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Research on the Relationship between Audit Risk Assessment and Risk

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DOI: 10.1080/15228916.2022.2031726

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Research on the Relationship between Audit Risk

Assessment and Risk Governance: Evidence from
Tunisia

Imen Fakhfakh & Anis Jarboui

To cite this article: Imen Fakhfakh & Anis Jarboui (2022): Research on the Relationship between
Audit Risk Assessment and Risk Governance: Evidence from Tunisia, Journal of African Business,
DOI: 10.1080/15228916.2022.2031726

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JOURNAL OF AFRICAN BUSINESS
https://doi.org/10.1080/15228916.2022.2031726

Research on the Relationship between Audit Risk Assessment

and Risk Governance: Evidence from Tunisia
Imen Fakhfakh and Anis Jarboui
Department of Accounting, Sfax University, Sfax, Tunisia

ABSTRACT KEYWORDS
The study examines the relationship between corporate govern­ Audit risk; corporate
ance mechanisms and audit risk in firms listed on the Tunisian Stock governance; Tunisian firms
Exchange (TSE). The study covers the period 2006–2013. Panel
regression analysis was used to estimate the relationship between
corporate governance variables and audit risk. The results show
that board size, board independence and institutional ownership
were negatively related to audit risk. It is also discovered that audit
risk index level increases as poor corporate governance. These
findings may have important implications for analysts, investors,
regulators and academics. First, the identifying factors that may
influence the audit risk can help guide the reforms to improve the
functioning of the financial market. Second, the study provides
ample evidence of risk governance problems in the Tunisian mar­
ket, highlighting the necessity of new corporate governance
requirements. This study is unique in providing Tunisian evidence
on the effect of corporate governance on audit risk. This paper is
also relevant as it develops an index of audit risk and risk corporate
governance.

1. Introduction
The collapse of corporations such as Enron, Tyco International, WorldCom, Global
Crossing and BCCI requires the establishment of a stringent process that ensures that
auditors perform their audit assignment with professional care and high skill.
Furthermore, audit is the cornerstone of corporate governance (AlQadasi & Abidin,
2018). Its efficiency depends on the actuality and development of the corporate govern­
ance environment (Holm & Laursen, 2007). Establishing the confidence of users/inves­
tors requires that auditors deploy further effort in assessing their clients’ audit risk (Xu,
Carson, Fargher, & Jiang, 2013). According to the IAASB1 (2009), audit risk is defined as
«the risk that the auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated. Audit risk is a function of material misstatement and
detection risk» (GAAS. AU-C section 200).
The auditor shall design and perform further audit procedures whose nature,
timing, and extent are based on and are responsive to the assessed risks of material
misstatement at the assertion level. If high risk is expected, then reliable evidence

CONTACT Imen Fakhfakh imenfakhfakh.sakka@gmail.com Sfax University, Sfax, 3018 Tunisia

© 2022 Informa UK Limited, trading as Taylor & Francis Group
2 I. FAKHFAKH AND A. JARBOUI

should be collected. The primary goal is to minimize the overall risk to a sufficiently
low level, and to achieve the desired confidence more effectively (Nikolovski,
Zdravkoski, Menkinoski, Dicevska, & Karadjova, 2016). Auditors are more willing
to rely on internal audit work in a continuous audit environment compared to
a traditional one (Malaescu & Sutton, 2015). In the evaluation of audit risk, the
components of corporate governance are encompassed in control risk, which seems
to be determined by the management’s attitude toward internal controls, corporate
governance quality and the audit committee quality, expressed in terms of audit
committee independence and audit committee financial experiences (Cohen,
Krishnamoorthy, & Wright, 2010; Johnstone, 2000; Krishnan, 2005).
There is a growing interest around the relationship between audit risk and corpo­
rate governance and it has attracted the attention of professionals and the academia.
Prior studies have revealed that corporate governance affects the assessment of the
audit risk (Cao, Li, Zhou, & Zhou, 2015; Cohen & Hanno, 2000; Cohen,
Krishnamoorthy, & Wright, 2002; Demartini & Trucco, 2016). The current study is
expected to provide empirical evidence on the impact of corporate governance on
audit risk in developing countries such as Tunisia. The main research question of this
paper is: Which are the most crucial features that auditors consider in order to
evaluate the audit risk of the firm? This study shall contribute to the literature in
two ways. First, few studies have dealt with this issue in a context related to
a developing country such as Tunisia. The Tunisian case is an interesting field of
investigation because of its socio-cultural specificities (Arabo-Muslim civilization)
and its emergent character (Zgarni, Hlioui, & Zehri, 2016). In fact, the 2011 Tunisian
revolution allowed the various parties who were against good governance to negatively
affect investor confidence in auditors. Second, according to our knowledge, this is the
first study to examine the relationship between audit risk and corporate governance by
using the weakness corporate governance practices. Poor corporate governance
ensures the collapse of an organization as it can encounter fraud, bankruptcy and
even closure of the organization.
The remainder of this paper is organized as follows. The next section is devoted to the
literature review and hypothesis development. Section 3 describes the data and research
design, while section 4 presents the findings of the study. Finally, section 5 provides the
conclusion.

2. Previous literature and hypothesis development

2.1. The assessment of the audit risk
The established audit risk model in SAS 3002 identifies the overall audit risk. This is
defined as the auditor giving ‘an inappropriate audit opinion on financial statements’.
This risk has three key components: inherent risk, control risk and detection risk.
Aufditrisk ¼ Inherent risk � Control risk � Detection risk
Inherent risk is defined as ‘the susceptibility of an account balance or a class of
transactions to material misstatement, either individually or when aggregated with
misstatements in other balances or classes irrespective of related internal controls’.
 JOURNAL OF AFRICAN BUSINESS 3

Control risk is defined as ‘the risk that a misstatement could occur that would not be
prevented or detected and corrected on a timely basis by the accounting and internal
control system’. Detection risk is defined as ‘the risk that the auditors’ substantive
procedures do not detect a misstatement that could be material’ (SAS 300). Inherent
and control risk are risks which lie within the company itself. Detection risk lies with the
auditors. The extent of substantive testing carried out by an auditor is a function of the
assessment of the level of inherent and control risk within the company.
The auditor always plans sufficient procedures that will minimize the audit risk and
maximizes the detection of errors, fraud and other irregularities in the financial
statements.

2.2. Theoretical framework

The association between corporate governance and audit risk is explained within the
agency theoretical framework. A simple agency model suggests that, because of infor­
mation asymmetries and self-interest, principals lack reasons to trust their agents
(Jensen & Meckling, 1976). Therefore, they will seek to resolve these concerns by
putting in place mechanisms to align the interests of agents with principals and to
reduce the scope for information asymmetries and opportunistic behavior.
Independent audit is one of the most important and yet one of the most effective
ways to align the interests of managers and shareholders. Similarly, the existence of
corporate governance systems helps to mitigate the information asymmetry associated
with the principal-agent relationship. Corporate governance provides a framework for
internal control that reduces agency problems. According to Jensen (1993), corporate
governance serves as the last resort that aligns the interest of both managers and
shareholders. However, poor corporate governance, low quality of financial reporting
and external changes in the economic environment can increase risks such as audit risk.
In this regard, it is deemed necessary to consider corporate governance structure in
audit strategy and planning. This study follows this argument to develop a number of
hypotheses on the specific relationships between corporate governance and audit risk.

2.3. Corporate governance mechanisms and audit risk

2.3.1. Directors’ boards and audit risk
The directors of the board have two key functions relevant to monitoring and advising
the board (Charu & Raheja, 2005). According to agency theory, a greater number of
board members play a critical role in making strategic decisions by the companies.
Moreover, as the number of members increases, the possibility of management control
increases and it the experience of the board of directors is enriched (Salehi, Tarigh, &
Rezanezhad, 2017). Due to their collective expertise, a larger board is more capable of
executing their duties and abridging management control (Akhtaruddin et al., 2009;
Hussainey & Wang, 2010; McDonald & Westphal, 2013). However, it is argued that the
advantages of superior control of management by a huge board nullifies the disadvan­
tages that are caused by the coordination, communication and decision making diffi­
culties. According to Jensen (1993), the link between the number of board members
and levels of conflict is positive. He claimed that when the number of board size is more
4 I. FAKHFAKH AND A. JARBOUI

than eight, it is likely to be difficult to coordinate or be effective. In this line, some

studies have indicated that smaller boards are more efficient due to better director-to-
staff communication, as well as smaller firms being easier to manage (Basiruddin,
2011). Then, according to Ibrahim and Jehu (2018), the relationship between board
size and financial reporting quality are found to be in threefold: negative relationship
(Anderson, Mansi, & Reeb, 2004; Khudhair, Al-Zubaidia, & Rajia, 2019; Xie, Davidson,
& DaDalt, 2003), positive relationship (Alzoubi, 2014; Beasley, 1996; Nel, Scholtz, &
Engelbrecht, 2020), and no relationship (Abbott, Parker, & Peters, 2004). Cohen,
Krishnamoorthy, and Wright (2007) examined the role of the board of directors in
monitoring management (agency role) and/or the role of the board in helping to
formulate corporate strategies (resource dependence role) on the auditors’ planning
judgments. They showed that auditors respond to the role of the board when making
judgments with respect to control risk assessments and the planned scope of audit tests.
Therefore, the first hypothesis is formulated as follows:

H1a: There is a negative relationship between board size and audit risk.

Independent directors do not have any family relationship with those holding power
or hold any shares in the firm. Agency theory focuses on board independence to ensure
the effectiveness of the monitoring process. Fama and Jensen (1983) argue that the
administrative board is the most efficient control mechanism to supervise management
actions and focus on the necessity of board independence. As representatives of share­
holders, directors need to protect their wealth and avoid major loss due to the
company’s financial problems (Kasim, Hashim, & Salman, 2016). In protecting share­
holder’s wealth, directors may seek high quality audit services (Carcello, Hermanson,
Neal, & Riley, 2002). According to Chau and Leung (2006), the board of directors
whose majority of the members are independent individuals has suitable control over
the opportunistic behaviors of the management. Abdullah, Ismail, and Jamaluddin
(2008) then Mahdavi, Maharlouie, Ebrahimi, and Sarikhani (2011) suggested that
increasing the percentage of outside (independent) directors increases the possibility
of selecting a high-quality audit firm. Previous studies have found that a higher
percentage of independent directors on the board helps to reduce the frequency of
fraudulent financial reporting (Beasley, 1996) and lower the occurrence of earnings
overstatement (Dechow, Ge, & Schrand, 2010). Then, more independent directors on
corporate boards could improve information disclosure and enhance transparency
(Buertey & Pae, 2020)
Therefore, the second hypothesis can be formulated as follows:

H1b: There is a positive relationship between board independence and audit risk.

CEO-duality refers to a practice by an individual who serves as CEO and the

chairperson of the board at the same time. The combination of the two functions
has several effects on the board and may result in poor performance (Kasim et al.,
2016). Ineffectiveness of the board with CEO duality occurs due to conflict of interest.
Tsui, Jaggi, and Gul (2001) investigated the relationship between CEO duality and
audit pricing in a study of Hong Kong companies finding that less audit effort and
 JOURNAL OF AFRICAN BUSINESS 5

lower audit fees result when CEO duality is absent. Muniandy (2007) supported the
view that auditors perceive higher inherent risk in a firm where the CEO and the chair
of the board is the same individual. Therefore, we offer our third hypothesis as
follows:

H1c: There is a positive relationship between CEO duality and audit risk.

2.3.2. Ownership structure and audit risk

Regarding the prediction of agency theory, claiming that agency conflicts are driven
by widely dispersed ownership and the separation of shareholders and management
(DeFond, 1992; Jensen & Meckling, 1976). Watts and Zimmerman (1983) argue that
the conflicts of interest between agents and principals increases the demand for the
audit quality, which is common in diffusely owned firms. However, firms with
concentrated ownership have less severe traditional agency problems and controlling
shareholders have more incentives to maximize the firm’s value and its ability to
monitor managers (Claessens & Fan, 2002). Munisi (2019) found that when there is
high ownership concentration, the controlling shareholders or managers might
become entrenched and powerful. As a result, they may use their power to expro­
priate minority shareholders. Then, AlQadasi and Abidin (2018) demonstrated that
companies with a higher concentration of ownership are less likely to demand
extensive auditing. Chen, Harford, and Li (2007) indicated that the audit service
requested by firms with controlling shareholders could be different from that
requested by firm without controlling shareholders. They also evealed that audit
quality is damaged and compromised when an auditor faces a business with family-
controlled clients.
Based on the competing and alternative predictions of the evaluation for audit risk in
firms with concentrated ownership, the following hypothesis is proposed:

H2a: There is a positive relationship between ownership concentration and audit risk.

Prior research demonstrated that large institutional shareholders actively monitor

corporate affairs including the financial reporting process and reduce the probability of
material misstatements in reported financial numbers (Mitra, Deis, & Hossain, 2007).
However, Han, Kang, and Yoo (2012) find that long-term institutional investors
demand higher quality audits to enhance corporate monitoring, and that short-term
institutional ownership is positively associated with higher audit risk. Chen, Hui, and
Chen (2017) found that auditors perceive the reduction in agency costs and audit risk
caused by the changed institutional ownership, and hence charge lower audit fees.
Then, they report that institutional investors that require high quality disclosure would
induce firms to hire tough auditors, who are not likely to be impaired by the economic
bond with corporate managers. The above discussion leads to our hypothesis:

H2b: There is a negative relationship between institutional ownership and audit risk.
6 I. FAKHFAKH AND A. JARBOUI

2.4. Risk governance and audit risk

The role of corporate governance is crucial in order to ensure the integrity of the financial
reporting process and to deter fraud (Cohen et al., 2002; Demartini & Trucco, 2016;
Tetteh, Kwarteng, Aveh, Ato-Dadzie, & Asante-Darko, 2020). Because efficient corporate
governance is able to control and reduce a company’s agency problem, it has the ability to
evaluate, inspire and motivate management, which can effectively prevent the manipula­
tion of financial information and fraud (Cai, 2007). Demartini and Trucco (2016) found
that the quality of corporate governance is a more relevant factor in evaluating the audit
risk for new clients after the global financial crisis in the Italian context compared to
inherent risk and detection risk.
Cohen and Hanno (2000) examined how auditors consider CG structure upon plan­
ning an audit program. They found auditors believe that companies with independent
board of directors and audit committees seemed to have lower audit risk. To recognize the
CG characteristics affecting audit plans, auditors must first identify and properly assess the
strength of CG and, second, appropriately weight and use this evidence to develop an audit
plan (Cohen et al., 2002). If the CG structure is strong, then auditors potentially reduce
sample size and thus the extent of costly substantive testing. Finally, program plans affect
the evidence obtained and, thus, the quality of audit decisions (Fooladi & Farhadi, 2011).
Cao et al. (2015) demonstrated that when auditors have adjusted their audit strategy to
meet the regulations, risk-based auditing is achieved to a degree. Reasonable and effective
corporate governance helps to optimize audit resource allocation, and smaller auditing
firms in particular should urgently strengthen their risk-based auditing capability.
Poor corporate governance can increase the risk of material misstatements and is less
conducive to saving audit effort.
Weaknesses in CG structure often result in lower financial reporting quality, earnings
manipulation, and even overt financial statement fraud. Cohen and Hanno (2000), Cohen
et al. (2007) examined how auditors consider corporate governance structure when they
are planning an audit program. They found that auditors believe that companies with an
independent board of directors and audit committees seem to have lower audit risk.
Cassell, Giroux, Myers, and Omer (2012) found that big4 auditors consider some
characteristics of corporate governance in audit strategy, especially after the introduction
of the Sarbanes-Oxley Act of 2002 (SOX), which increased the public’s focus on corporate
governance.
Accordingly, we propose the following hypothesis.

H3: There is a positive relationship between risk governance and audit risk.

3. Data collection and research methodology

3.1. Sample composition and data collection
Our sample includes all non-financial listed companies in the Tunis Stock Exchange
during the period 2006 to 2013. The initial sample comprised 77 companies in 2006, but
we eliminated 34 financial companies as they operate in a different, stricter and regulatory
environment, and possess different characteristics. Then, companies with incomplete data
 JOURNAL OF AFRICAN BUSINESS 7

were excluded. The period of the study covered the eight years from 2006 to 2013 to
include the reforms in the Tunisia auditing environment during that period, especially
after the promulgation of Tunisian Financial Security Law (2005), and the global financial
crisis. The data were collected from two main sources: the annual reports of companies
available on the Tunis Stock Exchange (TSE) and Financial Market Council (FMC)
relevant websites. Thus, 28 companies and 224 observations remain in the sample.

3.2. Research design

3.2.1. Measurement of variables
3.2.1.1. Audit risk index. A summary audit risk index (ARI) for 28 Tunisian firms was
created. The ARI is a measure of audit risk including factors that auditor must consider
in audit work. We identified factors from the work elaborated by Brumfield et al. (1983)
and from the Commercial Companies’ Code, which can be specific for the Tunisian
context. Each of the 17 factors is coded 1 for a high risk level and 0 otherwise. ARI is
calculated as the total score of individual firm/expected score of all the items. Thus,
higher values indicate higher audit risk (Annex 1 for a summary audit risk items).

3.2.1.2. Risk governance index. Several empirical studies suggested a construction of

corporate governance index (Bollaert, Daher, Deroo, & Dupire-Declerck, 2010; Ezzine &
Olivero, 2013; Gompers, Ishii, & Metrick, 2003). The Corporate Governance Index (CGI)
comprises 22 items, covering four sub-indexes: board structure, external auditor, ownership
structure, and transparency. We identified poor corporate governance provisions in firms
and created an index in which higher scores indicate weaker governance. Each of the items is
coded 1 for a high risk governance and 0 otherwise. Thus, RGI is calculated as the total score
of individual firm/expected score of all the items (Annex 2 for a summary risk governance
items).

3.2.1.3. Corporate governance mechanisms. Following prior research, the key conven­
tional quantitative measures used in our study to gauge the effectiveness of corporate
governance structure in a corporate setting mainly includes audit committee, board size,
board independence, dual role of CEO ownership concentration and institutional ownership.
Table 1 presents the definitions of all variables.

3.2.2. Model specification

We use two models listed below to examine the effect of corporate governance on audit
risk. The first regression (1) tests the effect of the corporate governance mechanisms on
audit risk, which serves to simultaneously test the influence of the board leadership
structure and its size, independent directors, presence of audit committee, institutional
ownership and ownership concentration.

ARIit ¼ β0 þ β1 BSIZEit þ β2 BINDit þ β3 CEOit

þ β4 CONit þ β5 INVESit þ β6 SIZEit (1)
þ β7 LEVit þ β8 ROE þ εit
8 I. FAKHFAKH AND A. JARBOUI

TABLE 1. Summary of Variables Definitions.

Variable names Measures
Audit risk index ARI Audit risk index consisting of 17 items, coded 1 for a high risk level, and 0 otherwise
Board size BSIZE Number of directors on the board
Board independence BIND Number of outside directors to total of directors on the board
CEO duality CEO A binary variable taking value “1” if there is duality function of the CEO, “0” otherwise
Ownership CON Proportions of shares held by the majority shareholder of the company
Concentration
Institutional INVES Proportions of equity held by institutional investors
Ownership
Risk governance RGI Risk governance index consisting of 22 items, which coded 1 for a poor governance,
index and 0 otherwise
Firm size SIZE Log of firm’s sales
Leverage LEV Total liabilities to total assets
Firm performance ROE Net income to shareholder equity

Where: ARI = the audit risk index, BSIZE = the board size, BIND = the board
independence, CEO = CEO duality, CON = ownership concentration, INVES = institu­
tional ownership, SIZE = firm size, LEV = debt level, ROE = firm performance,
β0 = constant; β1; β2; β3; β4; β5; β6; β7; β8 = parameters to be estimated, and ε =
model residue.
However, prior research argued that using a composite of structural variables reduces
any error in individual structural variables (Srinidhi, He, & Firth, 2014). O’Sullivan,
Percy, and Stewart (2008) concluded that an aggregate measurement has a stronger
impact than individual measurement. Thus, the current study uses a composite measure
for the firm’s poor governance. The RGI variable is an index of 22 variables relating to
board structure, external auditor, ownership structure, and transparency). That is why in
the second regression (2), as follows, we are going to test, the effect of risk governance
index on audit risk.
ARIit ¼ β0 þ β1 RGI þ β2 SIZEit þ β3 LEVit þ β4 ROE þ εit (2)

Where; AR = the audit risk index, RGI = the risk governance index, SIZE = firm size,
LEV = debt level, ROE = firm performance, β0 = constant; β1; β2; β3; β4 = parameters to
be estimated, and ε = model residue.
This study extends the literature by examining the relation between corporate govern­
ance and audit risk by using, on the one hand, measures of each mechanism separately
and on the other hand, a comprehensive measure for a firm’s governance.

4. Findings
4.1. Descriptive statistics
Table 2 shows the descriptive statistics for the variables used in the current study. The
result indicates that audit risk index has an average rate of 38.9%, denoting that
companies in our sample do not show a high audit risk, which appears to vary between
0.157 and 0.684.
The mean value of risk governance index (0.490) reveals well that our sample
companies are characterized by a relatively effective governance and suffer from certain
risks that have to be considered in audit work. Table 2 shows well that firms of our sample
 JOURNAL OF AFRICAN BUSINESS 9

Table 2. Descriptive Statistics Numeric Variables’ Descriptive Statistics.

Variables Minimum Maximum Mean SD
ARI 0.157 0.684 0.389 0.102
RGI 0.270 0.720 0.490 0.0850
BSIZE 4 12 8.47 1.88
BIND 0 83 41 .23 26.52
INVES 0 88.8 15.56 22 .69
SIZE 13.700 20.120 17.390 1.310
LEV 0.080 2.640 0.530 0.360
ROE −2.360 1.080 0.090 0.250
Dichotomous variables’ descriptive statistics
Variables Frequency Percentage (%)
Variable = 0 Variable = 1 Variable = 0 Variable = 1
CEO 82 142 36.61 63.39
CON 153 71 68.30 31.70
All variables are defined in Table 1.

are characterized by large boards, with an average size of 8.47, and with the dominance of
outside directors at the board level, with an average rate of 41.23%. Then 63, 39% of firms
tend to be characterized with a president and the CEO respective roles. It is actually this
combination of roles, which leads to a high concentration of power likely to threaten the
board’s independence.

4.2. Correlation analysis

To examine the correlation between the independent variables, a correlation analysis was
conducted. Hair, Black, Babin, and Anderson (2010) argue that correlation coefficients
between independent variables above the absolute value of 0.700 indicate the presence of
a multicollinearity problem. However, Table 3, which presents the correlation coefficients
between independent variables, indicated that they are between 0.001 and 0.0452. Such
a finding allows accepting the null hypothesis of no correlation between variables. The
table also indicates that the variance inflation factors (VIFs), relevant to the entirety of
our independent variables set, were much lower than the 10-cutoff point, as set by Greene
(2003). Indeed, in all cases the VIF are discovered to be set below two levels, a fact which
confirms the absence of any multi colinearity problem.

4.3. Regression results

This section provides the results of multivariate tests estimated using FGLS regression
Table 4 reports the results of Models 1 and 2. The selected independent variables explain
the variation in audit risk. The adjusted R2 of this study reported 49.29 and 30.04%,
respectively. Table 4 reports that the results for board size are significantly (at the 0.01
level) and negatively associated with audit risk, thus confirming hypothesis (H1.a). This
result is consistent with Khudhair et al. (2019) who reported a negative relationship
between board size and audit quality. These results suggest well that a large board helps
well implement greater more control, eliminate environmental uncertainties, and
10 I. FAKHFAKH AND A. JARBOUI

TABLE 3. Correlation Analysis for Independent Variables.

Variables BSIZE BIND CEO CON INVES SIZE LEV ROE VIF
BSIZE 1 1.32
BIND 0.1432* 1 1.12
CEO 0.0656 0.1562* 1 1.10
CON −0.1289 0.2198* 0.0246 1 1.19
INVES 0.0004 0.1089 −0.0814 0.2409* 1 1.19
SIZE 0.4378* 0.0645 −0.1323* −0.1548* 0.2182* 1 1.45
LEV 0.4378* 0.0147 0.1146 −0.0706 −0.0528 0.1646* 1 1.07
ROE 0.1491* 0.0285 0.0799 0.0482 0.1746* 0.1223 −0.0368 1 1.08

TABLE 4. Regression Results.

Model 1 Model 2
Variables Pred. Sign Coefficients z-Statistic P>|z| Coefficients z-Statistic P>|z|
BSIZE - −0.015*** −4.79 0.000 ———— ———— ————
BIND - −0.039* −1.86 0.062 ———— ———— ————
CEO + 0.040*** 3.79 0.000 ———— ———— ————
CON + 0.066*** 4.49 0.000 ———— ———— ————
INVES - −0.046* −1.70 0.088 ———— ———— ————
RGI + ———— ———— ———— 0.150** 2.55 0.011
SIZE ± 0.011** 2.34 0.019 0.001 0.020 0.845
LEV ± 0.072*** 5.76 0.000 0.083*** 5.72 0.000
ROE +/- -0.041** -2.13 0.033 -0.042** -2.10 0.036
Cons ? 0.264*** 3.17 0.002 0.254** 2.33 0.020
R2 51.33 31.29
Ad R2 49.29 30.04
Prob>F 0.0000 0.0000
Observations 224 224
*, **, ***Significant at the 10, 5 and 1% levels, respectively.
The t-statistic values are in the parentheses.
All variables are defined in Table 1.

decrease audit effort. The board independence has a significant effect on audit risk, with
a significantly negative coefficient of −0.039 that is significant at the 10% level, thus
confirming hypothesis (H1.b).
This finding is consistent with those of Abdullah et al. (2008) and Mahdavi et al.
(2011). Indeed, with a high percentage of board independence, the auditors can rely on
a board role of the client firm, and then they will be able to reduce their control effort. In
this way, auditors can divert resources that are generally committed to assess the control
risk toward other value-adding activities in the process of evaluation of the overall audit
risk. Consequently, the quality of the audit procedure can improve. Additionally, the
CEO duality (CEO) has a positive impact on audit risk, which is significant at the 1%
level, thus supporting hypothesis (H1.c). Such a result corroborates the findings of
Muniandy (2007) who suggested that auditors perceive higher inherent risk in a firm
where the CEO and the chair of the board is the same individual. This result shows that
the quality of corporate governance is more relevant as a factor in evaluating the audit
risk. The internal controls were found to be weak and ineffective in monitoring manage­
ment when the above corporate governance measures are absent or defective. The
ownership concentration (CONC) variable appears to have a positive and significant
effect at the 1% level, confirming the hypotheisis (H2.a). Such a result consists with the
agency theory which predicts that in an efficient market, managers in a highly concen­
trated ownership situation will have sufficient incentives to have more rigorous audits
 JOURNAL OF AFRICAN BUSINESS 11

performed. This result proves the finding of Cohen and Hanno (2000) who suggested
that auditors in their experimental setting planned increased substantive testing in the
presence of ineffective corporate governance. This idea has been empirically confirmed in
the research of AlQadasi and Abidin (2018) who suggested that the ownership structure
must be considered in examining the effectiveness of corporate governance. The institu­
tional ownership has a significant effect on audit risk, with a significantly negative
coefficient of – 0.046 that is significant at the 10% level, thus confirming hypothesis
(H2.b). This finding is inconsistent with Hoand Kang (2013) who suggested that institu­
tional ownership is positively associated with higher audit risk. For the reported FGLS
models, all control variables are significant: the firm size (SIZE) has a significant effect on
audit risk, with a significantly positive coefficient of 0.011 that is significant at the 5%
level. Additionally, the debt level variable (LEV) has a positive impact on audit risk,
which is significant at the 1% level. The ROE variable appears to have a negative and
significant effect at the 5% level. Such results highlight that firm’s characteristics that
affect significatively the lever of audit risk.
Table 4 reports the regression results for the test of H3. The relation between corporate
governance and audit risk is based on a composite measure for the firm’s poor govern­
ance. Therefore, an aggregate measure of 22 governance characteristics was constructed
where each firm was classified as having strong or poor governance. With respect to
Model 2, the FGLS regression results indicate that the (RGI) variable is positive and
significant at the 5% level. Thus, hypothesis (H3) is confirmed. This result is consistent
with Demartini and Trucco (2016) who demonstrated emperically that the quality of
corporate governance is more relevant as a factor in evaluating the audit risk for new
clients after the global financial crisis, in the Italian context, compared to inherent risk
and detection risk. This idea has been supported in several investigations, mainly those
conducted by Krishnan (2001), Cohen and Hanno (2000), Cassell et al. (2012), and
Stanley (2011) who reported that auditors consider some characteristics of corporate
governance in audit strategy, the evaluation of the audit risk for new clients and there­
fore, the clients’ acceptance decision.

5. Conclusion
Few prior studies have addressed how auditors should consider the several features of
corporate governance in evaluating the audit risk. Thus, our study highlights the rele­
vance of quality of corporate governance in evaluating audit risk in the Tunisian context
over the period ranging from 2006 to 2013. First, we examined the effect of corporate
governance mechanisms such as board directors and ownership structure on audit risk. It
is reported that audit commettee, board size, board independence and institutional
ownership are negatively related to audit risk. Our findings are consistent with previous
literature (Cao et al. 2015; Cohen & Hanno, 2000; Cohen et al., 2002; Demartini &
Trucco, 2016), that if the auditors can rely on a sound corporate governance of the client
firm, they will be able to reduce their control effort. Then, empirical evidence suggests
that CEO duality and ownership concentration increase of audit risk. This relation can be
explained by the Tunisian setting specificity to outside members who represent the major
shareholders, the families, the State, the financial institutions and the foreigners. In the
Tunisian context, the board usually contains other types of directors (in addition to
12 I. FAKHFAKH AND A. JARBOUI

outside members) who represent the major shareholders, the families, the State, the
financial institutions and the foreigners. The presence of these directors can be seen as an
effective governance mechanism since they can monitor the managers and incite them to
improve the financial reporting quality (Bacha, 2019). Our findings supports the com­
plementary view between internal governance mechanisms and external auditing (Hay,
Knechel, & Ling, 2008; Srinidhi et al., 2014; Wahab, Mat Zain, & James, 2011). Second,
we test the impact of risk governance on audit risk. It is reported that risk governance is
positively associated with audit risk. Our findings are consistent with previous literature
that auditors in their experimental setting planned increased substantive testing in the
presence of ineffective corporate governance (Bedard & Johnstone, 2004; Cohen &
Hanno, 2000). This study extends the audit literature by examining the impact of
corporate governance mechanisms on the audit risk in the Tunisian context. We analyze
this relationship using on the one hand an individual measure for each corporate
governance mechanism and on the other hand using an aggregate measure of a firm’s
governance mechanisms to measure the risk governance. Our findings imply that all
types of audit firms would benefit from an increased understanding of the audit envir­
onment in the corporate governance setting. This opportunity would help them in
assessing the propriety of continuing their current strategies and policies, therefore,
enhance the positive strategies and policies and correct the negative ones (Hassan,
Aljaaidi, Bin Abidin, & Nasser, 2018).
The findings may have important implications for analysts, investors, regulators and
academics. First, identifying factors that may influence the audit risk can help guide the
reforms to improve the functioning of the financial market. Second, the study provides
ample evidence of risk governance problems in Tunisian market, highlighting the
necessity to create new corporate governance requirements. Third, our study is useful
to a wide range of stakeholders, managers of the audited firms to appraise the quality of
their financial statements, corporate governance procedures and internal control, and
financial analysts at large to better understand the factors that can affect the quality of
disclosures (Guidara, Achek, & Dammak, 2016). The study’s findings open up avenues
for further research.
The results of this study are subject to the following limitations. First, the measure of
dependent variables, the audit risk index, is inspired by the work elaborated by Brumfield
et al. (1983) but it is vulnerable subjective judgments. The other limitation of the study
was the inability to include more sample due to the unavailability of necessary data
relevant to the review period which ranges between 2006 and 2013.

Notes
1 IAASB Handbook. Glossary of Terms, 2009.
2 SAS 300: Audit risk assessments and accounting and internal control systems.

Disclosure statement
No potential conflict of interest was reported by the author(s).
 JOURNAL OF AFRICAN BUSINESS 13

ORCID
Anis Jarboui http://orcid.org/0000-0002-4811-6729

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Annex 1. Audit Risk Index (ARI)

The economy in which the company operates The industry in which the company operates
The location of the company The structure of the company
The company’s control environment, including the possibility The company’s previous audit history.
of management override.
The company’s financial position and operating performance. The business reputation of the company’s
management and principal owners.
Company ownership: Client understanding of the auditor’s responsibilities
- Institutional ownership (auditor change).
- Ownership concentration
- Conflicts of interest, regulatory problems Co-commissary problems
- auditor independence problems.
The relevant characteristics of the company’s management and principal owners.
- Independance
- Separation between the CEO and the chairman functions
- Composition/size

Annex 2. Risk Governance Index (RGI)

Governance mechanisms Items

Board Stucture Separation between the CEO and the chairman functions
Board size
Foreign directors
Independence
Administrators’ mandates
Specific committee
Lack of committee independence
Presence of the CEO/chairman in committees
External Auditor Auditor independence
Auditor specialization
Audit-firm zise
Co-commissariy
Ownership structure Ownership concentration
Institutionnal investors
Unequal voting rights: Dual class shares
Transparency Board Evaluation
Directors’ remuneration disclosure
Charter unavailability
External auditors’ fees disclosure
Audit committe missions disclosure
Board missions disclosure
Directors’ transactions disclosure

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