International Review of Financial Analysis 77 (2021) 101798

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International Review of Financial Analysis

journal homepage: www.elsevier.com/locate/irfa

Audit quality, accruals quality and the cost of equity in an emerging

market: Evidence from Vietnam
Ha Thi Thu Le a, b, Ha Giang Tran b, Xuan Vinh Vo b, *
a
Banking Academy, 12 Chua Boc Street, Hanoi, Viet Nam
b
Institute of Business Research, University of Economics Ho Chi Minh City, 59C Nguyen Dinh Chieu Street, District 3, Ho Chi Minh City, Viet Nam

A R T I C L E I N F O A B S T R A C T

Keywords: This study explores the relationship between audit quality, accruals quality, and the cost of equity in the context
Audit quality of Vietnam. Particularly, we examine the impact of auditor size and accruals quality on the industry-adjusted
Accruals quality earnings – price ratio. Using a sample of Vietnamese listed companies, the study shows that firms audited by
Auditor size
a Big Four auditor are associated with a lower cost of equity than firms with a non-Big Four auditor. The results
Cost of equity
Vietnam stock market
indicate that the auditors' information role is more relevant than the insurance role in a civil law context with a
relatively low auditor litigation risk. In addition, the findings show that companies with better accruals quality
are associated with a lower cost of equity. The study has implications for managers and regulators. The findings
highlight the importance of ensuring sound auditing practices and maintaining high-quality financial reporting
for corporations.

1. Introduction
The effect of audit quality dimensions on the cost of capital has
attracted the interest of researchers recently (Krishnan & Zhang, 2019;
Persakis & Iatridis, 2015). An external audit is intended to enhance the
reliability of a firm's financial reporting, reducing information risk and
eventually reducing the return required by investors (Azizkhani, Mon­
roe, & Shailer, 2010; Khurana & Raman, 2004; Krishnan & Zhang,
2019). Big audit firms are often perceived as having higher audit quality
and are used as a representative for audit quality. Most of the empirical
evidence from the US and other Anglo-Saxon countries with a common
law system indicate that companies audited by a reputable auditor have
a lower cost of equity (Azizkhani et al., 2010; Khurana & Raman, 2004;
Persakis & Iatridis, 2015). The impact of perceived audit quality on the
cost of capital is grounded on the information quality theory and in­
surance theory, where an auditor is supposed to improve the reliability
of reported earnings on the one hand and provide a source of claims to
investors in the event of an audit failure on the other (Azizkhani et al.,
2010; Karjalainen, 2011; Khurana & Raman, 2004). In addition to
auditor size, the quality of accruals in the audited financial statements
has been considered as having an impact on the cost of capital in the
prior literature, as accruals quality represent firm-specific information
risk that is not diversifiable (Francis, Lafond, Olsson, & Schipper, 2005;
Gray, Koh, & Tong, 2009). The question of interest is whether audit
quality and accruals quality influence the cost of equity in a less
developed market with civil law characteristics and a low auditor liti­
gation exposure, which is an issue that has not been addressed exten­
sively in the existing literature. Although various studies are examining
different aspects of finance and accounting using the Vietnam context
(Vo & Chu, 2019; Vo & Phong, 2018; Vo, Xuan Vinh, & Hong Thu,
2016), there has been no research investigating the link between audit
quality, accruals quality, and the cost of equity.
Therefore, the study is conducted to investigate the impact of audit
quality and accruals quality on the cost of equity. Following prior studies
(Azizkhani et al., 2010; Eliwa, Haslam, & Abraham, 2016; Khurana &
Raman, 2004; Persakis & Iatridis, 2015), the study uses Big Four audi­
tors to measure perceived audit quality and industry-adjusted earnings
to price ratio as a representative for the cost of equity. Using a sample of
Vietnamese listed companies, the results show that Big Four audit firms
have a significant negative association with the cost of equity, which
means firms audited by a Big Four auditor have a lower cost of equity.
The findings also show that firms with better accruals quality are related
to a lower cost of equity, which implies that accruals quality is a risk-
price factor in the Vietnamese stock market. The findings confirm that
the information quality theory is more relevant than the insurance
theory in relation to big audit firms' impact in a civil law system with low

* Corresponding author.
E-mail addresses: haltt@hvnh.edu.vn (H.T.T. Le), giangth@ueh.edu.vn (H.G. Tran), vinhvx@ueh.edu.vn (X.V. Vo).

https://doi.org/10.1016/j.irfa.2021.101798
Received 26 March 2021; Received in revised form 6 May 2021; Accepted 24 May 2021
Available online 27 May 2021
1057-5219/© 2021 Elsevier Inc. All rights reserved.
H.T.T. Le et al.
auditor litigation risk and are in line with the prior studies concerning
the relevance of audit quality and earnings quality to investors' pricing
decisions, such as Francis et al. (2005), Azizkhani et al. (2010), Persakis
and Iatridis (2015), Houqe, Ahmed, and van Zijl (2017) and Soon Kim,
Young Chung, Hwon Lee, and Cho (2020). However, the results are not
consistent with the evidence from Khurana and Raman (2004) that
auditor litigation risk is more important than an auditor's brand-name
reputation in the capital market. The study indicates that the gover­
nance role of a reputable auditor is important in an emerging market
with a relatively lower level of investor protection.
The study contributes to the literature on the impact of audit quality
and accruals quality on the cost of capital in a less developed financial
market with a civil law tradition. The context of Vietnam offers an
interesting case for studying firm behavior and investor behavior in
financial markets (Batten & Xuan Vinh, 2019; Xuan Vinh. Vo, 2018; X.V.
Vo, Nguyen, Ho, & Nguyen, 2017; X.V. Vo & Phong, 2018).The study has
implications for managers and regulators. The findings highlight the
importance of maintaining high-quality accounting information and
ensuring sound auditing practices for corporations. For regulators, the
study shows that the reliability of financial reporting matters to capital
market participants. Therefore, the authorities should take rigorous
measures to ensure the enforcement of compliance with accounting and
auditing regulations.
The rest of the paper is structured as follows. Section 2 provides a
review of the related theories and hypotheses development. Section 3
describes the research design and sample selection. The results of the
study are reported and discussed in Section 4. Finally, Section 5 sum­
marizes major findings and provides suggestions for future research.
2. Literature review and hypotheses development
2.1. Audit quality
According to IAASB (2009),1 the aim of an audit is to enhance the
confidence of interested users in the financial statements through the
auditor's expressing an opinion on the truth and fairness of the financial
statements. The need for an independent audit arises from concerns of
agency problems and asymmetry of information among shareholders
and management (Alzoubi, 2018; Lin & Hwang, 2010). A quality audit
contributes to the transparency and integrity of reported financial
information.
DeAngelo (1981) defines audit quality as the auditor's ability to
uncover and report material misstatements in a client's financial state­
ments. The ability to detect material misstatements is dependent on an
auditor's competence, while the willingness to report the misstatements
is influenced by the auditor's independence from the client.
Audit quality is not an easy metric to measure. For other goods or
services, customers could easily perceive and test the product quality
during consumption or usage. In contrast, the work performed by au­
ditors is inherently not observable by third parties. Therefore external
users of financial statements usually make judgments about audit
quality using observable indirect indicators such as auditor size, auditor
expertise, or auditor tenure. Of which auditor size is a proxy for
perceived audit quality that has been employed most frequently in the
audit research literature (Becker, Defond, Jiambalvo, & Subbramanyam,
1998; Habbash & Alghamdi, 2017; Huang, Wen, & Zhang, 2020;
Krishnan, 2003). Prior studies have concentrated on comparing the
impact of audit quality, measured as auditor size, on financial reporting
quality. Several papers conclude that big auditors have higher perceived
and actual audit quality. For example, bigger audit firms are related to a
lower magnitude of earnings management (Becker et al., 1998;
1
IAASB, 2009. International standard on auditing 200. [Online] Available at:
http://www.ifac.org/system/files/downloads/a008-2010-iaasb-handbook-isa
-200.pdf
2
International Review of Financial Analysis 77 (2021) 101798
DeBoskey & Jiang, 2012; Francis, Maydew, & Sparks, 1999; Lin &
Hwang, 2010; Persakis & Iatridis, 2015); and a higher possibility of
issuing a modified audit opinion (Francis & Krishnan, 1999).
2.2. Auditor size and the cost of equity
External audits play an essential role in maintaining confidence in
the integrity of financial reporting. The role of external audit arises from
its information quality theory and insurance theory (Azizkhani et al.,
2010; Khurana & Raman, 2004; Mansi, Maxwell, & Miller, 2004).
Information theory is formed based on the expectation that an audit
increases the quality of financial information provided by the manage­
ment, thus reducing information risks for external users of financial
statements such as investors and creditors. In contrast, auditors' insur­
ance role stems from the belief that investors who rely on audited in­
formation may claim on the auditor for subsequent losses caused by the
auditor's negligence (Dye, 1993; Mansi et al., 2004).
The association of large audit firms with audit quality and the cost of
equity could be explained by both information quality and insurance
theories. Big audit firms are often perceived as better in detecting and
reporting misstatements as they have more finance to invest in staff
training and developing audit methodology (Craswell, Francis, & Tay­
lor, 1995). In addition, big audit firms possess greater knowledge and
desire to protect their reputation and defend themselves from litigation
risk (Francis & Krishnan, 1999; Khurana & Raman, 2004). Big audit
firms also have larger professional insurance coverage to compensate
investors in the case of litigation (Lennox, 1999). Therefore, it is ex­
pected that big audit firms are associated with high audit quality, which
enhances the credibility of audited financial statements, reduces infor­
mation risk, and decreases the cost of equity required by investors.
Most empirical evidence shows that companies audited by bigger
audit firms are connected with a lower cost of debt and equity capital.
Persakis and Iatridis (2015) investigate the effect of audit quality,
earnings management, and financial crisis on the cost of capital in 18
developed countries, which are classified into three clusters according to
the level of investor protection. They report that the cost of equity has a
negative relation with companies audited by Big Four auditors in all
clusters, regardless of the level of investor protection.
Azizkhani et al. (2010) investigate the influence of Big Four auditors
on the cost of equity for firms in Australia. The results indicate that Big
Four audits lower the cost of equity until 2001, but not after 2001, due to
Big Four audit failures in the US and Australia during 2001–2002. Chou,
Zaiats, and Zhang (2014) find out that the selection of an auditor affects
a firm's ability to attract foreign equity capital. In particular, companies
audited by Big Four auditors show higher foreign mutual fund
ownership.
Several studies imply that the impact of big auditors on the quality of
financial reporting and the cost of capital varies in different economic
and legal environments. Khurana and Raman (2004) investigate the
impact of auditor litigation exposure and reputation concerns on the
perceived audit quality, using the cost of equity as a proxy for financial
reporting quality. The results show that big audit firms are associated
with a lower cost of equity for firms in the US but not in Australia,
Canada, and the UK, as auditor litigation exposure is higher in the US
than in the other three countries. The findings suggest that the risk of
litigation against auditors affects perceived audit quality rather than
brand name reputation. Francis and Wang (2008) suggest that big au­
ditors' conservatism is higher in a stronger investor protection envi­
ronment and a common law system.
Most of the prior studies on the link between audit quality and the
cost of equity are from advanced financial markets, while evidence from
less developed economies is still limited. Vietnam is a developing
country with a young and growing stock market. The stock market in the
country is characterized by a low level of transparency and weak
corporate governance (Vo & Phan, 2019; World Bank, 2016). The
country applies the Vietnamese Accounting Standards, which are
H.T.T. Le et al. International Review of Financial Analysis 77 (2021) 101798

outdated compared to the International Financial Reporting Standards.
The financial reporting environment is relatively weak due to insuffi­
cient compliance with the accounting standards (World Bank, 2016).
Therefore the presence of a reputable auditor is expected to improve the
reliability of financial information and increase investors' confidence,
thus lowering the cost of equity of the audited firms.
Regarding the legal system, Vietnam has a civil law tradition
(Nguyen & Trinh, 2020). According to Maijoor and Vanstraelen (2006),
civil law countries often have less developed financial markets, weaker
investor protection, and a lower auditor litigation risk than countries
with a common law system. Even though there are several financial
statement frauds in Vietnamese listed companies recently, there have
been almost no noticeable law cases against the auditors in the past
years. In this audit environment, the insurance value of Big Four audits
is probably lower to investors. However, we expect that the information
quality theory to be relevant to Big Four audits. If the result of our study
is in line with our expectation, it would confirm the role of the infor­
mation theory over the insurance theory, which is contrasting to the
conclusion provided in the prior studies such as Khurana and Raman
(2004) that auditor litigation risk is a stronger driver than auditor
reputation behind perceived audit quality. Based on the above argu­
ments, our first hypothesis is developed as follows:
H1. : Firms audited by a Big Four auditor have a lower cost of equity
than firms audited by a non-Big Four auditor.
its components on the cost of debt on a sample of listed firms in Vietnam.
The results show that higher accruals quality is associated with lower
interest costs, and the discretionary accruals quality also has a negative
impact on the cost of debt. In contrast, the innate component does not
show a significant effect on creditors' pricing decisions. However, the
study has not addressed the impact of audit quality and accruals quality
on the cost of equity capital.
From the prior theoretical and empirical studies, we expect that
better accruals quality is related to a lower cost of equity. Therefore, the
second hypothesis is developed as follows:
H2. : Firms with better accruals quality have a lower cost of equity
than firms with poorer accruals quality.
3. Research design
3.1. Measures of audit quality
Following prior research (Azizkhani et al., 2010; Khurana & Raman,
2004; Persakis & Iatridis, 2015), the study uses Big Four auditors to
proxy for higher audit quality. Big Four audit firms are the four inter­
national firms: PWC, Deloitte, KPMG, and Ernst & Young. A dummy
variable is used to measure the auditor size where 1 is given to a firm if it
is audited by one Big Four auditor and 0 if otherwise.

3.2. Measure of accruals quality

2.3. Accruals quality and the cost of equity
Consistent with prior research (Francis et al., 2005; Soon Kim et al.,
Accruals quality is included as a proxy for earnings quality of audited 2020), accruals quality is estimated based on the model developed by
financial statements in some prior studies concerning the influence of Dechow and Dichev (2002) and extended by McNichols (2002). We
audit quality on the cost of capital, such as Azizkhani et al. (2010), estimate accruals quality in two steps. In the first step, total current
Karjalainen (2011). accruals are regressed on operating cash flows, the change in sales, and
Accruals signify the difference between reported earnings and cash the gross amount of property, plant, and equipment as follows:
flows and could be affected by management intervention. Accruals
TCAi,t = α1 + α2 CFOi,t− 1 + α3 CFOi,t + α4 CFOi,t+1 + α4 ΔRevi,t + α5 PPEi,t + ϑi,t
quality can be used to measure how earnings can forecast future cash
flows (García-Teruel, Martínez-Solano, & Sánchez-Ballesta, 2010; Van­ (1)
der Bauwhede, de Meyere, & van Cauwenberge, 2015). Recent studies
where subscripts i and t indicate firm i and year t. TCAi,t is a firm's total
by Lewellen and Resutek (2019) and Nallareddy, Sethuraman, and
current accruals; TCAi, t = ΔCAi, t − ΔCashi, t − ΔCLi, t + ΔSTDEBTi, t.
Venkatachalam (2020) suggest that accruals can be used to predict a
∆CAi,t represents the change in current assets, ∆Cashi,t is the change in
firm's future earnings and cash flows. Thus accruals quality can be used
cash, ∆CLi,t is the change in current liabilities, ∆STDEBTi,t is the change
to represent the quality of the audited information. Higher accruals
in debt in current liabilities between year t-1 and year t.
quality lowers information risk, thus decreases the required returns by
CFOi,t-1, CFOi,t, CFOi,t+1 are the operating cash flows in year t-1, t and
investors.
t + 1, respectively. ∆Revi,t represents the change in revenues between
Prior studies have found that companies with poorer accruals quality
year t-1 and year t, PPEi,t is the gross amount of property, plant and
have a higher cost of equity. Based on theoretical research findings that
equipment in year t.
information risk is not diversifiable (Easley & O'hara, 2004; O'Hara,
All variables are divided by average total assets to mitigate the
2003), Francis et al. (2005) investigate the pricing of accruals quality in
heteroscedasticity problem. Eq. (1) is estimated cross-sectionally for
the US during the period 1970–2001. The results show that poorer ac­
each industry and year combination using OLS with a minimum of ten
cruals quality is related to higher costs of debt and equity. Eliwa et al.
firms in each industry-year.
(2016) inspect whether earnings quality affects the cost of equity in the
The model represents the extent to which current accruals are related
UK during the period 2005–2011. The study finds a significant inverse
to cash flow realizations and the change in revenues and tangible non-
relationship between accruals quality and the cost of equity, and the
current assets. The residual of Eq. (1) represents the accruals that are
relationship is more prominent during the financial crisis. Australian
not linked to cash flows, the change in revenues, and non-current assets.
evidence documented by Gray et al. (2009) and Azizkhani et al. (2010)
In the second step, we calculate a firm's specific accruals quality in
also shows a negative association between accruals quality and the cost
year t as the standard deviation of the residuals of the firm from year t-4
of equity.
to year t. A higher standard deviation implies a poorer accruals quality
Soon Kim et al. (2020) study the influence of accruals quality on the
because of the higher volatility of the accruals. To facilitate the inter­
cost of equity in the Korean stock market, using institutional investors'
pretation of this variable, we multiply the standard deviation of the
net trading activity as a proxy for the ex-post cost of capital. The findings
residuals with − 1. Thus, a higher value of the measure indicates higher
show that institutional investors' net selling increases for firms with
accruals quality.
lower accruals quality, which confirms the pricing effect of accruals
quality. Kim and Qi (2010) show that accruals quality affects investors'
pricing decisions after adjusting for low-priced stocks, and return pre­ 3.3. Measure of the cost of equity
mium connected with accruals quality is usually observable during times
of economic growth. Following previous studies conducted by Eliwa et al. (2016) and
Le, Vo, and Vo (2021) investigate the impact of accruals quality and Francis et al. (2005), this paper adopts the industry-adjusted earnings to

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H.T.T. Le et al. International Review of Financial Analysis 77 (2021) 101798

price ratio (InEP) as a variable represented for the cost of equity. This Table 1
measure is widely used in literature (Basiruddin, Benyasrisawat, & Breakdown of firms by year and industry.
Rasid, 2014; Eliwa et al., 2016; Francis et al., 2005; Francis, Lafond, Per, Panel A: by year Panel B: by industry
& Schipper, 2004) and allows us to work with a large data sample set.
Year No. of % Industry No. of %
The other advantage of the industry-adjusted earnings to price ratio is observations observations
that it can capture the industry growth and risk factors and compare the
2012 59 7.75 Materials 171 22.47
audit quality-cost of the capital relationship between firm peers in the 2013 120 15.77 Industrials 170 22.34
same industry (Alford, 1992; Francis et al., 2005). A higher value of the 2014 140 18.40 Transportation 94 12.35
industry-adjusted earnings-price ratio indicates a higher cost of equity and logistics
capital. 2015 142 18.66 Consumer 40 5.26
Discretionary
Ideally, we would like to measure the cost of equity using either the
2016 146 19.19 Consumer 125 16.34
traditional capital asset pricing model (CAPM) (Lintner, 1965; Sharpe, Staples
1964) or implied/ex-ante cost of equity capital. They are widely used in 2017 154 20.24 Utilities 58 7.62
studies investigating the cost of equity-accounting earnings nexus Real estate 103 13.53
(Chan, Lin, & Strong, 2009; Eliwa et al., 2016; Francis et al., 2004; Total 761 100.00 Total 761 100.00

Francis et al., 2005). However, these proxies are mainly employed for
developed markets while they are criticized for capturing the cost of
equity in the context of emerging countries. The CAPM is problematic to
estimate the emerging-market risk (systematic risk) since emerging
markets do not have characteristics of an efficient market (Harvey,
1995). In addition, the use of implied/ex-ante cost of equity capital re­
quires reliable analyst forecasts, which are significantly restricted in
emerging markets. Accordingly, both CAPM-based cost of capital and
implied/ex-ante cost of equity capital are unreasonable and inappro­
priate to capture the cost of capital in the context of Vietnam, an
emerging market.
As listed firms in Vietnam are required to publish their audited
financial statements within 90 days from the end of the fiscal year, so to
measure the industry-adjusted earnings-price ratio of firm i in year t, we
begin by calculating earnings to price ratio for the firm using the closing
price of the last trading day of March in year t + 1, and earnings per
share (EPS) of year t. We exclude firms that have negative earnings
because when the earnings per share are negative, the price-earnings
ratio for a firm is not meaningful and is usually not reported. All the
firms are classified into seven industry groups based on four-digit Global
Industrial Classification Standard (GICS) codes. We then compute the
median value of earnings-price ratio for all firms in the same industry in
a given year. We finally determine the industry-adjusted earnings to
price ratio of each firm in a year as the difference between the earnings
to price ratio of the firm and the median value of the industry in that
year.
3.4. Model specification
To explore the impact of audit quality on the cost of equity, we follow
previous studies (Eliwa et al., 2016; Francis et al., 2005; Persakis &
Iatridis, 2015) and employ the following regression model:
firm i at time t, measured as the natural logarithm of the total market
value of equity in year t; Betai, t is the Beta, calculated based on a three-
year rolling data acquired from firm-specific CAPM estimations using
monthly stock price; it requires a firm to have a minimum of 18 monthly
observations; LEVi, t is the leverage of firm i at year-end, calculated as the
ratio of total interest-bearing debts to total assets; BMi, t is the ratio of
book value to the market value of equity of firm i in year t; GROWi, t
measures year over year percentage growth in the number of shares
outstanding; εi, t is the error term. We also include industry
(IND_DUMMY) and time (YEAR_DUMMY) dummy variables to control
for industry and time effects. In line with previous studies, we expect
that β3 and β6 have a negative sign while β4, β5, and β7 have a positive
sign (Basiruddin et al., 2014; Eliwa et al., 2016; Francis et al., 2004;
Francis et al., 2005).
3.5. Data and sample collection
Our sample is selected from a population of listed companies in the
Ho Chi Minh City Stock Exchange during the period 2007–2018. The
accounting data and the stock price of the firms are obtained from
Thomson Reuters' database. We exclude banks and other financial firms
from our sample because of their specific characteristics. For example,
banks typically have a high level of leverage, different asset and liability
structures, and different classification of financial statement items,
which may affect the measures of the variables. Observations without
auditor information and accounting data to calculate accruals quality
and the cost of equity are excluded from the sample. As the calculation of
accruals quality requires strict data demand, including prior and sub­
sequent period cash flows, and five-year annual residuals, accruals
quality can be calculated for firms during the period 2012–2017. The
sample selection procedures lead to a final sample of 171 firms with 761

COECi,t = β0 + β1 Big4i,t + β2 Accrualsi,t + β3 MKCi,t + β4 Betai,t + β5 LEV i,t + β6 BM i,t + β7 GROW i,t + IND DUMMY + YEAR DUMMY + εi,t (2)

where COECi, t is the cost of equity capital for firm i in year t, measured
as the industry-adjusted earnings-price ratio; Big4i, t is a dummy variable
with a value of 1 if the auditor is a Big Four audit firm, and 1 if other­
wise; and Accrualsi, t is accruals quality, measured as the standard de­
viation of the residuals of the firm from year t-4 to year t from the annual
cross-sectional regressions of the modified Dechow and Dichev (2002)
model as in Eq. (1). We expect β1and β2 to have a negative sign, which
implies that Big4 and better Accruals are associated with a lower cost of
equity.
To capture other factors that may affect the firm's cost of equity
capital, we include a wide range of control variables. MKCi, t is the size of
firm-year observations. Industry groups are defined according to four-
digit Global Industrial Classification Standard (GICS) codes. Table 1
presents details of the sample by year and industry.
4. Results and discussion
4.1. Data description
Table 2 represents the sample descriptive statistics. The table shows
that COEC has a mean of 0.012 and a median of 0.000. 35.2% of the
observations are audited by a Big Four firm, which is lower than the

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H.T.T. Le et al. International Review of Financial Analysis 77 (2021) 101798

Table 2
Descriptive statistics of variables.
Variable Mean Std.Dev. Min 25% Median 75% Max

lndEP 0.012 0.085 − 0.228 − 0.040 0.000 0.052 0.555

Big4 0.352
Accruals − 0.122 0.069 − 0.383 − 0.158 − 0.104 − 0.069 − 0.017
MKC 27.244 1.471 23.927 26.136 27.086 28.132 33.344
LEV 0.251 0.185 0.000 0.088 0.241 0.389 0.758
Beta 0.376 0.307 − 0.751 0.172 0.359 0.569 1.310
BM 1.253 0.807 0.077 0.680 1.049 1.606 8.765
GROW 0.075 0.295 − 0.500 0.000 0.000 0.009 5.131

Note: This table presents the descriptive statistics of the variables used in the study. COEC is measured as the industry-adjusted earnings to price ratio. Big4 is a dummy
variable with a value of 1 if a Big Four auditor audits the firm, otherwise if 0. Accruals is measured as the standard deviation of the residuals of the firm from year t-4 to t
from the annual cross-sectional regressions of the modified Dechow and Dichev (2002) model. MKC is measured as the natural logarithm of the total market value of
equity in year t. Beta is computed based on a three-year rolling data acquired from firm-specific CAPM estimations using monthly data. LEV is the ratio of total interest-
bearing debts to total assets. BM is the ratio of book value to market value of equity. GROW is defined as the year over year percentage growth in the number of shares
outstanding.

figures reported in previous studies in well-developed financial markets,
such as 88.7% in Australia (Azizkhani et al., 2010), 96.5% in the US,
88.8% in the UK (Khurana & Raman, 2004).
The mean (median) values of Accruals are − 0.122 (− 0.104). The
values of accruals quality in the study are negative due to the structure
of the variable in which we multiply the values of the residuals obtained
from the Eq. (1) with − 1. The absolute value of the mean (median)
values of Accruals are higher than those reported in the prior studies,
such as Xu, Gong, and Gong (2017) -0.06 (− 0.05); Eliwa et al. (2016)
0.084 (0.059); Francis et al. (2005) 0.0442 (0.0313). The higher abso­
lute value of the variable reveals a lower level of accruals quality in
Vietnamese listed companies.
The mean of leverage (LEV) is 0.251, which is higher than 0.182 in
the UK (Eliwa et al., 2016) and lower than 0.276 in the US (Francis et al.,
2005). For Beta, the statistics show the mean of 0.376 compared to 0.889
(Eliwa et al., 2016), suggesting that the stock price of Vietnamese firms
on average is less correlated with the market than that of UK firms.
4.2. Univariate test
In Table 3, we divide the whole sample into two groups of firms,
based on whether a firm has a lower or higher cost of equity than the
median of the whole sample, in which the median cost of equity of the
whole sample is 0. Column (I) shows the statistics of the firms with a
lower cost of equity than the sample median; column (II) presents the
statistics of the firms with a higher cost of equity than the sample me­
dian. Column (III) reports Pearson's chi-squared test results for the
dichotomous variable; and t-test and Mann-Whitney U test for mean and
median comparison of the continuous variables for the two groups.
According to Table 3, group (I) has a higher probability of being
audited by a Big Four firm and better accruals quality. Moreover, the test
for Big4 and Accruals suggests firms with higher accruals quality and
audited by Big Four auditors have a lower cost of equity, which supports
the two hypotheses.
Group (I) also has higher market capitalization, higher leverage, and
higher Beta at conventional significance levels. The figures indicate that
even though firms with a lower cost of equity are larger, they are not
necessarily less risky than firms with a higher cost of equity, as indicated
by their higher leverage and Beta.

Table 3 4.3. Correlations among variables

Univariate comparisons.
Dichotomous (I) COEC (II) COEC > (III) Test of difference H0: Table 4 reports the correlation among variables employed in the
variable ≤Median (N = Median (N = (I) – (II) = 0
regression of the cost of equity on auditor size, accruals quality, and
382) 379)
other control variables. According to Table 4, the cost of equity is
2
% % stat p-value negatively correlated with Big4, Accruals, which supports the hypothe­
Big4 (Big4 = 1) 21.16 14.06 16.14 0.000 ses. The cost of equity also has a significant negative association with
Continuous Mean (Median) Mean (Median) t stat (z stat) p-value market capitalization, leverage, Beta, and book to market ratio. In
variables contrast, it has a positive correlation with the growth in the number of
Accruals − 0.117 − 0.127 2.0419 0.042 outstanding shares.
(− 0.096) (− 0.113) (2.493) (0.013)
MKC 27.433 27.053 3.5914 0.000
(27.228) (26.969) (3.035) (0.002) 4.4. Multivariate test
LEV 0.263 (0.253) 0.238 (0.229) 1.8785 0.060
(1.783) (0.075)
Table 5 reports the regression results of the cost of equity on auditor
Beta 0.425 (0.253) 0.327 (0.229) 4.4451 0.000
(4.423) (0.000) size, accruals quality, and the control variables. Again, the coefficients
BM 1.321 (1.053) 1.184 (1.046) 2.3752 0.018 of interest are those on Big4 and Accruals. The expected sign of the co­
(0.864) (0.387) efficients on these two variables is negative, which implies that Big Four
GROW 0.059 (0.000) 0.092 (0.000) − 1.5568 0.120 audit firms and better accruals quality are associated with a lower cost of
(− 0.2640) (0.792)
equity.
This table reports the univariate test results of two groups of firms with a lower To deal with possible time-series and cross-sectional correlations in
and higher cost of equity than the median of the whole sample. The definitions the residuals, we employ OLS regressions with fixed time effects and
for the variables are provided in the footnotes of Table 2. p-value is from Pear­ clustered robust errors by firm-level. Hypothesis testing is based on OLS
son's chi-squared test for dichotomous variable; t-tests and Mann-Whitney U
results, although fixed effect and random effect regressions are pre­
two-sample tests for means and medians of continuous variables.
sented to compare the sensitivity test. Following prior research, we
winsorize all continuous variables at 1% and 99% to moderate the
impact of the outliers.

5
H.T.T. Le et al. International Review of Financial Analysis 77 (2021) 101798

Table 4
The correlation among variables employed in the analysis.
COEC Big4 Accruals MKC LEV Beta BM GROW

COEC 1
Big4 − 0.151*** 1
Accruals − 0.140*** − 0.041 1
MKC − 0.133*** 0.458*** − 0.004 1
LEV − 0.042 0.033 − 0.168*** 0.080** 1
Beta − 0.175*** 0.115*** 0.002 0.187*** 0.143*** 1
BM − 0.093** − 0.210*** − 0.086** − 0.549*** 0.009 0.172*** 1
GROW 0.069* − 0.024 − 0.169*** 0.115** 0.059 0.066* − 0.001 1

This table presents the correlations among variables employed in Eq. (2) COECi, t = β0 + β1Big4i, t + β2Accrualsi, t + β3MKCi, t + β4Betai, t + β5LEVi, t + β6BMi, t +
β7GROWi, t + IND_DUMMY + YEAR_DUMMY + εi, t The definitions for the variables are provided in the footnotes of Table 2. The symbols *, **, and *** indicate
statistical significance at the 10%, 5%, and 1% levels, respectively.

lower cost of capital. The result is also consistent with a report by the
Table 5 World Bank (2016) that users generally place more reliance on financial
The impact of audit quality on the cost of capital of firms listed on the Vietnam
statements audited by bigger firms.
stock market.
The finding is also in line with the view that investors take into
Variables Pred. Model (1) Model (2) Model (3) consideration accruals quality when making investment decisions. The
Sign
Coefficient (t- Coefficient (t- Coefficient (t- results support the theory that better financial reporting quality reduces
stat) stat) stat) information risk to investors, which in turn decreases the cost of equity.
Constant 0.4492*** 0.5021*** 0.4219*** The results are consistent with empirical evidence by Azizkhani et al.
(3.56) (4.39) (3.46) (2010), Francis et al. (2004), Aly Zaher, Mohamed, and Basuony (2020)
Big4 − − 0.0208** − 0.0217** that better accruals quality are related to a lower cost of capital.
(− 2.35) (− 2.47)
Accruals − − 0.1547** − 0.1601**
We turn our attention to control variables. The results from Table 5
(− 2.21) (− 2.31) show that the coefficients of MKC are negative and significant. This
MKC − − 0.0146*** − 0.0171*** − 0.0140*** finding indicates that larger Vietnamese companies with a higher mar­
(− 3.14) (− 4.13) (− 3.11) ket value have a lower cost of equity. This result is consistent with prior
LEV − 0.0055 − 0.0153 − 0.0167
+
studies (Eliwa et al., 2016; Francis et al., 2005).
(− 0.24) (− 0.70) (− 0.76)
Beta + − 0.2220 − 0.0223 − 0.0204 Of particular note is that the earnings-price ratio has a negative,
(− 1.32) (− 1.34) (− 1.25) insignificant relationship with a leverage ratio and Beta. We expected
BM − − 0.0282*** − 0.0292*** − 0.0286*** LEV and Beta to have a positive sign in the regression model, assuming
(− 4.91) (− 5.16) (− 5.11) that firms with a higher leverage ratio and higher Beta are riskier, thus
GROW 0.0318** 0.0291*** 0.0258**
having a higher cost of equity capital. However, the results obtained
+
(2.15) (2.10) (1.85)
Industry Yes Yes Yes from Table 5 reflect that an increase in the leverage rate and Beta lead to
dummies a decrease in the earnings to price ratio. Although the findings are not in
Year dummies Yes Yes Yes line with expectations, they are consistent with Francis et al. (2005).
No. 761 761 761
According to Francis et al. (2005), these unexpected signs could come
Observations
Adjusted R- 0.1116 0.1145 0.1257 from the strong correlation between Beta and either or both firm size
squared and leverage. This could apply to our case, as Table 4 shows significant
F-value 4.18*** 3.78*** 4.2*** correlations between Beta and both leverage and market capitalization.
This table presents OLS regression results of Eq. (2): COECi, t = β0 + β1Big4i, t + As predicted, the coefficients of GROW are positive and significant,
β2Accrualsi, t + β3MKCi, t + β4Betai, t + β5LEVi, t + β6BMi, t + β7GROWi, t + suggesting that firms with a higher growth rate are likely to have a
IND_DUMMY + YEAR_DUMMY + εi, t. The definitions for the variables are higher ratio of earnings to price. This finding is inconsistent with the
provided in the footnotes of Table 2. All models are estimated using firm-level conclusion of Eliwa et al. (2016) and Francis et al. (2005) but consistent
clustering to produce robust standard errors. Continuous variables are winsor­ with the finding of Basiruddin et al. (2014). In the context of an
ized at the 1% and 99%. The symbols *, **, and *** indicate statistical signifi­ emerging market, investors require a higher value of the earnings-price
cance at the 10%, 5%, and 1% levels, respectively. ratio for firms with a high growth rate. Beaver, Kettler, and Scholes
(1970) suggest that excess returns generated from a high expected
In models (1) and (2), either Big4 or Accruals is included in the test. In growth are riskier than normal returns. La Porta (1996) also provides
model (3), both variables are included in the regression. Table 5 shows evidence that the stocks with a high expected growth rate in earnings
that in all three models, the coefficients on Big4 and Accruals are nega­ have higher volatility in returns than low expected-growth stocks.
tive and significant at the 5% level. The results suggest that Big Four Finally, we observe from the results presented in Table 5 that book to
audit firms and accruals quality have a negative association with the cost market ratio is negatively and significantly related to the earnings-price
of equity. These results, therefore, support the hypothesis that Big Four ratio. In other words, Vietnamese firms with a higher market to book
auditors and better accruals quality reduce the cost of equity of Viet­ value ratio have higher earnings to price ratios. This finding is consistent
namese listed companies. with the results of Francis et al. (2004), which employ advanced coun­
Vietnam has the features of a civil law country with low litigation tries' data.
risk against auditors; thus the insurance theory is less likely to influence
investors' decision making. However, the negative association between
big audit firms and the cost of equity indicates that investors place more 4.5. Propensity score matching analysis
confidence in financial reports audited by a big audit firm, suggesting
that the information quality theory matters to investors. The finding is Our regression results may be subject to self-selection bias, as firms
consistent with prior studies such as Persakis and Iatridis (2015) and with a lower cost of equity may systematically choose a Big Four auditor.
Azizkhani et al. (2010) that bigger audit firms are associated with a Thus, the observed relation between the cost of equity and audit firm
size could be attributable to firms with a low cost of equity preferred to

6
H.T.T. Le et al. International Review of Financial Analysis 77 (2021) 101798

Table 6 which estimates the likelihood of engaging a Big Four auditor. We use all
Comparisons of two groups of firms in the matched sample. control variables in Eq. (2), except for the Big4 variable. Next, we match
Variables (I) (II) (III) each firm audited by a Big Four auditor with a firm audited by a non-Big
Four auditor with the closest propensity score, allowing a firm with a
Non-Big 4 Big 4 Test of difference
non-Big Four auditor to be matched more once. Then we re-estimate the
(N = 133) (N = 222) H0: (I) – (II) = 0 OLS regression in Table 5 using the matched sample.
Mean (Median) Mean (Median) t stat (z stat) p-value In Table 6, we show the comparison of the mean (median) of the
Accruals − 0.120 − 0.125 0.646 (− 0.717) 0.519 variables for the two groups of firms with and without a Big Four auditor
(− 0.107) (− 0.097) (0.473) in the matched sample. The test of difference between the mean and
MKC 27.570 27.757 − 1.552 0.122 median values of the two groups in column (III) shows no significant
(27.612) (27.620) (− 1.072) (0.283)
differences between the two sets of firms, indicating that the matching
LEV 0.241 (0.231) 0.253 (0.254) − 0.636 0.525
(− 0.679) (0.497)
process enhances the similarity between the two groups.
Beta 0.407 (0.391) 0.419 (0.401) − 0.345 0.730 Table 7 reports the results of the regression on the matched sample
(− 0.314) (0.830) based on Eq. (2). As reported in Table 7, Big4 and Accruals continue to
BM 1.165 (0.995) 1.085 (0.869) 1.114 (1.608) 0.266 show a significant negative relationship with the cost of equity as in the
(0.108)
original test.
GROW 0.060 (0.000) 0.066 (0.000) − 0.311 (0.659) 0.756
(0.509)

This table reports the mean/(median) values of the variables and the univariate 4.6. Sensitivity test
test results of the two groups of firms in the matched sample. There are 222 firms
with a Big 4 auditor in column (II), and only 133 firms with a non-Big 4 auditor
To test the robustness of the results, we conduct several sensitivity
in column (I), as a firm in the non-Big 4 auditor group can be matched more than
once, making a total of 444 observations in the regression on the matched
analyses. Firstly, in addition to the OLS regression, we perform fixed
sample reported in Table 7. The definitions for the variables are provided in the effects and random effects regression of Eq. (2). Table 8 reports the re­
footnotes of Table 2. Column (III) shows p-value from t-tests and Mann-Whitney sults of fixed and random effects regressions. The Hausman test shows
U two-sample tests for means and medians of the continuous variables. that the random-effects model is more appropriate than the fixed effects
model. The results for Big4, Accruals, and Grow in both models are
be audited by a more reputable audit firm, rather than because of the similar to those reported in Table 5. Thus the test confirms the impact of
impact of the auditor per se. To control for self-selection bias, we employ big auditors and accruals quality on the cost of equity.
the propensity score matching technique (Rosenbaum & Rubin, 1983) Secondly, we use the auditor industry specialization as another proxy
concerning a firm's choice of a Big Four auditor versus a non-Big Four for audit quality. Auditor industry specialization is the level of an au­
auditor. ditor's expertise about clients in a particular industry. A specialist
First, we run a logistic propensity score regression for auditor choice, auditor can better assess the reasonableness of accounting estimates and
judgment made by management, thus enhancing the reliability of
financial reporting. Several prior studies use auditor specialization as a
Table 7 proxy for perceived audit quality (DeBoskey & Jiang, 2012; Kanagar­
Propensity score matching analysis. etnam, Lim, & Lobo, 2010). Following previous research, auditor
Variables Pred. Model (1) Model (2) Model (3) specialization is a dummy variable that equals 1 if the auditor has from
Sign 30% of market shares in terms of clients' assets in a particular industry in
Coefficient (t- Coefficient (t- Coefficient (t-
stat) stat) stat) a year, and 0 if otherwise. Statistics show that 17% of the observations
are audited by a specialist auditor, as compared to 35% audited by a Big
Constant 0.5469*** 0.5388*** 0.5490***
(3.56) (3.43) (3.57)
Big4 − − 0.0186** − 0.0183** Table 8
(− 2.20) (− 2.12) Fixed effects and random effects regression results of the impact of audit quality
Accruals − − 0.1551* − 0.1529* on the cost of equity of firms listed on the Vietnam stock market.
(− 1.80) (− 1.81)
MKC − − 0.0175*** − 0.0180*** − 0.0181*** Variables Pred. Fixed effects Random effects
(− 3.26) (− 3.29) (− 3.34) Sign
Coefficient t-stat Coefficient t-stat
LEV + − 0.0163 − 0.0253 − 0.0263
(− 0.61) (− 0.88) (− 0.92) Constant − 0.3137 − 0.89 0.0355 2.16
beta + − 0.0632*** − 0.0593*** − 0.0592*** Big4 − − 0.0205** − 2.01 − 0.0234*** − 3.00
(− 3.24) (− 3.14) (− 3.16) Accruals − − 0.1380* − 1.82 − 0.1518** − 2.40
BM − − 0.0221*** − 0.0214** − 0.0217*** MKC − 0.0127 1.00 − 0.0093* − 1.83
(− 2.78) (− 2.47) (− 2.66) LEV + − 0.0636* − 1.66 − 0.0346 − 1.53
GROWTH + 0.0042 (0.15) − 0.0046 − 0.0050 Beta + − 0.0344** − 2.01 − 0.0247* − 1.70
(− 0.18) (− 0.19) BM − − 0.0117 − 1.09 − 0.0256*** − 4.40
Industry Yes Yes Yes GROW + 0.0380*** 2.88 0.0381*** 3.12
dummies Industry dummies Yes Yes
Year dummies Yes Yes Yes Year dummies Yes Yes
No. 444 444 444 No. Observations 761 761
Observations Adjusted R- 0.0802 0.1182
Adjusted R- 0.2171 0.2193 0.2348 squared
squared F-value 3.23*** 71.02***
F-value 3.54*** 3.31*** 3.31***
This table presents panel fixed effects and random effects regression results of
This table presents OLS regression results of Eq. (2): COECi, t = β0 + β1Big4i, t + Eq. (2): COECi, t = β0 + β1Big4i, t + β2Accrualsi, t + β3MKCi, t + β4Betai, t + β5LEVi, t
β2Accrualsi, t + β3MKCi, t + β4Betai, t + β5LEVi, t + β6BMi, t + β7GROWi, t + + β6BMi, t + β7GROWi, t + IND_DUMMY + YEAR_DUMMY + εi, t. The definitions
IND_DUMMY + YEAR_DUMMY + εi, t. The definitions for the variables are for the variables are provided in the footnotes of Table 2. All models are esti­
provided in the footnotes of Table 2. All models are estimated using firm-level mated using firm-level clustering to produce robust standard errors. Continuous
clustering to produce robust standard errors. Continuous variables are winsor­ variables are winsorized at the 1% and 99% to mitigate the outliers. The symbols
ized at the 1% and 99%. The symbols *, **, and *** indicate statistical signifi­ *, **, and *** indicate statistical significance at the 10%, 5%, and 1% levels,
cance at the 10%, 5%, and 1% levels, respectively. respectively.

7
H.T.T. Le et al.
Four auditor. The untabulated regression results of Eq. (2) show that
auditor specialization also has a negative relation with the cost of equity
at the 5% significant level. The results confirm that investors perceive a
reputable auditor to be of higher quality and require a lower cost of
equity for the related auditee.
5. Conclusions
This paper examines the association between audit quality, accruals
quality, and the cost of capital in the context of an emerging market. We
use auditor size as a proxy for audit quality and the industry-adjusted
ratio of earnings to prices as a representative for the cost of equity.
Using a sample of Vietnamese listed companies, the findings show that
big audit firms have a significant negative association with the cost of
equity, which means firms with a Big Four auditor have a lower cost of
equity than firms with a non-Big Four auditor. The findings also reflect
that firms with higher accruals quality are connected with a lower cost
of equity, which implies that accruals quality is a risk-price factor in the
Vietnamese stock market. The findings confirm the information quality
theory where a reputable auditor is expected to improve the reliability of
an auditee's financial statements, and in line with the prior studies
concerning the value relevance of perceived audit quality and earnings
quality to the pricing of equity capital, such as Francis et al. (2005),
Azizkhani et al. (2010), Persakis and Iatridis (2015), Soon Kim et al.
(2020). However, the results are not in line with prior empirical evi­
dence from Khurana and Raman (2004) that auditor litigation risk is
more important than an auditor's brand-name reputation in the capital
market. The results suggest that the governance role of a reputable
auditor is important in an emerging market with a relatively lower level
of investor protection.
We also observe that the cost of equity capital is affected by other
factors. The industry-adjusted earnings-price ratio is likely to reduce as
firms have a higher market value of equity, a higher ratio of book to the
market value of equity, and a higher Beta value. In addition, firms that
are financed with more debts have a lower value of the industry-adjusted
earnings-price ratio. In contrast, Vietnamese firms with a higher growth
rate have a higher ratio of earnings to price. These findings are consis­
tent with previous studies (Basiruddin et al., 2014; Eliwa et al., 2016;
Francis et al., 2004; Francis et al., 2005).
The study extends the current literature by providing evidence on the
relationship between audit quality, accruals quality, and the cost of
equity capital in the context of an emerging market with civil law
characteristics. The findings have implications for managers and regu­
lators. First, the study highlights the importance of maintaining high-
quality accounting information and ensuring sound auditing practice
for corporations. Further, the study confirms that selecting a quality
auditor plays a role in good corporate governance and delivers a signal
to investors about a firm's commitment to the integrity of financial
reporting, which has economic consequences on the firm's cost of cap­
ital. For regulators, the study shows that the reliability of financial
reporting matters to capital market participants. Therefore, the gov­
ernment authorities should take rigorous measures to ensure the
enforcement of compliance with accounting and auditing regulations.
Future studies can extend the analysis to the impact of audit quality and
financial reporting quality on other aspects of investors' decision-
making, such as investors' trading behavior.
Acknowledgement
This research is funded by the University of Economics Ho Chi Minh
City.
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