The mediating effect of audit quality on the relationship between corporate governance and firm performance

Abstract

Although several studies have explored the nexus between corporate governance, audit quality and firm performance, there are still some areas that need further attention. These areas include (1) the mediating role of audit quality in the relationship between corporate governance and firm performance; (2) the impact of corporate governance characteristics such as board training, board nationality, board education, nomination committees and audit firm rotation on firm performance. Thus, the aims of the study are to examine (1) the impact of corporate governance on firm performance; (2) the relationship between corporate governance and audit quality; (3) the effect of audit quality on firm performance; and (4) the mediating role of audit quality in the relationship between corporate governance and firm performance. To achieve these objectives, data were collected from 542 listed companies in Bursa Malaysia for the period of 2003 to 2012. This study used multiple regression for data analysis. The corporate governance characteristics examined includes board of directors (size, independence, training, nationality, education), audit committee (size, independence, meeting), and nomination committee (size, independence, experience). There are three proxies of audit quality employed which are audit fees, industry specialist auditor and audit firm rotation. Firms performance is measured using return on assets, return on equity and Tobin‘s-Q. In general, the results show that firms with effective corporate governance are more likely to have better performance and demand for higher audit quality. In addition, firms with higher audit quality are more likely to have better firm performance. The finding also shows that audit quality mediates the relationship between corporate governance and firm performance. This means that there is direct relationship between firms with strong corporate governance and firm performance as well as indirect relationship between them through audit quality as a mediator. These findings are robust on other estimators and sensitivity analysis. The results provide several implications to investors, policy makers, researchers and regulators, especially with regard to enhancing firm performance, adopting mandatory audit firm rotation and board diversity under the current corporate governance principles.