CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

        Public limited companies (PLCs) are pivotal drivers of economic growth and development in both developed and emerging economies (Arestis & Sawyer, 2004). Public limited companies (PLCs) form the backbone of modern economies, serving as key drivers of innovation, employment, and economic growth (Smith, 2020). Their ability to raise capital from a wide range of investors through stock markets hinges on their commitment to transparency and accountability. Reliable financial reporting is paramount in this context, providing crucial information that stakeholder, including investors, creditors, and regulators, use to make informed decisions (Jones & Smith, 2022). These entities, characterized by their ability to raise capital from the public through the issuance of shares, play a vital role in facilitating investment, fostering innovation, and creating employment opportunities (Shleifer & Vishny, 1997). Given their substantial influence on the financial landscape, the integrity of their financial reporting is of paramount importance. Accurate and reliable financial statements are essential for maintaining investor confidence, ensuring efficient allocation of resources, and sustaining the overall health of capital markets (Lev, 1989).

To ensure the credibility and accuracy of these financial statements, PLCs rely on external auditors. External auditing serves as a critical assurance mechanism, offering an independent assessment of whether financial reports are presented fairly and in accordance with applicable accounting standards (Porter, 2021).In this context, the external audit function assumes a critical role. External audits serve as an independent assessment of the fairness and accuracy of these financial statements, providing reasonable assurance that they are free from material misstatements, whether due to fraud or error (AICPA, 2019).

             External audits play a crucial role in enhancing the reliability of financial statements, thus fostering trust among stakeholders (DeAngelo, 1981). In public limited companies, where ownership is dispersed among numerous shareholders, the need for high-quality audits becomes even more pronounced. The quality of external audits is linked to improved corporate governance, which can lead to increased company value (Cohen et al., 2007). As the business landscape evolves, understanding the impact of audit quality on value creation is essential for both practitioners and researchers. However, the effectiveness of the audit process is not uniform. It depends largely on the quality of the external audit itself (DeAngelo, 1981). Audit quality is not a singular concept, but a multi-faceted construct that reflects an auditor’s competence, independence, objectivity, and adherence to professional standards (Knechel et al., 2013). When audit quality is compromised, the reliability of financial information deteriorates, which can lead to a loss of investor confidence, increased costs of capital, and, ultimately, a decline in the overall value of the company (Jensen & Meckling, 1976). Therefore, audit quality is not simply a compliance issue but rather a vital aspect of good corporate governance and a significant determinant of value creation.

        However, not all external audits are equally effective; their efficacy is contingent upon the quality of the audit process itself (DeAngelo, 1981). Audit quality is a multi-faceted construct, encompassing factors such as the auditor’s independence, competence, objectivity, professional skepticism, and adherence to established auditing standards (Knechel et al., 2013; Porter, 1993). Compromised audit quality can manifest in numerous ways, including insufficient audit procedures, a lack of professional skepticism, or conflicts of interest that can undermine the reliability of financial statements (Humphrey, Moizer, & Turley, 2009). Such deficiencies can lead to a chain of negative consequences, such as reduced investor confidence, increased information asymmetry, higher costs of capital, and ultimately, a decline in the perceived and actual value of the company (Jensen & Meckling, 1976). Consequently, ensuring high-quality external audits is not merely a matter of compliance but a fundamental aspect of effective corporate governance and a key driver of sustainable value creation within public limited companies.

       Value creation, in the context of PLCs, is a multifaceted concept that goes beyond short-term financial gains (Freeman, 1984). It incorporates the long-term sustainability of the business, its contribution to stakeholders (including shareholders, employees, customers, and society), ethical considerations, effective risk management practices, and the efficient use of resources (Kaplan & Norton, 2004). Therefore, value creation involves a holistic approach that aligns with strategic goals, stakeholder expectations, and broader societal values. Value creation in public limited companies extends beyond short-term profitability. It also encompasses long-term sustainability, stakeholder satisfaction, and efficient resource allocation (Freeman, 1984). This broader understanding of value creation highlights the importance of ethical behavior, social responsibility, and, significantly, accurate and credible financial reporting. As such, the link between external audit quality and value creation becomes increasingly apparent: a high-quality audit can enhance investor confidence, reduce information asymmetry, lower the cost of capital, and, consequently, positively influence value creation for public limited companies (Francis, 2011). The interplay between external audit quality and value creation is particularly significant; a high-quality external audit can enhance the perceived reliability of financial statements, reduce information risk, lower the cost of capital, facilitate access to debt and equity markets, and foster a culture of accountability and transparency. This, in turn, leads to improved investor confidence, a higher stock price, and overall, greater stakeholder value (Francis, 2011; Myers, Myers, & Omer, 2003).

1.2 Statement of the Problem

          The effectiveness of external audit in promoting transparency, accountability and value creation in public limited companies remains a subject of ongoing debate, with concerns about audit quality, independence and impact on stakeholder’s trust and confidence (Knechel et al 2013). While the theoretical link between external audit quality and value creation in public limited companies is widely acknowledged in accounting and finance literature, the practical manifestation of this relationship remains somewhat complex (Ball & Shivakumar, 2005). Despite significant research efforts aimed at understanding and defining audit quality, and its effect on value, there is still no conclusive agreement on which specific factors of audit quality are most influential in the value creation process (Salehi & Azary, 2021).Empirical studies in this area have produced varying results, often failing to pinpoint the precise mechanisms through which audit quality impacts value (Carey, 2017). Prior studies have offered varied results, pointing to the complexity of the subject matter. This raises important questions: Is it the audit firm’s reputation, their industry expertise, the length of the audit tenure, or perhaps other factors that are most influential? The implications of this lack of clarity are considerable: poor audit quality can erode investor confidence, increase the risk of financial misstatements, increase the cost of capital, and lead to an inefficient allocation of resources (Beasley et al., 1999). This, in turn, affects shareholder value and hampers the overall growth prospects of the company. There is a continuing debate on whether certain factors such as auditor expertise, independence, or firm reputation play a more significant role than others (Choi et al., 2010). In many cases, the literature has offered conflicting findings, indicating that the relationship is not straightforward and requires further investigation using a variety of methods and contexts (Niemi & Stensaker, 2017).

          The lack of conclusive understanding about the exact drivers of audit quality and their precise impacts on value creation has significant consequences. A compromised audit quality, resulting from deficient auditor performance, can undermine the reliability of financial statements. This raises doubts about the credibility of reported financial data, increasing investors’ perceived risk and consequently raising the cost of capital for PLCs (Watts & Zimmerman, 1986). This can also lead to suboptimal resource allocation, mispricing of assets, and in some cases, increased exposure to fraud and corporate scandals (Beasley et al., 1999). These outcomes undermine investor confidence and diminish the perceived and actual value of the firm. Therefore, research focusing on isolating specific factors impacting audit quality and their links to value is not only essential for academic contribution but also for improving real-world practices in auditing and corporate governance. This research aims to address this gap by investigating specific factors that drive audit quality and their subsequent impact on value creation, providing a more comprehensive and clear understanding of this critical relationship. There is a need for research that carefully evaluates the different dimensions of audit quality to allow for a more effective approach in both practice and regulation.

        Despite the widely recognized importance of external audits for financial reporting and corporate governance (DeAngelo, 1981; Jensen & Meckling, 1976), the specific impact of external audit quality on value creation within public limited companies (PLCs) remains unclear. While external audits are intended to enhance the credibility and reliability of financial information (Watts & Zimmerman, 1986), it’s not always certain how audit quality translates into tangible benefits such as improved investor confidence (Francis, 2004), reduced cost of capital (Anderson et al., 2002), or enhanced firm performance. There is a need to explore the direct and indirect mechanisms through which external audit quality influences value creation in PLCs, a relationship that may be more nuanced than previously understood.

            The quality of external audits in public limited companies (PLCs) can vary depending on factors such as auditor independence (DeFond & Zhang, 2014), expertise (O’Keefe et al., 1994], and diligence. However, it is uncertain how the specific dimensions of audit quality (e.g., auditor specialization (Balsam et al., 2003), tenure (Johnson et al., 2002), firm size) influence the overall value creation process. There’s a concern that weaknesses in certain aspects of audit quality, such as compromised independence or insufficient industry expertise, may undermine the potential benefits of external audits, leading to suboptimal value creation within PLCs. Therefore, research is needed to identify which specific attributes of external audit quality are most critical for enhancing value creation in PLCs.

          In the wake of recent corporate scandals and heightened regulatory scrutiny (e.g., Sarbanes-Oxley Act of 2002), the importance of external audit quality has come under renewed focus. Public limited companies (PLCs) face increasing pressure to demonstrate the integrity and reliability of their financial reporting (Coffee, 2006). However, the influence of recent regulatory changes and market dynamics on how external audit quality translates into value creation is not fully understood. There’s a need to assess the effectiveness of current audit practices in creating value for stakeholders, particularly in light of evolving regulatory requirements and investor expectations.

           Within the Nigerian public limited company (PLC) sector, it is unclear how differences in external audit quality (see Eshun & Eshun, 2020) for a review of challenges) affect *value creation*. Weaknesses in regulatory enforcement, auditor competency, or corporate governance practices [Akani, 2016] can create a landscape where the benefits of external audits are not uniformly realized. Thus, there is a need for empirical research to identify what aspects of audit quality matter the most to value creation and to explore the contingencies or moderators that affect that relationship within Nigeria.

1.3 Research Questions

  1.3.1 Principal Research Question.

 What is the influence of external audit quality on value creation within public limited companies in Bamenda?

  1.3.2 Specific Research Questions.

1. To what extent does audit specialization enhance the value creation process in public limited companies through its impact on external audit quality?
2. How does the duration of the audit mandate impact the value creation process in public limited companies through its influence on auditor independence and objectivity?
3. To what extent does the reputation of the audit firm influence the credibility of financial reports in public limited companies?

1.4 Research Objectives

  1.4.1 Principal Objective.

 To investigate the influence of external audit quality on value creation within public limited companies.

  1.4.2 Specific Objectives

1. To assess the extent to which audit specialization enhances the value creation process in public limited companies through its impact on external audit quality.
2. To examine how the duration of the audit mandate impacts the value creation process in public limited companies, focusing on its influence on auditor independence and objectivity.
3. To investigate the extent to which the reputation of the audit firm influences the credibility of financial reports in public limited companies.