The beneficial effect of shareholder participation in general meetings: Evidence in the context of audit quality.
| Autor | Bazrafshan, Ameneh |
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Introduction
Shareholder participation in general meetings (SPGM) is an important part of corporate governance in publicly-traded companies (e.g., Apostolides, 2010; Bebchuk, 2005; Krishnan & Ye, 2005). Theoretically, higher SPGM is desirable, as it serves the interests of shareholders by giving them a stronger voice regarding important governance issues (Holland et al., 2021; Institutional Shareholder Services (ISS), 2016; SEC, 2018a; SEC, 2018b) and leads to a broader reflection of shareholders' interests in the corporate governance processes (e.g., ISS, 2016; Stratling, 2003). Furthermore, higher SPGM provides shareholders with a better opportunity to hold management accountable and may prevent managers from engaging in opportunistic behaviors (e.g., Mayhew & Pike, 2004). For these reasons, regulators and securities commissions usually encourage higher SPGM (European Union, 2020; Institutional Shareholder Services, 2012; Krishnan & Ye, 2005; U.S. Department of the Treasury, 2008). Nevertheless, several theoretical studies question the value of this higher SPGM (e.g., Jong, Mertens & Roosenboom, 2006; Sjostrom, 2006). Moreover, the empirical research does not provide a lot of evidence on the beneficial effect of higher SPGM.
In this research, we focus on one of the potential consequences of higher SPGM: audit quality. Specifically, we examine how SPGM affects audit quality, defined as higher assurance that corporate reports reliably reflect the company's underlying economics (Defond & Zhang, 2014). Theoretically, SPGM may reduce the influence of managers in the auditor selection and auditing processes (e.g., Advisory Committee on the Auditing Profession, 2008; ISS, 2016) and may therefore change the potential focus of the auditors from the managers' reporting preferences to the investors' reporting preferences (e.g., DoT, 2008; Hermanson, Krishnan, & Ye, 2009; Lev, 2002; Tanyi & Roland, 2017), resulting in higher audit quality. Moreover, SPGM serves as a monitoring device that influences auditors and their work (ISS, 2016; Krishnan & Ye, 2005; Tanyi & Roland, 2017) and may ensure that the choice of auditor meets the company's specific needs (e.g., ACAP, 2008; DoT, 2008; Federal Trade Commission--FRC, 2003), resulting in higher audit quality.
The motivation for this focus is based on the following facts. First, audit quality plays an important role in reducing agency conflicts between shareholders and managers and has substantial effects on a significant portion of subsequent discussions, decisions, and shareholder interests (e.g., Dao, Raghunandan, & Rama, 2012; Defond & Zhang, 2014). Hence, the concept is fundamental in itself.
Second, regulators are considering issuing recommendations to require all public companies to have a shareholder vote on auditor selection (e.g., Cunningham, 2017; Institutional Shareholder Services, 2015). To clarify, some professional bodies such as the UK Financial Reporting Council and the US Advisory Committee on the Auditing Profession argue that to ensure the auditors are suitable for the companies and corporate reporting needs, shareholder engagement in the selection and ratification of auditors through the general meeting should be considered (e.g., DoT, 2008; FRC, 2007). In this regard, the need for related empirical evidence is highlighted by calls for further research (e.g., Mayhew, 2017).
Third, there are international debates on the beneficial effect of shareholder engagement in auditor appointments and re-appointments (e.g., Cunningham, 2017; Dao et al., 2012). To clarify, on the one hand, shareholder engagement may lead to a broader reflection of shareholders' interests in audit quality and play an important role in reducing agency conflicts between investors and managers (e.g., Cohen, Krishnamoorthy, & Write, 2010; Dao et al. 2012; Krishnan & Ye, 2005). This is because in many companies the boards of directors (and audit committees) are dominated by management (e.g., Mayhew & Pike, 2004) and, therefore, auditors' natural response is to be more likely to go along with managements' preferred accounting choices (Cohen et al., 2010; KPMG, 2004). On the other hand, the majority of voters may not have sufficient knowledge about the quality of the auditors and therefore the majority of votes may be reflective of factors (such as stock returns achieved in the period leading up to the vote) that are outside the auditor's scope (e.g., Cunningham, 2017; Liu, Raghunandan, & Rama, 2009). This is particularly relevant when many audit characteristics are only partially observable (Fontaine, Leteifa, & Herda, 2013).
Fourth, while there is theoretical and experimental evidence indicating that SPGM may influence audit quality (e.g., Dao et al. 2012; Lev, 2002; Stewart & Munro, 2007), empirical evidence on the association between SPGM and audit quality is rare, especially in emerging capital markets. For example, while prior experimental research indicates that SPGM may influence auditor selection and therefore SPGM may lead to higher audit quality, such research significantly simplifies the research setting (Mayhew & Pike, 2004), and thus the experimental methodology may deviate from realism (e.g., Swieringa & Weick, 1982). Moreover, the studies usually focus on developed capital markets, where, on the one hand, there are various information channels that may provide more extensive information besides audited reports (Su, Peng, Tan, & Cheung, 2014), and therefore the importance of auditing is lower. On the other hand, there are various institutional settings that help shareholders to prevent manager influence in the auditing process and to monitor and control the audit quality. This is particularly relevant, as managerial discretion in emerging markets is relatively higher than in developed capital markets (e.g., Hesarzadeh, 2019; 2020). For these reasons, the related literature (e.g., Krishnan & Ye, 2005) mentions the need for research outside developed countries.
Our sample includes listed companies in Iran's capital market. As we will discuss in the "Sample and data" section, this is an appropriate research setting, particularly because in Iran, consistently with the research question, all listed companies must conduct an annual selection of the external auditor through the annual meeting and proxy process (e.g., Sajadi, Farazmand, & Gorbani, 2012). To clarify, consistently with Iran's Commercial Law and Regulations Governing the Trusted Auditing Firms of the Securities and Exchange Organization (Islamic Consultative Assembly, 1979; Securities and Exchange Organization, 2007a), in general meetings, shareholders elect and appoint the auditors through a voting process.
Our findings show that, in general, there is an insignificant association between SPGM and audit quality. However, we find that (a) there is a positive and significant association between the presence of institutional shareholders in general meetings and audit quality, and (b) for the companies with a high presence of institutional shareholders in their general meetings, there is a significant and positive relationship between the participation of other shareholders in the general meetings and audit quality. Thus, collectively, the findings propose that the impact of SPGM on audit quality is conditional to the presence of institutional shareholders in general meetings.
The findings contribute to the literature on both SPGM and audit quality in several ways. To clarify, first, this study reveals evidence on the beneficial effect of higher SPGM in an emerging capital market. Second, the study introduces SPGM as a positive determinant of audit quality, when the presence of institutional shareholders in general meetings is high. More broadly, the study adds to the international debate over whether SPGM enhances corporate governance (e.g., Cunningham, 2017; Sjostrom, 2006; Strand, 2013).
The next section presents the background and develops the research hypotheses. This is followed by the presentation of the research method, the empirical results, and, finally, the conclusions.
2 Background and hypotheses development
2.1 Shareholder participation in general meetings
Modern companies are characterized by the separation of ownership from management. This separation leads to a further need for the practical mechanisms of corporate governance to ensure that resources are efficiently and effectively used (Velury, Reisch, & O'Reilly, 2003). In this regard, SPGM is a basic and an essential part of corporate governance (Bebchuk, 2005; Proctor & Miles, 2003).
To clarify, annual general meetings are an appropriate platform that enables shareholders to hold managers accountable and, thus, annual general meetings constrain the possibility of shareholder expropriation by managers (Stratling, 2003). Apostolides and Boden (2005) stress the importance of general meetings as a corporate governance mechanism. This is because, first, general meetings are forums where shareholders are informed about substantial company matters and they consequently have an opportunity to exercise their control over managers and to participate in the diverse decision-making processes. Second, general meetings provide rare occasions in which diverse stakeholders in a company come together in one place to have their discussions about firm governance and other important matters (Apostolides, 2010). Third, the meetings also provide an instrument of checks and balances, where managers have to explain themselves to shareholders and where the latter may take corrective actions by exercising their ownership rights (Beuthel, 2006; Daniel, 2010; Stratling, 2003).
Related empirical research, while relatively rare, generally reveals that general meetings provide effective means for shareholders to communicate with managers, and managers usually take corrective actions in response to shareholder votes (Yermack, 2010). For instance, Bebchuk and Cohen...
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