**2. Litterature review**

### **2.1 External audit choice**

There are different techniques through which the EAC could be demonstrated (independence, audit tenure, auditor size, auditor experience, BIG4, etc.) [39–42].

### *How to Successfully Select the Best-Performing Bank Based on the Best Auditor's… DOI: http://dx.doi.org/10.5772/intechopen.113201*

The best choice is measured by qualification, sufficient training, and experience. The annual report's quality is regarded as the most important tool for monitoring the EAC [4, 18]. For the firm's transparency and accountability obligations towards the stakeholders [13], a lot of detailed information should normally be mentioned in the annual report. This information mainly concerns the operational risk level, financial parameters' evolution, significant errors, and the tests' extent carried out to assess the assets' value at market value. There are different techniques through which the EAC could be demonstrated (independence, audit tenure, auditor size, auditor experience, BIG4, etc.) [39–42]. The best choice is measured by qualification, sufficient training, and experience. The annual report's quality is regarded as the most important tool for monitoring the EAC [4, 18].

For the corporation's transparency and accountability obligations towards its stakeholders, a lot of detailed information should normally be mentioned in the annual report [13]. It mainly concerns the operational risk level, financial parameters' evolution, significant errors, and the tests' extent carried out to evaluate the assets' value at market value. This information could go beyond EA's technical functions, but it contains all financial measures and adjustments to all assistants' interests [43]. The approval or rejection of accounting data is not a simple control process; it requires a lot of vigilance and professionalism to extract the errors of the mismanagement of any bank, which also depends mainly on the EAC's effectiveness. In this sense, Kamolsakulchai [44] showed a strong and positive link between the quality of audits and the quality of financial reporting, as determined by an unqualified audit opinion. This indicates that financial reporting was prepared according to generally accepted accounting standards.

The main limitations of the EAC effectively contributed to little transparency in audit procedures, the absence of large databases (Big Data) containing official figures, and the dearth of in-depth studies that illustrate the real hurdles of global regulation and the profession's dynamism. In reality, there is an insufficiency of practical explanations that represent unique standards to judge the EAC's quality. External audits as well as the audit control authorities could not clearly define the EA's role [34]. The visibility issue is fundamental not only for academic researchers but also for regulators and global rating agencies to appreciate and evaluate the EA's efforts. Ideal oversight requires the auditor's ability to judge difficult times with consistency, vigilance, and transparency, as well as their resistance to pressure and conflict from leaders [45, 46]. Otherwise, the EAC will have doubts about the EA's independence. The greater the auditor's financial dependence, the greater the pressure on their responsibilities to interfere with their duties. Conversely, the more the EA's independence improves, the richer the audit quality. As a result, the EAQ maintains good surveillance. This leads to supporting the bank's profitability, creating more liquidity, repaying more liquidity, and contributing to a rational use of resources that is normally positively reflected in wealth creation.

However, previous empirical studies resulted in controversial outcomes on the effect of competition between auditors operating in similar audit markets. Regulators discovered that little competition in the audit market is likely to curb the EAQ, while its strengthening promotes auditor independence and improves the EAQ, even though other researchers reported the opposite. More specifically, Fujiao [47] studied the impact of competition between EAQ in the audit market on the EAQ. He stated that competition negatively reflects the auditee-auditor relationship. The competition considerably modifies the EAC that moderates the EAQ provided to the customers by providing non-audit services (NAS) by the agent. However, EAC,

measured by competition, has a positive moderating impact on the inverse association between the NAS provision and the EAQ. He also discovered that EAC indirectly affects EAQ through increased auditor independence. In conclusion, he declared that weak internal control, such as continuity notices (favorable or unfavorable) and financial restatements, determines the EAQ.

Likewise, Brooks et al. [48] came to the conclusion that the EAQ increases in parallel with the mandates' length due to a learning effect and decreases with recent audit mandates due to a surety effect. When the link effect dominates the learning effect during the service period, the EAQ decreases as a result of the decrease in the audit team's independence. The EAQ change grows with EAC, BIG4 auditors, and specialist auditors. Also, Elad [49] noted that the auditors' training has a partial effect on the intentional reduction of their responsibilities related to the preparation of accounting records and financial statements since this facilitates the audit procedure judgment. However, the auditors' training does not affect the detection of fraud, the financial statements' reliability, and the usefulness of decisions.

Indeed, to evaluate the risk of sudden and recent changes in control approaches applied by the chosen audit firms, Kutum [50] tested the extent of applying the risk audit approach to business by non-BIG4 auditors, as well as its pros, cons, and consequences, particularly in three countries, which are the United Kingdom, America, and Canada. As measurement parameters, our paper relies on four alleged advantages for large companies, which are, respectively, the informational content of audit reports, the consistency of audit practices with audit manuals worldwide, the auditors' awareness of risks, and audit effectiveness. During the period of collecting information, the author considered the contextual factors affecting non-BIG auditors' choices. The results showed that non-BIG4 auditors in the three countries adopted firms' risk auditing. First, this approach helps auditors better understand their customers, promotes audit efficiency, and facilitates the audit risk management process. Second, risk control makes it easier to follow the general trend of non-BIG4 auditors and the accounting standards applied within each country.

Nevertheless, other studies that analyzed the EAC effect on the banks' FP revealed the opposite. It turned out that big audit corporations are the best known. They have higher expertise [46, 51], are more able to appreciate the situation's complexity [39, 52], are more independent [53, 54], and are more competent [45, 55] than others because they no longer have to worry about their reputation. Moreover, they are more cautious about significant legal sanctions [56]. According to this current, the certification of multinational banks by this type of auditor is not tainted by manipulation, omissions, or falsification. In addition, big auditors will be more likely to maintain the audit's credibility than small audit corporations by resisting accounting and financial pressures when negotiating their fees. The various EAC approaches proved that the services provided by BIG4 audit are distinctive and provide better services suited to their customers' needs compared to those of other firms because they are less involved in fraudulent acts. In this sense, Watts and Zimmerman [57], Chan et al. [58], and Firth [59] found that auditors who are involved in bad accounting manipulations lose their reputations.

Based on its experience, Ernst and Young reported in 2003 that the audit committees' power was stronger than that of EAs in the studied institutions. However, big audit firms better recognize how to interact with banks' committees. Indeed, they know how to rise above difficulties, solve problems, and communicate solutions. To do so, Ernst and Young indicated that a detailed assessment of the guidelines would help audit committees adopt more efficient operating procedures. To improve the

### *How to Successfully Select the Best-Performing Bank Based on the Best Auditor's… DOI: http://dx.doi.org/10.5772/intechopen.113201*

discussed correlation, Baumann and Erlend [60] noticed that banks disclosing more information on their profits and FP have higher funds ratios. This reserve provides greater protection against the probability of unexpected losses. In conclusion, thanks to their good EAC, banks that improve their publishing processes increase their FP because they build stakeholder confidence by attracting new investments [61, 62]. A good EAC positively influences the governance quality and, consequently, the equity book value.

Returning to the accounting literature, the audit firms' classification started as BIG6s, then as BIG5s, and then as BIG4s, which currently represent a basic benchmark related to control quality worldwide [63]. For example, Francis et al. [64] found that on average, 50% of the audit services costs were granted to leading corporations in the audit market, whereas only 22% of these services were entrusted to small firms. Besides, the most developed sectors in America are audited by BIG5 firms. Thus, the sample was distributed according to the audit firms: 14 companies for Arthur Andersen, 5 companies for Deloitte & Touche, 16 companies for Ernest & Young, 9 companies for KPMG, and 19 companies for PricewaterhouseCoopers. Moreover, Jeff et al. [65] confirmed that, generally, investment banks are oriented towards BIG4 auditors mainly for insurance and trust reasons. This proves that the choice between BIG4 firms and second-level firms is not based on actual quality that reflects their fundamental independence but rather on a preference limited to their perceived quality based mainly on structural choices.

According to international auditing standards, before expressing an opinion, the EA must comply with accounting standards, the bank's operating principles, and good governance rules. Because the communication of FP information in conventional and Islamic banks is very delicate, these banks call on the big audit firms as part of their stakeholders - shareholders, creditors, and investors - who are looking for reliable and relevant FP information. This helps to monitor the leaders' behavior, protect their interests, and evaluate their decisions [4]. The fundamental role of a good EAC is to curb the information asymmetry between both holders and users of FP information. In the event of financial manipulation, the EAs assume responsibility for their actions and the results of the fake FP information. The truly independent EA always tends to reduce FP information asymmetry. However, since qualified auditors are more likely to behave in compliance with standards, boosting the banks' FP depends on the EAC's activeness and their ability to discover inappropriate accounting practices, limit managers' opportunistic behavior, detect moral hazard problems that threaten the shareholders' interests, and cover managers' revenue manipulation [66, 67]. The EAs generate a fundamental role as bank supervisors if they guarantee that depositors are informed about the encountered financial difficulties that may affect the bank's FP and lead to a bank panic. In this case, their role is still focused on strengthening deposit protection so that depositors have fewer incentives to monitor the bank [68, 69]. The published report consistently reflects the various aspects of a bank's operations with or without reserves [44].

Because all audit missions must be carried out in secrecy to protect property rights and to respect the banks' private information, the information covers the protection of their customers' particularities in front of their competitors and also agrees with the accounting methods' conservatism. Indeed, Steven et al. [70] stated that in firms audited by experienced auditors, the managers' discretionary power is weak. It is recognized that all practices, experience, and professional audit training in various fields that are acquired over time increase the error detection levels in financial statements [71–74]. In the same sense, Chia et al. [75] noticed that the companies

audited by BIG4 record lower rates of earnings management than other companies. Moreover, given the BIG4s' reputation in the global financial market, Cahan and Zhang [76] reported that big audit corporations are more attentive to litigation risk compared to smaller ones. Similarly, other academics explored the link between the EAQ and the earnings management level. They noticed that the institutions audited by BIG4 auditors recorded low rates of earnings management [25, 26]. From the same perspective, Lee and Vivek [77] studied the link between discretionary accruals and the litigation risks of private firms audited by BIG6 versus firms audited by non-BIG6. They concluded that the former managed fewer discretionary accruals than the latter since they avoided the risk of losing their reputation on the market. In the Korean context, Jeong et al. [78] demonstrated that companies that have certified accounts by state-appointed auditors recorded a higher level of abnormal accruals than firms audited by freely chosen auditors. Furthermore, Hasan et al. [18] examined the moderating impact of audit quality on financial reporting quality, i.e., real earnings management, in Malaysian companies. They recorded that audit quality plays an important role in restricting real earnings management practices.

Moreover, Houqe et al. [79] revealed that compliance with ethical principles leads to a positive and significant effect on the BIG4s' choice. Thus, all the countries' control variables are positively linked to the BIG4's choice. Yet, by controlling both company and country factors, the probability of hiring a quality auditor is enhanced by the company's ethical values. Yet, the impact of the company's ethical values on the auditor's choice remains significant and positive when the control variables in the country are included in the model. So, the indicators of the companies' ethical values have additional explanatory power for controlling countries. In conclusion, the EAC indirectly improves the relationship between companies' compliance with ethical standards and financial information quality.

As for the impact of EAC that results in the EAQ on FP, Teoh and Wong [26], Becker et al. [30], and Krishnan [25] noted that the EAQ and the results quality announced by the companies audited by BIG4s are more reliable compared to the results of firms audited by non-BIG4s [13, 80]. The BIG4s' resources are greater than those owned by small firms [81], so as to maintain their reputation and ensure accounting and financial information quality. Indeed, the perceived independence of BIG4 firms is positively correlated with a competitive environment [82]. Consequently, BIG4s certify more credible financial statements compared to the financial statements audited by other auditors [25, 30]. Moreover, Hamed et al. [83] showed the existence of an insignificant correlation between EA quality proxies and ROA. They also noted that the audit fee has a positive and significant relationship with Tobin's Q. Yet, EAs' rotation has an insignificant correlation with Tobin's Q. Indeed, Ezejiofor et al. [24] examined the impact of audit quality on the FP of bank deposits in Nigeria between 2009 and 2016. Their results showed the existence of a significant correlation between audit quality and deposits' FP. Furthermore, Rahman et al. [13] found that BIG4s have a positive and significant correlation with firms' FP. Even more, Ziaee [5] found that EAQ could affect companies' FP. Similarly, Muotolu et al. [84] revealed that BIG4 positively and significantly affects Nigerian banks' FP. To avoid the deposits' management, the researchers suggested that Nigerian banks be audited by one of the BIG audit firms. In the same context, Ado et al. [23] showed that auditor size positively and significantly affected the ROA. Moreover, they concluded that auditor independence had more power over the FP than auditor size.

The discussion of the EAC effect on the IBs' FP is not very extensive in the literature given the delimitation of the IBs' networks worldwide [85]. A few studies *How to Successfully Select the Best-Performing Bank Based on the Best Auditor's… DOI: http://dx.doi.org/10.5772/intechopen.113201*

have previously assessed whether the EAC really affects or contributes to the growth of the IBs' FP [86–89]. According to Quttainah et al. [89], IBs support the risk of losing all or some of their investments since they use contracts like Murabaha, Musharakah, and Mudarabah. Without the Charia audit, IBs rely on the same auditing standards used by their competitors [12]. However, according to some researchers, an independent external audit system is very important in IBs since it ensures management supervision and develops a healthy culture within the organization adapted to the nature of their risks [87]. In Indonesia, for example, the central bank regulations require the presence of an independent EA within the Indonesian IBs. The auditing of the financial statements is obligatorily entrusted to competent personnel. Furthermore, the Indonesian central bank is forcing IBs to appoint an accounting firm registered in its system of recognized independent auditors who must put the enhancement of the IBs' FP at the top of their priorities [88]. To reach this goal, by obligation, the EA should disclose much information in their report, such as equitable ownership of the board's members, compensation policy, board meetings, internal fraud, charity funds allocation, rooting symptoms, etc. Therefore, the EAs deal with inappropriate accounting treatment, failures in the risk management system and internal control, obstacles that prevent the creation of FP, fraud, and manipulation of charges and products, which add to operational management weaknesses.

From the history of previous research that has explored this theme, we estimated the following hypotheses:

Hypothesis 1:

Hypothesis 1-1: The EAC positively impacted the FP of conventional and Islamic banks.

Hypothesis 1-2: The EAC negatively impacted the FP of conventional and Islamic banks.

Hypothesis 1-3: The EAC positively impacted the CBs' FP and negatively affected the IBs' FP.

Hypothesis 1-4: The EAC negatively impacted the CBs' FP and positively affected the IBs' FP.

### **2.2 Control variables**

We selected control variables that focus on the factors that best explain the measures of FP. In order to achieve our research objective, we chose four commonly used parameters that, we believe, can shed light on the FP of both conventional and Islamic banks. These variables consist of the age, size, type, and inflation of the banks.

### *2.2.1 Bank size*

In a contractual environment, while the financial system remains stable, individuals who seek personal gains focus on taking advantage of agency relationships. The bank's size plays a crucial role in determining the nature of financial streams and informational content beyond its financial policy, regardless of the specific bank type. In situations that deviate from the norm, like conflicts of interest or information imbalances, opportunistic individuals in governance tend to focus on specific factors such as net result, FP, cash flow, dividends, etc., in order to maximize their profits. For instance, Bhushan [90] claimed that executives in big companies were pressured into deliberately making errors. The purpose of earnings management is either to deceive shareholders by presenting unreal and distorted results that reflect the

achievement of predetermined objectives, or to underestimate actual results. In both cases, the directors have control over financial information. Skinner and Sloan [91] support this idea by stating that banks that do not accurately predict and analyze their FP based on rational accounting choices will face negative consequences in their results and profits. Consequently, they concluded that the size of a bank is negatively associated with its FP. Existing literature provides numerous studies illustrating the natural relationship between bank size and FP. **Table 1** demonstrates several diverse studies that utilized bank size in similar research.


*2 Bulgaria, Czech, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia.*

### **Table 1.**

*The contradictory findings of some studies regarding the association between FP and the size of banks.*

### *How to Successfully Select the Best-Performing Bank Based on the Best Auditor's… DOI: http://dx.doi.org/10.5772/intechopen.113201*

According to the legitimacy theory, as a firm grows larger, it becomes more accountable legally, socially, and politically to both the law and its stakeholders [99]. Consequently, as financial operations become more complex, the flow of financial information expands and financial complexities increase [100]. Moreover, as big banks focus on serving their customers [101], their size negatively impacts their FP. In fact, as the bank grows, bureaucratic obstacles start to hinder its FP.

After exposing the necessary theoretical foundations, our hypotheses were formulated as follows:

Hypothesis 2:

Hypothesis 2-1: Bank size affects the FP of conventional and Islamic banks.

Hypothesis 2-2: Bank size ameliorates the FP of conventional and Islamic banks.

Hypothesis 2-3: Bank size affects the CBs' FP and ameliorates the IBs' FP.

Hypothesis 2-4: Bank size ameliorates the CBs' FP and affects the IBs' FP.

### *2.2.2 Bank age*

Age was commonly used in literature as a variable for control, particularly in studies examining its influence on various bank parameters. Yet, the research results regarding the relationship between a bank's age and its FP were varied and inconclusive. This inconsistency motivated us to investigate and clarify the true correlation between these two variables. One prevailing belief is that regardless of the type of bank, the level of seniority can impact the quality of services and restrict the authority of auditors due to the presence of friendly connections and conflicts of interest. This hinders auditors from adhering to good governance standards and obstructs efforts to enhance FP and generate value. Another existing viewpoint elucidated the restricted growth of the Islamic banking sector, with studies revealing that the industry remains confined and primarily localized in certain regions due to various reasons. Additionally, the slow spread of the Islamic banking sector can be attributed to the limited support from the government and the low demand for investment, all while adhering to the Profit and Loss Sharing (PLS) technique [102]. Moreover, the lack of liquidity in the secondary markets has hindered the growth of the IBs, although there have been gradual improvements over time [103, 104]. The reason for the different conclusions of previous studies is explained by the fact that Islamic banks are concentrated in certain regions more than others, as stated by Samad [105]. However, it should be noted that the funding model has evolved over time, leading to the



### **Table 2.**

*The contradictory findings of some studies regarding the association between FP and the age of banks.*

expansion of the banking network to new regions. **Table 2** reveals the uncertainty regarding the impact of the banks' age on their FP.

In general, international banking networks view Islamic products as a chance for investment and profit, according to Siddiqui [108]. As time has passed, the Islamic banking model has evolved from a basic system of depositing funds to a more complex investment-focused system that emphasizes value creation. As the demand for Islamic products grew, shareholders were motivated to focus on creating flexible products that tailored to their customers' needs. In addition, they developed derivative products and innovative services that mirrored those offered by conventional banks, allowing them to tap into new markets [109].

From what we have already seen, the most suitable hypotheses are the following: Hypothesis 3:

Hypothesis 3-1: Bank age ameliorates the FP of Islamic and conventional banks.

Hypothesis 3-2: Bank age affects the FP of Islamic and conventional banks.

Hypothesis 3-3: Bank age ameliorates the CBs' FP and affects the IBs' FP.

Hypothesis 3-4: Bank age affects the CBs' FP and ameliorates the IBs' FP.

### *2.2.3 Bank type*

The objective of our study is to conduct a study that examines the different effects of flows on FP, and by distinguishing between different types of banks, we can consider the unique characteristics of each type. This segmentation of banks can be determined by factors such as the field, sector, or type of activity. The specific characteristics of different bank types are important in monitoring their economic and financial indicators, particularly governance. This interdependence between different criteria allows researchers to distinguish between the unique effects of conventional and Islamic banks, taking into account their inherent traits. However, specialization in *How to Successfully Select the Best-Performing Bank Based on the Best Auditor's… DOI: http://dx.doi.org/10.5772/intechopen.113201*


*The countries highlighted are India, Bangladesh, China, Hong Kong, Malaysia, Indonesia, Macao, Nepal, Pakistan, South Korea, Philippines, Singapore,Thailand, Sri Lanka,Taiwan, and Vietnam.*

### **Table 3.**

*The contradictory findings of some studies regarding the association between FP and the type of banks.*

banking allows for a narrower market and allows multiple competing banks to divide the available customer base in order to control the banks' overall FP (**Table 3**).

Based on the previous researches, the possible hypotheses are:

Hypothesis 4:

Hypothesis 4-1: Bank type affects the FP of conventional and Islamic banks.

Hypothesis 4-2: Bank type ameliorates the FP of conventional and Islamic banks.

Hypothesis 4-3: Bank type affects the CBs' FP and ameliorates the IBs' FP.

Hypothesis 4-4: Bank type ameliorates the CBs' FP and affects the IBs' FP.

### *2.2.4 Country inflation*

The finance literature extensively examined the effect of inflation on the FP of CBs. However, this aspect was not widely covered in Islamic finance literature. Despite operating under a specific regime, some research indicates that Islamic banks may not be affected by inflation's impact on their FP. Additionally, the finance literature observed that IBs are not affected by the interplay of inflation, interest rates, and traditional banks' financial policies. The connection between inflation and typical bank fees is not substantial as IBs do not engage in interest-based practices. In the context of inflation, IBs maintain stability and experience an increase in their return rate [112].

Prior studies found a positive correlation between inflation and banks' FP, regardless of the type of bank. However, recent research showed that changes in inflation have no impact on the profitability of banks, specifically the income costs of both CBs and IBs [113, 114]. On the other hand, other recent studies by Bashir [115], Bennaceur and Omran [100], and Saeed [116] demonstrated that inflation increases debt costs and decreases the value of banks. **Table 4** highlights selected previous research that investigated the impact of inflation on banks' FP.

The exposed literature leads us to pose the following hypotheses: Hypothesis 5:

Hypothesis 5-1: Country inflation affects the FP of Islamic and conventional banks.


*1 Egypt, Pakistan, Bangladesh, Saudi Arabia, Kuwait, Qatar, Iraq, United Arab Emirates, Sudan,Turkey, Bahrain, and Jordan.*

### **Table 4.**

*The contradictory findings of some studies regarding the association between FP and inflation.*

Hypothesis 5-2: Country inflation ameliorates the FP of Islamic and conventional banks.

Hypothesis 5-3: Country inflation affects the CBs' FP and ameliorates the IBs' FP. Hypothesis 5-4: Country inflation ameliorates the CBs' FP and affects the IBs' FP.
