Auditor Tenure, CEO Compensation and Earnings Management:
Evidence from Jordan
HAMZEH FATHI ALSHARE1, MOHD RIZUAN BIN ABDUL KADIR2,
KHAIRUL ANUAR KAMARUDIN3, HASMAIZAN BINTI HASSAN4
1College of Management, Universiti Tenaga Nasional (UNITEN), MALAYSIA
2College of Graduate Studies, Universiti Tenaga Nasional (UNITEN), MALAYSIA
3Faculty of Business, University of Wollongong, Dubai, UNITED ARAB EMIRATES
4College of Energy Economics & Social Science, Universiti Tenaga Nasional (UNITEN), MALAYSIA
Abstract: - The purpose of this study is to examines the impacts of auditor tenure on earnings management and
if the CEO remuneration moderates this relationship. The sample includes all firms listed on the Amman Stock
Exchange from 2015 to 2019 with the exclusion of the financial sector. The fixed-effect model, robustness
testing to ensure data integrity and alternative measurements to ensure reliable results were used in this study.
After examining the auditor tenure in this study, the study found that there is a negative and significant
association with earnings management. In additional, this study showed that the combined influence of CEO
compensation and auditor tenure had a negative and significant impact on earnings management. In order to
reduce earnings management by decreasing opportunistic behavior and conflicts of interest, this study
emphasizes the importance of high CEO compensation and auditor tenure, which is advantageous to investors,
shareholders, political, and stakeholders in Jordanian firms as well as auditing firms.
Key-Words: - Auditor tenure, CEO compensation, Earnings management.
Received: August 27, 2022. Revised: September 5, 2022. Accepted: September 25, 2022. Available online: October 11, 2022.
1 Introduction
This study is considered important in the
Jordanian context to provide solutions to
stakeholders about limiting the manipulation of
financial statements and to find a solution to the
problem of earnings management spread in
Jordanian companies [1]. There is a lot of
evidence that has occurred recently in the
Jordanian market of scandals and bankruptcy of
companies whose earnings management was the
main reason for their occurrence, such as United
Group Holdings., Al-Barakat Group Co., Al-Jamil
for Investment Co., Industrial Investment) [2].
The previous cases raised many questions about
the quality of the audit process in the Jordanian
environment and its ability to detect such
manipulations in the financial statements.
Kamarudin, Ismail and Ariff [3] pointed that the
audit quality might be reflected by the auditor
tenure in the firm. But the long period of auditor
tenure can lead to many risks, including the
relationship between the auditor and the executive
director, and thus reduce the independence of the
auditor. This long period may lead to a decrease in
the number of evidence collected by the auditor
during the audit process and his dependence on his
personal knowledge The company, given his
complete knowledge of the company as a result of
the long period spent by the auditor in auditing the
same company [4].
From another point of view, the auditor tenure for
a long period can present growth in the auditor’s
knowledge of the company, as he can become a
specialist in it and increase his ability to know the
strengths and weaknesses of the company, as this
helps him in detecting financial misshaping [5].
Many efforts have been made to establish the so-
called mandatory rotation of audit firms because
of its influence on enhancing the audit quality [6].
But in the Jordanian market, there is no
application by all companies of the mandatory
rotation of audit firms [2].
The agency theory will be used in this study, as it
assumes that opportunistic behavior is used in
their work and they are interested in their personal
gains at the expense of the company's gains, and
thus a conflict of interest and information
asymmetry arises where there is information that
the manager hides from the owners and
stakeholders. Where this refers to the manager's
practice of earnings management in the company
[7], [8].
Bedard [9] pointed out that the external audit is
more effective than the internal audit in reducing
the problems of earnings management. Guindy
and Basuony [10] has emphasized the significance
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of using the auditor tenure in studies that focus on
CEO conduct due to his capacity to lower the
CEO’s opportunistic behavior and lower the issues
with agency theory. The Jordanian market is
characterized by weak investor protection and thus
provides an incentive for the CEO to practice
opportunistic behavior and engage in earnings
management [11]. Previous studies indicated that
the company that records large earnings uses CEO
compensation in a large proportion, this indicates
opportunistic behavior by manipulating the
company’s earnings [12], [13]. This gives
evidence that this study is extremely important in
the Jordanian market and deserves study.
2 Literature Review and Hypothesis
Development
In the examination of earnings management, prior
research suggested that the administrative and
professional sides be used [14]. In response to
these recommendations, this study used auditor
tenure and whether CEO compensation moderates
the relationship between auditor tenure and
earnings management.
2.1 Auditor Tenure and Earnings
Management
The duration of an auditor’s employment with a
company is referred to as their auditor tenure.
Academics and decision-makers paid attention to
the auditor tenure and used it in their studies
because of its great importance to the quality of
the audit process, also Harber & Maroun, [15]
indicated that auditor tenure cannot be excluded
from the quality of the audit process, Qudah et al
[11] indicated that the length of auditor tenure
period indicates more auditor independence and
increased the auditor’s experience, as this benefits
the auditor’s acquisition of sufficient knowledge
that enables him to complete his work to the
fullest and with high quality.
another point of view, Kim et al [16] indicated
that the auditor tenure, if it is long, affects the
quality of the audit process negatively. In other
words, the long relationship between the auditor
and management leads to the auditor’s inability to
discover errors or discover financial manipulation.
Claims have increased to prevent the existence of
this relationship, so the so-called auditor rotation,
as the Jordanian Corporate Governance Law
forced the replacement of the auditor every three
years [17].
Qawqzeh [14] documented that auditor rotation
benefits the company in terms of the fact that the
new auditor has more doubts and a more accurate
view of the financial statements and does not
easily succumb to any pressures from the
management. On the contrary, Habbash &
Alghamdi [18] indicated in his study that changing
the auditor occurred in a large percentage of firms
that suffer from financial problems, with the aim
of appointing a more cooperative auditor to cover
the financial problems.
Arguments in favor of and against the length of
the auditor's employment, i.e., whether the length
risks the auditor's objectivity and professional
judgement or broadens their knowledge and
expertise of the company. This conflict becomes
important for studying the relationship between
the TENURE and EM.
Studies have shown that the TENURE has a
significant negatively impact on EM [19], [20]
[21]. Lin & Hwang [22] showed the existence of a
significantly and negatively correlation between
TENURE and EM. However, research have
documented that the TENURE positively and
significantly effects on EM [23], [24], There are
also studies that indicated the existence of an
insignificant positive association between
TENURE and EM [25], [26]. The following
hypothesis will be set forth in light of the
preceding findings:
H1: There is a significant relationship between
auditor tenure and earnings management practices.
2.2 CEO Compensation and Earnings
Management
The conflict of interest between CEOs and
investors is one of the most important reasons for
the emergence of the agency theory problem.
CEOs are responsible for accounting policies,
payment methods, and decisions related to
investment in the firm. Thus, CEOs tend to make
such decisions in a manner that serves their
personal interests, regardless of the risks that
could That confront or harm the interest of the
company [27].
Therefore, the so-called CEO compensation
related to the firm performance appeared and they
are two types of long-term compensation through
the firm shares, where the CEO is compensated
based on CEO performance by granting CEO
shares in the firm [28]. The second type is short-
term compensation through the salary and bonuses
received by the CEO during Year [29]. In this
study, short-term compensation will be relied on
to measure the CEO compensation, as it is
difficult to obtain data on long-term compensation
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and it is also not widely applied in Jordanian
companies.
One of the corporate governance instruments is
the COMP [30]. It is expected it will have a
significant impact on the earnings management.
Healy [28] indicated the CEO compensation is
only an incentive for the CEO to achieve earnings
for the firm in the short term. It soon appeared that
these incentives allow the CEO Practicing
opportunistic behavior, as it was clarified [31] in
his study that earnings management practiced in a
high percentage in firms in which the CEO has
multiple options within the firm with high
compensation, and they also suggested that these
compensations when monitored by the board of
directors and monitoring the reports of the CEO
contribute significantly to reducing earnings
management.
The conflict of opinions about the CEO
compensation have makes a great importance to
study the joint effect with the TENURE on EM as
it reflects the administrative aspect within the
firm. The finding of the previous studies
demonstrated that these findings are different, as
the reason for this may be due to the nature of the
markets in which the studies were conducted.
Therefore, this study reviewed some of the results
of these studies, where [32], [33], [34]
documented the existence of a significant positive
association between COMP and EM. Hassen [35]
informed that the CEO compensation negatively
affects the earnings management. As for the most
noticeable result in previous studies, the COMP
has positive effects on EM [36], [37], [38], [39],
[40]. The following is the proposed hypothesis
based on the prior findings:
H2: The CEO compensation moderates
relationship between audit tenure and earnings
management practices.
3 Research Methodology
3.1 The Sample of Study and Data
Collection
the association between TENURE and EM is
examined in this study, also determines whether
COMP influences that relationship, this study
primarily focuses on data from service and
industrial corporations enlisted on the ASE that
were posted between from 2015 until 2019. The
financial firms were excluded due to their own
circumstances in preparing their financial
statements [41], while they produce their financial
statements using various standards and accounting
standards [42].
The 81 service and industrial firms were used to
conduct this research during the study period. The
number of observations recorded from the panel
data reached 405 observations.
3.2 Measurement of Variables
Mcnichols & Wilson [43] technique is used in this
research to measure the EM by using discretionary
accruals. The Kothari 2005 model was applied in
this research [44] to quantify discretionary
accruals using the equation below, which is
expressed in the study as KDA, that was likewise
employed by [45], [46], [47].
KDAi,t = (NIi,t - OCFi,t) – (β0+ β1(1/ TAi,t-1) + β2
(ΔREVi,t / TAi,t-1 – ΔRECi,t / TAi,t-1 ) + β3(PPEi,t /
TAi,t-1) + β4(ROAi,t / TAi,t-1)) (1)
The modified Jones model as an alternative
measure for EM [48], which is referred to in the
paper as JDA. The discretionary accruals have
been determined using the following equation.
This study follows [49], [50].
JDAi,t = (NIi,t - OCFi,t) – (β0+ β1(1/ TAi,t-1) + β2
(ΔREVi,t / TAi,t-1 – ΔRECi,t / TAi,t-1 ) + β3(PPEi,t /
TAi,t-1)) (2)
Table 1. Measurement of Variables
Variables
Indicators
dependent variables
discretionary accruals
(KDA, JDA)
Where: TA= total assets; NI= net
income; OCF= operating cash
flows; REV= operating revenues;
REC= net receivables; PPE= gross
property, plant and equipment;
ROA= return on assets.
Independent variables
Auditor tenure
(TENURE 1)
If the client firm has employed an
auditor for longer than three years
it takes a dummy value of 1,
otherwise 0.
Auditor tenure
(TENURE 2)
The natural logarithm of the
number of years that the firm has
kept its auditor.
Moderating variable
CEO compensation
(COMP)
The natural logarithm of total CEO
compensation on the year
Control variables
LEV
Total debt/ total assets
FSIZE
The natural logarithm of total
assets
ROA
Net income/ total assets
MTB
Market to book ratio
CURRENT
Current assets
CFO
Cash flow from operation/ total
assets
INV
Inventory/ total assets
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3.3 Model of the Study
In order to examine the association between
TENURE and EM and whether COMP has a
moderating impact between TENURE and EM,
and to test the hypotheses, the following
regressions were estimated:
KDA = β0 + β1 TENURE 1 + β2CEO +
β3TENURE 1 * CEO + β4LEV + β5ROA +
β6FSIZE + β7MTB + β8CURRENT + β9CFO +
β10INV + ei,t (MODEL 1)
JDA = β0 + β1 TENURE 2 + β2CEO +
β3TENURE 2 * CEO + β4LEV + β5ROA +
β6FSIZE + β7MTB + β8CURRENT + β9CFO +
β10INV + ei,t (MODEL 2)
4 Results
4.1 Statistics Analysis
The descriptive analysis for the study’s variables
is shown in Table 2. The mean value of JDA is
0.03; mean value of KDA is 0.111, similar to
Jordanian evidence [52].
The mean value of TENURE 1
is 0.479 this
indicates that 47.9% of Jordanian firms keep the
auditor for more than 3 years. Besides, the table 2
shown the mean value of TENURE 2 is 0.514,
this indicates the convergence of the result with
TENURE 1, which is considerably similar to
Jordanian evidence by [14]. The mean for CEO is
77446JD, which is quite comparable by [53],
which considered that this value is high in the
Jordanian environment. the mean value for LEV is
0.353 which shows that 35% of a firm's assets are
financed by debt. The table also shows that the
mean value for ROA, FSIZE, MTB, CURRENT,
CFO and INV are 0.016, 4.889, 1.239, 7.695,
0.015 and 0.048, respectively.
The dependent and independent variables' Pearson
correlation analysis is shown in Table 3. The
findings indicate that the majority of the
independent variables have a positive relationship
with one another. Tables 3 shown the TENURE 1
and TENURE 2 have positive correlation with
KDA and JDA. CEO has a positive and significant
correlation with KDA and JDA.
Table 2. Descriptive Statistics
Variables
Minimum
Maximum
Mean
Std.
Deviation
KDA
-0.356
1.748
0.111
0.204
JDA
-0.365
2.106
0.030
0.231
TENURE 1
0.000
1.000
0.479
0.500
TENURE 2
0.000
0.903
0.514
0.244
CEO
400
533335
77446
3
LEV
0.001
0.959
0.353
0.228
ROA
-0.613
0.387
0.016
0.097
FSIZE
2.602
5.727
4.889
0.493
MTB
0.117
12.410
1.239
1.252
CURRENT
0.021
902.166
7.695
59.856
CFO
-0.689
0.835
0.015
0.123
INV
0.000
0.536
0.048
0.085
Table 3. Correlation Analysis
Probability
KDA
JDA
TENURE 1
TENURE 2
CEO
LEV
ROA
KDA
1.000
JDA
0.708***
1.000
TENURE 1
0.074
0.091*
1.000
TENURE 2
0.104**
0.112**
-0.609***
1.000
CEO
0.128***
0.143***
-0.066
0.083*
1.000
LEV
0.045
0.035
-0.079
0.048
0.388***
1.000
ROA
0.063
0.185***
0.062
-0.002
0.284***
-0.241***
1.000
FSIZE
0.048
0.095*
0.002
0.020
0.317***
0.144***
0.099**
MTB
-0.063
0.045
-0.029
0.695***
0.137***
0.095*
0.329***
CURRENT
-0.010
0.035
-0.032
0.038
-0.228***
-0.161***
-0.020
CFO
-0.053
0.012
-0.015
0.009
-0.141***
-0.085*
-0.136***
INV
-0.064
-0.057
0.084*
-0.082
-0.263***
-0.012
-0.040
FSIZE
MTB
CURRENT
CFO
INV
FSIZE
1.000
MTB
0.020
1.000
CURRENT
0.003
0.061
1.000
CFO
-0.082
-0.027
0.052
1.000
INV
0.099
-0.069
0.061
0.015
1.000
*, ** and *** represent significance at p<0.10, <0.05 and <0.01, respectively
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4.2 Main Empirical Results
Table 4 presents the fixed effect model to test
hypothesis of the study. Table 4 provides the
regression estimates for model 1 (KDA). also
provides the regression estimates of model 2
(JDA). Table 4 indicates a negative and significant
association between TENURE 1, TENURE 2 and
discretionary accruals (KDA and JDA), meaning
the auditor tenure can decrease the earnings
management practices when the firm keeps the
same auditor for a long time. This result agrees
with the agency theory that auditor tenure limits
earnings management due to auditor tenure
increasing audit quality [11]. Moreover, this result
consists with [19], [20], [21]. The first hypothesis
was accepted by this finding, which states that
there is a significant relationship between
TENURE and EM.
The COMP result in Table 4 demonstrated a
positive and significant association with EM (JDA
and KDA), this result contradicts the agency
theory because it shows that CEO compensation
cannot be increased while EM practices remain
unchanged. However, this finding is in line with
earlier research [32], [33], [34].
The findings in Table 4 reveal that the combined
impact of TENURE and COMP on EM has a
negative and significant relationship, for the main
and alternative measurement. This indicates the
longer the auditor’s tenure period, with the CEO
receiving high compensation, can less
opportunistic behavior practices and thus reducing
the EM. This finding is consistent with the agency
theory, which maintained that utilizing COMP
with high audit quality helps prevent conflicts of
interest and agency problems. The findings of the
control variables are also listed in Table 4; the
bulk of these data revealed a significant
association between LEV, ROA, CURRENT, and
INV on EM.
Table 4. Fixed Effect Model
Variables
KDA
JDA
TENURE 1
-0.027*** (2.066)
TENURE 2
-0.482** (2.322)
CEO
0.308*** (-2.146)
0.316*** (-2.331)
TENURE 1 *
CEO
-0.041** (2.141)
TENURE 2 *
CEO
-0.065** (2.771)
**
LEV
0.202*** (4.385)
0.115** (3.355)
ROA
0.466*** (0.126)
0.714*** (0.186)
FSIZE
0.004 (-0.727)
0.003 (0.689)
MTB
-0.005** (2.646)
-0.002 (2.190)
CURRENT
0.001*** (0.829)
0.001*** (2.329)
CFO
-0.026 (2.595)
-0.027 (-0.744)
INV
0.388*** (-3.617)
0.367*** (3.205)
R- squared
0.324
0.319
F- Statistic
819.354***
1003.5***
No. of obs
405
405
*, ** and *** represent significance at p<0.10, <0.05 and <0.01, respectively
4.3 Robustness Analysis
To demonstrate that the results are consistent, this
study contains tests. The tests include the
heteroscedasticity test, the serial correlation test
and the feasible generalized least square test. To
investigate whether the dataset had a problem with
heteroscedasticity, this study applied the Modified
Wald test for GroupWise heteroscedasticity. The
p-value in table 5 is higher than 0.1, it indicates
that there is no heteroscedasticity issue with the
panel data used for this analysis.
Table 5. Modified Wald Test
H0: there is no
heteroscedasticity issue
Chi2 (81) = 1.01e+03
Prob>chi2 = 0.204
*, ** and *** represent significance at p<0.10, <0.05 and
<0.01, respectively.
In this study, the serial correlation issue was
explored in this study by using the Wooldridge test
analysis. Table 6 displayed the Wooldridge test
findings; the result demonstrates that there is no
serial association in this study.
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Table 6. Wooldridge Test for Autocorrelation
H0: no first order autocorrelation
F(4,368) = 0.001
Prob>f = 0.362
*, ** and *** represent significance at p<0.10, <0.05
and <0.01, respectively.
The results of the feasible generalized least square
(FGLS) method are shown in Table 7. The study
used the (FGLS) method to examine the veracity
of the results presented above. According to
Bekhet et al [51] FGLS can solve issues like
heteroscedasticity, serial correlation, and panel
error structure.
According to the FGLS findings, TENURE
significantly and negatively impacts on EM. In
addition, the result shown the COMP has a
positive significant effect on EM. in addition,
Table 6’s findings revealed that they concurred
with the study’s findings when FEM was used,
demonstrating the validity of the research’s
findings.
Table 7. FGLS Results
Variables
KDA
JDA
TENURE 1
-0.031*** (2.128)
TENURE 2
-0.362** (2.161)
CEO
0.213** (-1.782)
0.244** (-3.002)
TENURE 1 * CEO
-0.123** (3.561)
TENURE 2 * CEO
-0.742** (3.114)
**
LEV
0.402** (3.678)
0.179** (3.382)
ROA
0.721*** (1.249)
0.321** (1.731)
FSIZE
0.012 (-1.329)
0.011 (-0.592)
MTB
-0.025** (1.862)
-0.319* (1.059)
CURRENT
0.120*** (0.763)
0.338*** (0.652)
CFO
-0.093 (2.562)
-0.023 (2.003)
INV
0.494** (-2.102)
0.319** (-1.876)
*, ** and *** represent significance at p<0.10, <0.05 and <0.01, respectively.
5 Conclusions
This study investigated the association between
TENURE and EM and whether COMP moderates
the association between TENURE and EM. An
alternative method was used to measure TENURE
and EM to verify the results of the study.
The study's findings showed a significant and
negative association between TENURE and EM,
when we used the main measure and alternative
measurement, The reason for this is that 50% of
Jordanian firms keep the auditor for a period of
more than 3 years, as this helps the auditor to
acquire the necessary experience and increases his
independence, as this leads to an increase the
quality of the audit process and thus reducing
earnings management. It is possible that the
reason, in addition to the increase in the auditing
quality and depending on the findings of the study,
which indicate that the size of companies in
Jordan is not large, as well as the business and
growth of the company is low, so it is easier for
the auditor when he has been in the firm for more
than 3 years to know all the work of the firm and
thus be able to spot errors and opportunistic
behavior.
The study revealed a significant and negative
relationship between TENURE and COMP on
EM, based on the investigation’s findings, the
reason for this is the CEO receives high
compensation compared to the firm’s performance
and the small profit that the company obtains,
where the CEO is cooperating with the auditor
who audits the company for a long time in
detection of any errors and abuses and thus limits
the earnings management. This study recommends
companies to retain the auditor for a long period
and at the same time give the CEO high
compensation coupled with performance in order
to be able to eliminate this opportunistic behavior.
The study also recommends using real earnings
management in future studies.
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