accounting, auditing and corporate
governance and has been successful in this field.
Yasin Fattahi lives in Iran. He is a PhD candidate at Imam Khomeini International University.
He is very interested in research in the field of accounting, finance, corporate governance,
social responsibility and sustainability reporting and has been successful in this field. He
has published two books and numerous articles in national and international academic
journals such as Corporate Governance (Emerald), Cogent Economics & Finance (Taylor &
Francis Group), Journal of Risk and Financial Management (MDPI), Iranian Journal of
Finance and Environmental Energy and Economic Research.
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