The History Of The Agency Theory Accounting Essay


This chapter describes the general theories aligned with the research. The research attempts to concentrate on the Agency theory, Stewardship theory and the Stakeholder theory which create a sound theoretical model.

The Agency theory discusses the relationship between the agent and the principal and issues arise while working towards the same aim.

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The Stewardship theory on the other manus is a utility position of Agency theory, in which directors are expected to move in their ain opportunisms at the spending of stockholders.

Stakeholder theory suggests that the thrust of a concern is to bring forth as much value for stakeholders. Harmonizing to Drucker ( 1990 ) , today corporations have to equilibrate their duties towards society in which they function, while run intoing the of all time increasing demands of their stakeholders to be competitory in a planetary economic system.

Agency Theory

The construct of Agency theory is an of import economic theory of answerability is defined as ‘one or more people appoint another individual to execute a service on their behalf which involves delegating some determination doing authorization to the agent ‘ ( Jensen & A ; Meckling, 1976 ) . Although this is chiefly destined to be the relationship among the stockholders and managers, it has besides said by Jenson & A ; Meckling that there are other trades which could be measured within the model such as managers and other involvement groups and such relates to gain the function of external hearers.

The allotment of authorization includes the belief among the agent and the chief whereby the Agency theory takes a position that people can non be trusted to move in the public good and in the involvement of the stockholders. This has resulted in rise of monitoring and controlling of the act of agents and mechanisms such as the external audit to beef up this trust.

External hearers are capable to supply a dependable and a liberate sentiment on the fiscal statements to the company stockholders but at the same clip they are expected to work autonomously.

The separation of direction and ownership leads to the job of agent and principal. This is farther explained by Watts and Zimmerman in 1978 by the positive accounting theory to happen motivations as to why directors cook their ain books. In practical universe, this is considered where the direction have a full switch on the capitals of stockholders where they tend self-serve by maximizing their ain pockets.

When understanding the operating theoretical account of listed companies in Sri Lanka the most of import footing of Agency theory is that the directors are normally motivated by their ain personal additions and work to work their ain personal involvements instead than sing stockholders ‘ involvements and maximizing stockholder value. For illustration, directors may be attracted to purchasing munificent offices, company autos and other excessive points, since the cost is borne by the proprietors. However the construct of scrutinizing and command carried out by a reputed audit house will guarantee that the operating theoretical account comes under proper examination.

Therefore, the key trouble indicated by Agency theory is guaranting that directors pursue the involvements of stockholders and non merely their ain involvements. Eisenhardt ( 1989, p. 58 ) explains that bureau jobs commence when “ The ends of the principal and agent struggle and it is hard and dearly-won for the principal to verify what the agent is really making ” .

Controversy occurs because principals are unable to supervise the public presentation of agents ( Jensen & A ; Meckling 1976 ) . The chase of self-interest additions costs to the house, which could include the costs of the formation of contracts, loss due to determinations being taken by the agents and the costs of detecting and commanding the actions of the agents. Leuz et Al. ( 2003 ) assert that the effects of such behaviors finally reflect in the company net incomes. It is now apparent that the investing in an audit demands to be apportioned to guarantee that the public presentation of the agents or directors is monitored and proper feedback is provided.

It is besides of import that the direction has an ground to pull off the company ‘s reported net incomes in order to run into or crush net incomes marks and, therefore, to have any fillips that may be tied to the company ‘s net incomes ( performance-related wage ) . This creates an information dissymmetry in that directors can exert the discretion they have on accumulations, which in bend reduces the relevancy and dependability of reported net incomes, and the whole fiscal statements. Davidson et Al. ( 2004 ) argues that when direction provides inaccurate fiscal coverage information, it introduces net incomes direction as a type of bureau cost. To counter this state of affairs an internal audit may non be sufficient and the importance of an external audit must be conducted to understand the discrepancies and alterations that happen in the operating theoretical account of a company. The rigorous monitoring of directors by the principals or their representatives, such as the house ‘s board, is seen as cardinal to protecting stockholders ‘ involvement from being compromised when directors maximise their opportunism at the disbursal of the administration ‘s profitableness.


In order to restrict bureau costs triggered by the separation of ownership and control, Fama and Jensen ( 1983b, p.309 ) propose that houses need a system that can divide determination direction from determination control. This would restrict bureau costs by commanding the power of direction and guaranting the proper consideration of stockholders ‘ involvements. It is clearly mentioned that the function of the external hearer is to cut down bureau costs by cutting information dissymmetry in fiscal coverage ( Poit, 2001 ) . This constitutes the importance of external audit and how it can positively impact the transparence in fiscal coverage.

Agency theory recognises external auditing as the most of import monitoring mechanism because it controls struggles of involvement and diminishes bureau costs. Watts and Zimmerman ( 1983 ) confirm that high quality external auditing will sabotage the timeserving behavior cost ( bureau cost ) introduced by management.A

These proctors act on behalf of the stockholders. As a consequence, high audit quality affecting specialised independent hearers like the Big 4 audit houses can diminish chances for directors to prosecute opportunism at the disbursal of proprietors and, therefore, principals obtain more favorable returns. Hence the bureau theory can be looked pon as a footing to develop theories for finding the relevancy and composing of audit fees for companies public quoted companies in Sri Lanka.

Stewardship Theory

Unlike the Agency theory, the Stewardship theory, based on a psychological and sociological attack, maintains that the involvements of corporate executives ( as stewards ) are aligned with those of the administration and its proprietors ( Albrecht et al. , 2004 ) . The stewardship theorists focus on constructions that empower and facilitate instead than supervise and command. They reject the extremely individualistic theoretical account of Agency theory that promotes a leery “ police officer ‘s ” attack, thinks that agents are egoistic and whereby both the principal and agent portion dissimilar involvements. This is a theory that contradicts and challenges to a certain extent the construct of external auditing for all purposes and intents of monitoring direction and employees of houses. The theory besides goes on to reject the position that principals need to proctor the timeserving agents by supervising them and use countenances or inducements as agencies of control.

Stewardship theory takes an opposite position in proposing that the agents are trusty and good stewards of the resources are entrusted to them, which makes monitoring unneeded ( Donaldson, 1990 ; Donaldson & A ; Davis, 1994 ; Davis et al. , 1997 ) . Since directors are non timeserving and act in the finest public assistance of the proprietors, they should besides be given independency grounded on belief, which reduces the cost of regulating their behavior. This means that harmonizing to the Stewardship theory directors are considered loyal and their behavior does non necessitate to be scrutinised. However Donaldson and Davis ( 1994, p. 51 ) informant, “ organizational role-holders are regarded being motivated by holding to derive duty and so to derive grasp from co-workers.

In most listed companies in Sri Lanka we see a important proportion of dividend paying companies ( i.e. Hayleys PLC, John Keels Holdings and etc. ) . From a Sri Lankan perspective a dividend paying company is considered stable and attractive to most investors. As per the Stewardship theory, the behavior of the steward is co-operative, because the steward looks out to carry through the administration ‘s ends ( e.g. profitableness ) . This, in bend, benefits the principals through the positive effects of net incomes on dividends and portion monetary values ( Davis et al. 1997 ) . In most local companies directors believe that their involvements are aligned with those of the house ‘s proprietors. Therefore, Stewardship theory maintains that the optimal administration constructions are those that enable effectual coordination in the endeavor. The stewardship position sees managers, every bit good as directors, as stewards of the. Davis et Al. ( 1997 ) suggest that stewards gain more satisfaction by accomplishing corporate aims than pursuit behind to carry through their ain pockets.

Davis et Al. ( 1997 ) argue that accomplishing organizational success besides satisfies the personal demands of the stewards. Therefore, the stewardship theory considers that directors ‘ determinations are besides influenced by non-financial motivations, such as demand for accomplishment and acknowledgment, the intrinsic satisfaction of successful public presentation, and regard for authorization and the work moral principle. However it is interesting to analyze, if this would be more outstanding as opposed to the fiscal incentives a director would visualize. This may good belie the Stewardship theory in the Sri Lankan context.

However, harmonizing to this theory, it makes sense for corporate administration to be based on the position that the managers, on behalf of stakeholders, want to be good stewards of the corporate assets, and there is no struggle of involvement or timeserving behavior at the disbursal of stakeholders. They work diligently to derive high degrees of corporate net income and stockholder return. These constructs have been documented in organizational surveies, such as in Muth and Donaldson ( 1998 ) . To this consequence the importance of an audit process may look far-fetched and the value proposition may non be as clear, if this theory were to be considered.


When understanding the impact of the Stewardship theory from a degree of the board, it considers the board of managers as an instrument of aid to a steward main executive officer instead than a commanding mechanism ( Albrecht et al. , 2004 ) . It besides considers that direction is less likely to pattern net incomes direction. However, the job lies in the extent to which the direction aspires to achieve a good corporate public presentation. This could besides take a bend where main executive officers ‘ may draw a bead on for personal inducements & A ; benefits over broader stockholder outlooks.

The construct of placing cardinal people and drivers is common in most local companies. This enables a selected clump of troughs to take on more duty and authorization to drive a house towards success. Davis et Al. ( 1997 ) recommend that cardinal directors identified within the house leads to a personal relationship with accomplishment or failure. Daily et Al. ( 2003 ) ground that direction personals besides want to guard their positions as adept determination shapers. As a consequence, directors run concerns in a mode that increases public presentation in footings of profitableness, while deriving a good return on stockholder financess.


The Stewardship theory goes on to reason that the houses which are managed by expert directors allow them to do the most of net incomes. Besides, the laterality of executive managers on board is much desirable as they are capable in doing better determinations due to their expert cognition, dedication and handiness to information ( e.g. Boyd, 1995 ) . In the listed companies a commission is appointed to do determinations of the audit patterns both internal and external. This would intend that the commission would be a transverse subdivision of directors, managers and the board who would jointly take determinations on behalf of the audit pattern within the company and guarantee best pattern.

In drumhead, the Stewardship theory argues that the duty and authorization of executive directors provides a better focal point on company aims, leading and execution of operational determinations, taking to more effectual corporate administration and corporation. Donaldson & A ; Davis ( 1994 ) contend that the Stewardship theory remains the theoretical foundation for better ordinance and statute law in corporate administration. Muth and Donaldson ( 1998 ) relate the likelinesss of Agency theory with those of Stewardship theory and hoarded wealth backup for the latter as a good theoretical account of world. The inquiry of how of import this this theory is for finding external audit is slightly ill-defined. Yet it adds a footing from which external audit is to be determined in the context of the audit pattern and good administration.

Stakeholder Theory

The stakeholder theory revolves around the constructs that directors should on the one manus pull off the corporation for the benefit of its stakeholders in order to guarantee their rights and the engagement in determination devising and on the other manus the direction must move as the shareholder ‘s agent to guarantee the endurance of the house to safeguard the long term bets of each group. However the definition of a stakeholder, the intent and the character of the administration and the function of directors are really ill-defined and contested in literature and has changed over the old ages.

Bisset ( 1708 ) chiefly defined the term stakeholders as “ a individual who holds the interest or bets in a stake ” . Freeman ( 1984 ) quotes as “ any group or persons who can impact or is affected by the achievements of the administration ends ” and supports that the house ‘s actions should be anticipated in a wider mentality and besides it should be utile to all relevant stakeholder instead restricting it merely to the portion proprietors. Furthermore it includes the safeguarding of the benefits of employees, stockholders, clients, authorities, society, providers and prospective stockholders. The characteristic of “ enlightened Stakeholder theory ” has been suggested by Jenson ( 2001 ) as a consequence of incapableness to protect the stakeholder involvements in a concern. This proposes that stockholder return growing is interlinked and hence ab initio the company should maximize the returns of stockholders and that would routinely take to the net income maximization of stakeholders as a whole.

In replying the stakeholder chances managers have a larger trade of answerability on run intoing their chances whereas hearers provide an confidence on the information provided by the managers through statutory audits. The construct of a Stakeholder theory around 60 old ages ago was proposed by Mary Parker Follett ( Schilling, 2000 ) and it re-emerged in the 1980 ‘s. Freeman ( 1984, p.52 quoted in Schilling 2000, p.225 ) defines a stakeholder as “ any group or person who can act upon or is influenced by the accomplishment of the administration ‘s aims ” . The term ‘stakeholder ‘ may, hence, include a big group of participants, in fact anyone who has a direct or indirect ‘stake ‘ in the concern ( Carroll 1993, p.22 quoted in Schilling 2000, p.225 ) .

In a Sri Lankan context it is of import to place direct stakeholders and what their impact is on the public presentation and operating theoretical accounts of a house. This is really of import in the context of the listed companies since stockholders are peculiarly concerned about the direct stakeholders of a listed entity. Direct stakeholders are stockholders, employees, investors, clients and providers whose involvements are associated with the administration. An illustration of an indirect stakeholder is the authorities, which is indirectly affected by the company ‘s function ( Kiel and Nicholson 2003 ) .


In a nutshell the Stakeholder theory supports that “ companies and society are co-dependent and that the concern aids a wider societal thrust than its responsibilities to stockholders ” ( Kiel & A ; Nicholson, 2003a, p. 31 ) . Donaldson and Preston ( 1995, p. 85 ) recognise stakeholders as “ individuals or groups with echt involvements in practical facets of corporate activity ” . Wheeler and Sillanpaa ( 1997 ) place the stakeholders that needs to be taken into attending in the administration construction as investors, directors, employees, clients, concern spouses ( e.g. providers and subordinates ) , local communities, civil society and the environment. Mitchell et Al. ( 1997 ) claim that stakeholders can be identified by a few features of:

Power to impact on the house

the legitimacy of relationship with the house

the urgency of their claim on the house

This allows directors to pay attending and react to several signifiers of stakeholders.

Upon deriving strength during the 1970s and 1980s the Stakeholder theory would reflect the fright at a social degree that big national corporations were going excessively powerful and beyond answerability to stakeholders, including authoritiess. With the clip, the subject raised increased societal consciousness and the inclination toward ternary bottom line coverage. In the context of Sri Lankan companies it is critical that this theory be looked upon critically. The ground for this is that the Colombo Stock Exchange is dominated by a few big pudding stones and ownership remainders with the authorities and a few high net-worth investors.

Given the monopolistic nature of the market the Stakeholder theory is more of an add-on of the bureau theory, which believes boards of companies to take attention of the benefit of stockholders. However, this all right focal point on stockholders has been prolonged to take into history the involvements of many diverse stakeholder groups ( Freeman, 1984 ; Donaldson & A ; Preston, 1995 ; Freeman et al. , 2004 ) . However, contrary to this Margaret Blair ( 1995 ) argues that, although stakeholder theory has more significant historical roots, practical applications, and rational entreaty than bureau theory, it has had much less impact on thought and policy-making about corporate administration.


Additionally it is of import that the directors ‘ inducements may non needfully be associated with the involvements of stockholders. However, directors who claim that this is due to consideration of other stakeholders ‘ aims “ may be utilizing stakeholder claims as a smoke screen to befog what is truly their inability to present value to the company ‘s stockholders ” ( Healy 2003, p.24 ) . Freeman et Al. ( 2004 ) suggests that directors should try to bring forth as much value as possible for stakeholders by work outing clangs among them so that stakeholders do non retreat the trade.

The theory summarises external audit as effectual monitoring systems that could protect all stakeholders ‘ involvements. In footings of audit quality, Baker et Al ( 2002 ) suggest that the function of external hearer as monitoring mechanisms is non merely directed for stockholders ‘ benefit, but besides for the involvements of all Stakeholders. This alteration in the function of the boards has directed to the betterment of Stakeholder theory. Stakeholder theory can be seen as non needfully back uping the position that magnifying stockholder value is the top precedence for a concern. Directors may lawfully follow aims that do non increase stockholder wealth. Finally Sundaram and Inkpen ( 2004a ) argue that stockholder value beef uping affairs because it is the lone aim that leads to determinations that encouragement consequences for all stakeholders. They claim that recognizing a big figure of stakeholders and their chief ethical motives is an impractical responsibility for directors. Supporters of the stakeholder point of view besides argue that stockholder value maximization will take to an expropriation of value from non-shareholders to stockholders. This discussed the importance of the Stakeholder theory as an drawn-out version of the Agency theory and lays a distinguishable foundation of theoretical research.


Among the findings it can be concluded that the Agency theory recognises external auditing as the most of import monitoring mechanism because it controls struggles of involvement and diminishes bureau costs. The allotment of authorization includes the trust between the agent and the principal, nevertheless the bureau theory takes a position that people can non be trusted to move in the best involvement of the stockholders. This has given rise to the demand of monitoring and controlling of the act of agents and hence demand to set in topographic point mechanisms such as the external audit to beef up this trust. The Stewardship theory argues that the effectual control held by professional directors empowers them to maximize the house ‘s public presentation and corporate net incomes. Subsequently, boards which are conquered by executive managers are desirable because of their proficiency and consciousness of capable affairs, entree to critical information and committedness to the house. Stakeholders ‘ theory positions external audit as effectual monitoring systems that could protect all stakeholders ‘ involvements. Stakeholder theory goes on to suggest that the emphasis of managerial activity should be on the development and preservation of all stakeholder relationships, non merely that with stockholders. Based on the theoretical model it is obvious that the function played by the external hearer in the listed companies is one of the great sensitivenesss and needs farther research for developing an audit fee theoretical account.



This chapter chiefly illustrates the philosophical model which describes the research scheme, the procedure, informations aggregation and research attack. Once the methodological analysis is defined it so develops the empirical theoretical account in line with the hypotheses by placing the independent variables ( i.e. size, complexness and hazard ) . These independent variables are analysed against the dependant variable which is the audit fees.

Research Doctrine

An indispensable measure in carry oning societal scientific discipline research is to find and warrant the chosen research doctrine adopted by the research worker.

Research doctrine has two paradigms, these are positive and the interpretive paradigms ( Hussey and Hussey, 1997 ; Patton, 1990 ) . These paradigms represent the terminal of a continuum in societal scientific discipline research which illustrates the links between these ontological, epistemic and methodological premises. Research doctrine can besides be mostly alienated into three positions ( i.e. positivism, interpretivism and pragmatism ) topic on the research worker ‘s philosophical thought ( Saunders et Al. 2003 ) .

The doctrine of positivism desire ‘working with an seeable societal world and that the terminal merchandise of such research can be law-like generalizations similar to those produced by the physical and natural scientists ‘ ( Remenyi et al. 1998 cited in Saunders et Al. 2003, p.83 ) . This theoretical account adopts that an intelligible pragmatism exists that is driven by absolute natural Torahs and mechanisms ( Guba and Lincoln, 1994, p. 109 ) . This theoretical account is defined by quantitative or scientific manners to clear up, prognosis and analyse testable hypotheses associating to associations between mensurable variables since it assumes that world is `objective ‘ or independent of perceivers.

The interpretive paradigm, on the other manus, assumes that world is `subjective ‘ or dependent on perceivers as they are really portion of what is being observed ( Patton, 1990 ) . This paradigm is hence described by qualitative attacks. Interpretivism has a assortment of different names including hermeneutic, qualitative, phenomenological and inductive research ( Ticehurst and Veal 1999, p.20 ) .

Realism attack recognizes the ‘social world ‘ like positivism but it emphases on fluctuation and struggle which may non ever seem. It is more concerned with sentiments, norms and ethical values, therefore research workers need to understand history, implement a set of values, and cognize where to look for cardinal construction to construe the facts ( Neuman 1997 ) . Therefore, the realistic paradigm recognises the subjective world and efforts to understand people ‘s socially constructed readings at the same clip ( Saunders et al. , 2000 ) .

This research will follow the positivism attack due to its relevancy to this type of research. Positivism is taken to bespeak the undermentioned political orientations:

Knowledge confirmed by the senses can unfeignedly be acceptable as cognition.

The intent of theory is to make hypotheses that can be tested.

This research is hypotheses based ; and these hypotheses will be tested utilizing quantitative methods.

Knowledge is arrived through collection of groundss that provide the footing for Torahs.

The research uses a random sample of companies and collects facts from their one-year studies to prove the hypotheses.

Science must be led in a manner that is value free.

Sample choice will be by systematic random trying method ; and informations will be tested to see if there are any relationships between the variables utilizing correlativity techniques.

Research design

The deductive attack tends to be preferred more by rationalist research workers than interpretivist ( Ticehurst and Veal 1999 ) . The deductive research process includes the development of a theory or hypothesis to prove the hypothesis. The inductive attack is used when information is collected foremost, and a theory is developed as a consequence of the information analysis.

The deductive research attack is besides built on the cosmopolitan thought to make at the precise province and it is linked with the positivism theoretical account, whereas, inductive attack works over a specific thought to generalize the state of affairs as per the research subject, is linked with the interpretivism paradigm ( Crowther and Lancaster 2009 ) .

Positivism is linked with systematic, probationary, quantitative and deductive models where research workers seek specific quantifiable observations therefore frequently utilizing statistics and experiments to prove their hypotheses ( Neuman 1997 ) . Therefore, this research uses a deductive attack where the general information is worked down towards more specific state of affairs which is to find factors impacting audit fees.

Research procedure

Upon designation of the research design, the following measure being the research procedure is to place ways of bring forthing the cognition. This takes three different signifiers ; empirical research, constructive research and explorative research.

Empirical research

Empirical research is constructed on matter-of-fact and mensural phenomena. It reports researches based on existent observations or tests utilizing quantitative research methods and it may bring forth mathematical informations between two or more variables. Some of the intents of the empirical research are to travel beyond merely describing observations and advance an environment for a better apprehension while uniting wide-ranging research with elaborate instance surveies excessively.

Constructive research

Constructive Research covers the country of theory, and does n’t necessitate that the research be based on soundness. It is more based upon instance surveies, theories and hypotheses. It is used to prove theories and suggest solutions to a job or inquiry.

Exploratory research

Exploratory research is of import to research methods as it helps to sketch a new job or question. Exploratory research is conducted for a job that has non been clearly defined.

The information was collected or produced in a manner consistent with the recognized pattern in the field of survey. When taking a research attack the empirical, constructive and explorative attacks were considered. Exploratory research is conducted for a job that has non been clearly defined. This is non consistent since the attack involves a uninterrupted procedure of enquiry and probe that is likely to be open-ended and may bring forth indefinite results.A Constructive research on the other manus is used to prove the theories and suggest a solution which is non in line with the result of the research. Further the research is based on quantitative informations and statistical analysis.

It is logical that the empirical research attack be used to roll up new informations on the proposed subject which is reasonably understood. The information collected is quantitative and suited for analysis utilizing statistical methods. Hence empirical research attack was selected as it tests the feasibleness of a solution utilizing empirical grounds which is appropriate to the aims of the survey. This is supported by Simunic 1980 ) who established an of import “ optimistic theoretical account of the class by which audit fees are determined ” . Simon et Al ( 1986 ) found similar consequences similar to old research in India. Again, Size and Complexity were cardinal determiners of audit fees.

Research type

The two chief informations assemblage methods discussed are primary research and secondary research.

Primary Research

There is no information available and informations demands to be gathered from primary beginnings such as questionnaires and studies.

Secondary Research

Secondary research gathers bing information through available information beginnings such as published records, one-year studies, diaries and anterior research documents.

It is singular to observe that primary research is dearly-won to carry on as it comprises primary beginnings and the clip taken to carry on such is typically extended when compared to the clip taken to execute a secondary research. For all purposes and intents secondary informations has been selected for this survey as it is valid, audited, clearly documented and easy accessible.

All informations contained within in this survey is achieved from published one-year studies which were found on Colombo Stock Exchange web site for the old ages 2009, 2010 and 2011. The companies were selected on a random footing crossing all 20 sectors ( i.e. Banks, fiscal establishments and insurance, Food drink and baccy, diversified retentions, hotels, plantations, IT, energy, oil thenars, fabrication, etc. )

The procedure involved an scrutiny of the balance sheet, income statement, hearer ‘s independent study and the manager ‘s study to placing the needed variables.

Research attack

Research methodological analysis is chiseled by Leedy & A ; Ormrod ( 2001 ) as “ the general method the research worker takes in transporting out the survey ” .

Two chief methods of research attack are quantitative and qualitative.


Quantitative research is conclusive in its intent as it tries to quantify the job and understand how prevailing it is by looking for projectable consequences to a larger population. Quantitative research involves the aggregation of informations so that information can be quantified and subjected to statistical intervention in order to back up or rebut “ alternate cognition claims ” ( Creswell, 2003, p. 153 ) . Quantitative research attacks use a criterion layout, with a few minor inter-disciplinary changes, of making a hypothesis to be verified or non. This hypothesis must be incontrovertible by mathematical and statistical agencies, and is the footing around which the whole survey is designed.


Qualitative research has no clear purpose to number or quantify the decisions, which are alternatively describes in the linguistic communication employed during the research procedure ( Leach, 1990 ) . The chief aim of qualitative research is to derive an apprehension of implicit in grounds and motives and supply penetrations into the scene of a job for subsequently quantitative research.

However in quantitative attack the findings are definite and normally expressive in nature. Quantitative research design is an outstanding manner of finalizing consequences and formalizing a declared hypothesis. The attack will cipher informations and generalise consequences from a sample to the population of involvement and is the preferable attack for this survey.

5.3 Development of Hypotheses

In designation of the hypotheses, it is influenced by a organic structure of scholarly work that has reviewed audit fee determiners. Overall past scholarly work & A ; anterior research ( e.g. Simunic, 1980 and Taffler & A ; Ramalingam, 1982 ) has identified that there are two cardinal factors “ size ” ( measured in balance sheet and/or income/expense footings of the entity under audit ) and “ complexness ” ( assessed in footings of the range and related hazard of the assorted operations of the entity under audit ) that influence the audit fee. Hence this research identified relationships chiefly upon client size, client complexness and the hazard faced by the client.

While there have been extremely many subscribers to the literature on audit fee mold, it is by and large agreed that the seminal part has come from Simunic ( 1980 ) . For this ground, the research by Simunic ( 1980 ) is explained in some item in some of the undermentioned paragraphs. Later, that seminal parts were supported by parts from, Firth ( 1985 ) , Palmrose ( 1986 ) , Haskins et Al ( 1988 ) , Low et Al ( 1990 ) , Chan et Al ( 1993 ) and Brinn et Al ( 1994 ) .

The three hypotheses are developed consequently to reply the research inquiry which is addressed before in this research. These three hypotheses will be tested utilizing the audit fee theoretical account whereas the void hypothesis will be tested for the intent of statistical significance by utilizing graphical and statistical methods and these will be discussed in the following subdivision and consequences will be examined in the latter portion.

The three hypotheses are stated as follows:

H1 There subsists a positive relationship between the size of the house and audit fees.

H2 There subsists a positive relationship between the hazard and the audit fees.

H3 There subsists a positive relationship between the complexness of the client and the audit

Ho There subsits homogeneousness of discrepancy ( homoscedasticity ) in the information.

Measurement of the dependant variable

The Securities and Exchange Commission of Sri Lanka requires revelation of audit fees and it is this disclosed figure, which is used as the dependant variable. This figure can be relied upon harmonizing to the Accounting organic structure and the Colombo Stock Exchange. Thus with consideration to the above, an initial list of variables was extracted from the relevant fiscal statements.

Audited account fees consist of the full fees salaried by the company to its hearer be it domestic and abroad including all subordinates. It take history of all the disbursals refering to the audit work, but eliminates any other particular work which is non related to the audit such as direction consultancy services. The value of audit fees should be revealed in the company ‘s one-year study as hearers are required to uncover it for constitutional intents, as stated in the 4th agenda of the Companies Act 2007.

Measurement of the independent variables

This subdivision provides elaborate information about the measuring of each independent variable. The variables are grouped into three chief categories, where each integrating distinct variable/s stand foring elaborate properties. The single variables for each of these classs are discussed below.

Firm Size

The most reliable consequence in all the old research has been the size of the company is by far the most significant explanatory variable in finding audit fees. Several of these surveies have used ‘total assets ‘ as a step of size. This is chiefly a balance sheet based step.

Firms ‘ Hazard

The bulk of audit houses in Sri Lanka base their auditing on some sort of audit hazard theoretical account. There is an association between audit hazard and audit fee. Higher the hazard higher the audit fee either as a consequence of more audit testing or as an ‘insurance premium ‘ ( Chan et al, 1993 ) . Firm hazard was measured by the two ratios ; long term debt to entire assets and current assets to entire assets.

Firm Complexity

This variable is non peculiarly relevant in the instance of Sri Lanka, as fiscal statements are non required to be consolidated. But this was still used due to the confirmation of agendas of subordinates. A much more relevant variable might hold been the figure of associated companies – and this could be considered within future surveies.

Empirical Model

The empirical theoretical account with the chief variables of this survey is formed as follows:

AF it = I± + I?1 TA it + I?2 QUICK it + I?3 LTD it + I?4 CATA it + I?5 SUB it +

Iµ it

AF: Natural log of audit fees

Tantalum: Entire Assetss

Quick: Quick Ratio

LTD: Long term debt to entire assets

CATA: Current assets to entire assets

Bomber: Number of subordinates held by the single company

Analytic process

This subdivision will discourse the statistical methods employed for informations analysis. The information sample used in this research was identified by systematic random trying method. A sample of 95 companies out of a population of 285 across three old ages ; 2009, 2010 and 2011 were selected in order to give a high grade of assurance in the statistical testing and will be following the arrested development equation in a generalized mode to the selected sample of 95 companies. The information for this survey is analysed utilizing the package bundle SPSS. Once the information was collected it was screened and cleaned, utilizing SPSS maps to guarantee the information was accurate and contained no input mistakes. In order to specify the relationship between the audit fees and the identified independent variables ; the proposed hypotheses need to be tested with the aid of suited and appropriate statistical trials. Therefore the pick for right statistical testing is critical.

The statistical methods for analyzing informations are classified into two wide classs: one is parametric and the other is nonparametric. In general, the nature and features of the survey informations will find which method should be used.

Gujarati ( 2003 ) suggests four critical premises that must be met before using parametric trials:

1 ) Premise of normalcy: Under this premise, samples must be drawn from usually distributed populations. A normal distribution is an idealized sample which is based on a population of an infinite figure of instances and which takes the signifier of a bell.

2 ) Premise of One-dimensionality: This premise suggests that the theoretical account should hold additive parametric quantities.

3 ) Premise of homoscedasticity: This premise requires the discrepancy or standard divergence of the dependant variable within the group to be equal.

4 ) Premise of independency of mistake footings: Under this premise the mistake footings are independent from one another and hence no consecutive correlativity exists.

In general, parametric trials are more powerful when all premises are met and when the variables under analysis are measured on at least an interval graduated table ( Judge et al. 1985 ) . However, if any of the antecedently mentioned premises are violated by the nature of informations ; non-parametric trials become more appropriate ( Balian, 1982 ) .

Therefore, the premises of the parametric trials will be tested in the undermentioned chapter utilizing as suggested by Mark ( 2008 ) through the graphical presentation of a histogram, Kolmogorov-Smirnov trial and Shapiro-Wilk trial and Normal Q-Q secret plan to look into for the normalcy premise. To prove the homosedasticity premise, the most common trial is used, viz. , ocular review of the remainders. Harmonizing to Mark ( 2008 ) the remainders are plotted in a graph against the independent variable that is suspected of doing the job of heteroscedasticity. To prove for multicollinearity, this survey applies correlativity coefficient and discrepancy rising prices factors ( VIF ) trials. The tolerance factor and discrepancy rising prices factor of each variable is so calculated. A tolerance factor close to 0, and a value of the discrepancy rising prices factor greater than 10, shows the presence of multicollinearity in the theoretical accounts and farther to this Hair et Al. ( 1998 ) and Kennedy ( 2008 ) suggests that a VIF of more than 10 indicates multicollinearity.

Given the above treatment, the assorted trials are conducted to prove the information against the OLS premises. Parametric trials are adopted in this survey to analyze as the information of this survey does run into the conditions required for the parametric trials.

For the intent of this survey, it is felt that a additive arrested development theoretical account should be used. Out of the two basic additive arrested developments – simple additive arrested development and the multiple additive arrested development the research worker concentrated on the multiple additive arrested development. Simple additive arrested development is used to measure the relationship between a dependent variable and ‘one ‘ independent variable where as a multiple additive arrested development is carried out to measure a relationship between a dependent variable and ‘two or more ‘ independent variables. Therefore harmonizing to the nature of the dependant and independent variables, research worker has followed the multiple arrested development technique on SPSS which allows look intoing how a set of independent variables do tie in with a dependent variable of involvement.


Choosing the appropriate research methodological analysis and informations aggregation techniques is a really critical phase in carry oning any research because they guarantee that the research aims are achieved. This chapter has provided a elaborate description of the stairss taken to fix for the analysis stage of this survey which is discussed in the following chapter. These stairss include illustrations of the research doctrines, dependent variable measuring, the measuring of the independent variables and the choice of the appropriate analytical methods.

To summarize the methodological analysis described in this chapter, this research uses corporate revelation informations collected from one-year studies of the companies which are listed in the Colombo Stock Exchange web site to through empirical observation prove for the determiners of audit fees. Firms were indiscriminately selected for this survey and the old ages 2009, 2010 and 2011. This research will follow the positivism attack and a clip series attack is applied to prove the hypotheses, and theoretical account is tested utilizing pooled panel OLS arrested development.

The undermentioned Research findings chapter presents the consequences of the trials selected to analyze the information gathered harmonizing to the stairss described in this chapter.


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