Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014РАЗДЕЛ 2КОРПОРАТИВНАЯ
ОТЧЕТНОСТЬИ АУДИТ
SECTION 2
CORPORATE REPORTING
AND AUDIT

WHAT DETERMINES AUDIT INDEPENDENCE AND EXPERTISE
IN RUSSIA? FIRM-LEVEL EVIDENCE
Ichiro Iwasaki *Abstract
Using a unique dataset of joint-stock companies, we explore the corporate audit system in transition
Russia. In comparison with companies in Western and Asian Pacific states, Russian firms have aweaker audit system in terms of the independence and expertise of the audit committee and theexternal auditor. Board composition, foreign investment, and affiliation with a business group arehighly important factors determining audit committee composition and audit firm choice as well as a
combination of the two auditing bodies. However, each of these factors has a clearly distinct impact.
Moreover, empirical evidence suggests that government ownership, company size, fund procurement
activities, and overseas advancement significantly affect audit independence and expertise in Russia.**
Keywords: Audit Independence and Expertise, Board Composition, Business Integration, Foreign
Investment, Russia
JEL: G34, K22, L22, M42, P31, P34* Institute of Economic Research, Hitotsubashi University, 2-1 Naka, Kunitachi City, Tokyo 186-8603, Japan
Tel.: +81-42-580-8366 / FAX: +81-42-580-8333
E-mail: iiwasaki@ier.hit-u.ac.jp** This paper is the product of a Japan-Russia joint research project entitled “Corporate Governance and Integration Processes in
the Russian Economy” launched by the Institute of Economic Research, Hitotsubashi University (Tokyo), and the Institute forIndustrial and Market Studies, Higher School of Economics (Moscow). The research was financially supported by grants-in-aid
for scientific research from the Ministry of Education and Sciences in Japan (Nos. 19402023; 21402025; 23243032), the Inamori
Foundation, the Institute of Internal Auditors-Japan, the Joint Usage and Research Center of the Institute of Economic
Research, Kyoto University and Hitotsubashi University, and the Zengin Foundation for Studies on Economics and Finance. I
thank Simon Commander, Daniel Ferreira, Sergei Guriev, Norio Horie, Anne Loft, Fumikazu Sugiura, Riichi Tabata, Ann
Vanstraelen, and an anonymous referee for their valuable comments and suggestions, Kazuhiro Kumo for providing usefulmaterials, and Jim Treadway for his editorial assistance. Needless to say, all remaining errors are mine.

1. Introduction

independent auditing mitigates agency conflict
between owners and managers through the

In the achievement of sound company management,
the role of auditing cannot be overemphasized. In fact,
it has been repeatedly verified that high-quality

81Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014
enhancement of management discipline.22 If thoroughcorporate auditing is highly valued even in thedeveloped market economies of the United States andWestern Europe, the significance of well-performing
audit systems is certain to increase from the viewpointof ensuring the transparency of corporate management
and the rights of shareholders in countries wheresecurity markets are undeveloped and theconcentration of property rights is noteworthy(Méndez and García, 2007).
Transition economies, such as those in Russia
and Central and Eastern Europe, are not exceptions.
In these economies, although 20 or more years havepassed since the breakdown of the Communist Bloc,
their security markets and banking systems are stilltaking shape, and, consequently, the market forcorporate control and financial institutions have
limited potential influence on managerial discipline ofdomestic companies. Under such circumstances, there
is a growing tendency in the transition economies togive more attention to the role of corporate auditing.
In fact, the Russian federal government recognizes
that the establishment of an effective audit system is
one of the critical policy issues that will make a great
contribution to improving corporate governance inRussian firms; hence, investigation into the actual
state of corporate activities in this field is strongly
desirable for policy makers (National Council on
Corporate Governance, 2010). However, to the best of
our knowledge, there have been no firm-level
empirical studies of this subject, although somestudies have addressed corporate auditing in Russia(Sweetman et al., 1999; Sucher and Bychkova, 2001;
McGee and Preobragenskaya, 2005; Samsonova,
2007; 2009). To fill this void, in this paper, we
empirically analyze the firm-level determinants ofaudit independence and expertise in Russia.
Besides the novelty of research, we makecontributions to the auditing literature in the following
manner: First, emerging markets with notably
different political and economic circumstances fromthose of developed economies provide valuable
research opportunities to redefine the significance androle of corporate auditing (Lin and Liu, 2009).23
Moreover, studies of Russia and other former socialist
transitional countries, in which government
regulations on corporate governance are relatively
moderate in comparison to those in developed
economies and, accordingly, firms have a wide rangeof discretionary powers over their audit systems, arevery useful for discovering the firm-level

determinants of audit activities. In this paper, we
examine the manner in which political and economic
forces and incentives emerging in a transition
economy with significantly different settings fromthose in advanced states influence corporate auditing.
Furthermore, with Russia as a target country, we
study the factors affecting audit independence andexpertise in greatly different legal settings from the
U.S. and European common law countries on which
the vast majority of empirical literature focuses. In
Russia, the joint-stock company is the most accepted
legal form of incorporation among middle-sized andlarge companies (Iwasaki, 2007a). According to thelaw, Russian joint-stock companies should establish
an audit committee (revizionnaya komissiya in
Russian) as the statutory company body of corporate
auditors. Unlike in the U.S. and many other European
countries, however, the Russian audit committee is
not a board subcommittee comprised of members of
the board of directors. In addition, Russian law
prohibits board directors to concurrently hold a postin their company's audit committee. In this sense, theaudit committee in Russian firms is rather closely
related to the board of corporate auditors in Japan andthe board of statutory auditors in Italy. 24 Therefore,
we attempt to develop and empirically verify atestable hypothesis regarding the determinants of
independence and expertise of the Russian audit
committee, taking the above unique legal conditions
into account along with specific political andeconomic factors in transition Russia.
In addition, in contrast to preceding studies, we
examine both the audit committee and the external
auditor (audit firm) in combination to provide acomprehensive assessment of the audit system in
Russian corporations. Here, we deal with not only
audit committee composition and audit firm choice
individually but also the possible combination ofthese auditing bodies. To this end, using a
multinomial Logit model, we propose a new empiricalmethodology in order to examine the determinants ofcomprehensive choice of the audit system by Russian
firms.
The main questions of this study are as follows:
As discussed later, a general shareholder meeting in a
Russian joint-stock company has the exclusive rightto appoint auditors. Under certain conditions,however, the board of directors is allowed to propose
auditor candidates at its discretion to a generalshareholder meeting. Moreover, the board of directors
is granted the right of pre-negotiation with external
auditor candidates (accountants or audit firms).

22

For instance, see Watts and Zimmerman (1983), Francis
and Wilson (1988), Craswell et al. (1995), Fan and Wong(2005), and Abbott et al. (2010). In addition, Fields et al.
(2001) and Turley and Zaman (2004) provide an excellent
overview of this research area.
23
In addition, see Ball et al. (2000) and Wang et al. (2008) for
their presentations on the importance of the comparative
study of corporate accounting in different institutionalsettings.

24

82

The mission of these auditing bodies in Japan, Italy andRussia are not greatly different from the audit committee inthe US, the role of which includes monitoring the integrity ofcompany’s financial statements, overseeing the company’s
relationship with and monitoring the independence of theexternal auditors, and monitoring the internal controls andthe compliance with the legal and regulatory requirements,and so forth.

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Therefore, it is presumed that the board of directors
has the right to select and propose external auditors toa general shareholder meeting. In earlier research(Iwasaki, 2008; 2009), we examined the determinantsof the composition of the board of directors and foundthe power balance in a general shareholder meeting ofa company, or, in other words, the company
ownership structure, is clearly reflected in thecomposition of the corporate board. In such a case,any proposal by the board of directors for theselection of a corporate auditor or an external auditor
is highly likely to be adopted as a resolution at a
general shareholder meeting without any difficulty. If
this statement is true, the composition of the board of
directors will be clearly evident as a highly importantelement in the corporate audit system in Russia. Thus,
testing this hypothesis is a focal point of the empiricalanalysis in this paper.
Along with the board of directors, specificshareholders may also have a substantial influence on
the audit system of the companies in which they
invested. As stressed in preceding studies (Citoron
and Manalis, 2001; Wang et al., 2008), also in Russia,
large shareholders, foreign investors, and thegovernment are noteworthy outsider owners who maystrongly demand transparency of their company
financial activities as well as reliability of theaccounting statements. In addition, business groups
that emerged as a result of intensive businessintegrations across the federation in recent years arealso considered to play an important role in thecorporate governance of affiliated firms in Russia(Iwasaki, 2007b). Estimating the influence of thesefour types of shareholders on the audit system is also
an important issue in the empirical analysis in thispaper.
Furthermore, the audit system of a Russian jointstock company can be affected by other factors,
including organizational structure and businessactivities of the company as well as the development
and market structure of the domestic audit industry.
As noted later, many studies of developed economies
have demonstrated that a series of factors, including
companysize,
businessdiversification,internationalization, reliance on market financing, andthe use of bank credits, significantly influences theaudit system and its activities. In our empiricalanalysis, the impact of these potential determinants
will also be examined to assess whether or not theempirical findings from developed economies areapplicable to Russia.
To achieve these goals, we conduct an empiricalanalysis based on a unique dataset of joint-stockcompanies obtained from a nation-wide enterprisesurvey in 2005.
Our empirical evidence strongly suggests that,when compared to companies operating in Westernand Asian Pacific states, Russian firms compose aquestionable audit system in terms of the
independence and expertise of the audit committee

and the external auditor. Our empirical analysis
suggests that the board composition, foreign
investment, and affiliation with a business groupthrough stock ownership are highly important factors
determining the audit committee composition and theaudit firm choice as well as a combination of the two
auditing bodies. At the same time, however, it is also
apparent that the scope of the impact of these threefactors differed greatly. In addition, we found thatgovernment ownership, company size, fundprocurement
activities,andbusinessinternationalization have significant impacts on theaudit system of Russian firms. To sum up thisempirical evidence, we have seen that audit
independence and expertise in Russia are greatly
affected by the political and economic factors
characterizing a country’s transition economy (e.g.,
the role of the federal government and emergence ofbusiness groups) as well as the elements, thestatistically significant effect of which previous
studies of developed economies have repeatedly
verified (e.g., board composition and foreign
investment).
The remainder of this paper is organized asfollows. Section 2 examines the legal framework andmarket environment of the corporate audit in Russia.
Section 3 describes the data used in this study andoverviews the actual state of the audit system in jointstock companies. Section 4 presents the testable
hypotheses regarding the determinants of audit
independence and expertise in the context of a
Russian transition economy, and Section 5 conducts
empirical analysis. Section 6 summarizes the major
findings and concludes the paper.
2.
Legal
FrameworkandMarketEnvironment of the Corporate Audit inRussiaIn Russia, the foundation of the legal framework forthe corporate audit of joint-stock companies is madeup of the Civil Code, the Federal Law on Joint-Stock
Companies (Law on JSCs), and the Corporate
Governance Code (CG Code).25 The Civil Code andthe Law on JSCs do not make companies with board
committees, such as those established in the U.S. andmany European countries. Rather, as reported in the
Introduction, the Russian corporate law adopts an
institutional design in which an audit committee isestablished under the general shareholder meeting as a
statutory company body of corporate auditors.
25

83

These provisions refer to Part I, Chapter 4 (Art. 96 to 104)of the Civil Code of November 30, 1994, the Federal Law
on Joint-Stock Companies of December 26, 1995, and the
Resolution of the Federal Commission for the Securities
Market dated April 4, 2002, regarding the recommendationof the adoption of the Corporate Governance Code. The
description of this section reflects the contents of the laws
and regulations that were in effect in Russia during theperiod of the joint enterprise survey that was the basis of
the empirical analysis.

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Regardless of their form of incorporation,company size, and public stock offering, all jointstock companies in Russia are required to establish an
audit committee. The number of members composing
the audit committee is not regulated by law. The
appointment of auditors is an exclusive right
exercised at the general shareholder meeting, and it isan ordinary resolution matter that cannot be delegatedto the board of directors or an executive body.
Although there is no special provision concerning
outsider auditors, the independence of the audit
committee in terms of personnel composition within
the company is secured by prohibiting auditors fromconcurrently holding the position in the board of
directors or other executive organs. Moreover, theLaw on JSCs of Russia simultaneously prohibits
directors and other executive officers from exercising
their voting rights when electing audit committee
members.
A shareholder who possesses 2% or more voting
shares has the right to propose auditor candidates at a
general shareholder meeting. Meanwhile, when no
shareholder proposes auditor candidates or thenumber of auditor candidates necessary for the
resolution of the general shareholder meeting cannot
be ensured, the Law on JSCs allows the board of
directors to propose auditor candidates selected attheir discretion to a general shareholder meeting.
Following developed countries, also in Russia,
the external auditor and the audit committee are
regarded as the two mainstays of corporate audit(Bulgakova, 2005; Iwasaki, 2007a).26 In accordancewith the provisions of the Civil Code and Audit
Activity Law,27 a legal external audit by a certified

public accountant or an audit firm is mandated to an
open joint-stock company28 in which stocks are freelytransferable to third parties and open to public stock
offerings as well as to a company in which annual
sales are 500,000 times or more than the official
minimum wage or the asset balance at the end of theterm on the balance sheet exceeds the wages by
200,000 times or more. Generally, the vast majority of
middle-sized and large enterprises in the industrial
and communications sectors are in this category. The
firms we surveyed were no exception.
The Law on JSCs stipulates that the external
auditor is approved (not “selected”) at the generalshareholder meeting and the compensation for thisduty is determined by the board of directors. Although
the Law on JSCs does not clearly specify who has theright of submitting a proposal for the selection of an
external auditor to the general shareholder meeting, it
is obvious from this provision that the board of
directors is delegated the right of pre-negotiation withnominee external auditors for the sake of its company.
Therefore, it is presumed that the board of directors
has such power.29
The selection of an external auditor is greatly
affected by the development and structure of the audit
industry as the supply side. Interaudit, which wasestablished in 1987 on the basis of the resolution of
the Cabinet of Ministers of the USSR, was the first
audit firm in modern Russian history and a sort ofnational policy corporation solely engaged in the
mandated audit of foreign joint venture companies(McGee and Preobragenskaya, 2005). Since then,amid ongoing drastic market-oriented economic
reform and the denationalization of business activities
triggered by the end of the socialist system, the needsof external audits have also expanded dramatically.
As a consequence, in 2005, the number of certified
public accountants and audit firms reachedapproximately 30,000 and 3,000, respectively. 30

26

Now, in Russia, leading listed firms classified into the Aclass quotation list are required to prepare financial
statements in strict compliance with International Financial
Reporting Standards and submit them to the securities
authority. In addition, all other listed firms and specificunlisted firms that meet certain conditions are required toprepare statutory financial statements based on thedomestic accounting rules. The financial statements ofRussian corporations, not only those of the listed firms but
also those of many unlisted firms, are broadly available
through the Internet, commercial databases, or othersources, and investors as well as counterpart companies
make extensive use of these disclosed statements formaking business decisions. As a consequence, theaccountability of external audits that endorse the reliabilityof these financial statements has been thoroughly
examined. In fact, it has often been reported that theprosecutor’s office or shareholders have indicted certified
public accountants or audit firms for their involvement inmisrepresentations or false statements about the financial
results of their clients (For relatively recent cases, see thearticles dated April 1, 2010, and October 21, 2010, in the
Russian daily newspaper “Kommersant,” among others). Ina court case over audit reporting on the major petroleum
company Yukos, its audit firm, PricewaterhouseCoopers,
was convicted and fined 16.8 million rubles in March 2007.
This has been recognized as a symbolic episode (Anon.,2007).
27
The Federal Law on Audit Activity of August 7, 2001.

28

According to the Civil Code and the Law on JSCs, anindividual who intends to set up a joint-stock company inthe territory of Russia must choose as a legal form ofincorporation either an open joint-stock company or aclosed joint-stock company in which a preferential
acquisition right for the transferred stocks is granted toother shareholders and the company (Civil Code, Art. 97
and Law on JSCs, Art. 7). In terms of minimum capital,
number of shareholders, and information disclosure
obligation, a certain difference is established between the
two types of companies. For more details on this point, see
Iwasaki (2007a; 2007c).
29
In fact, in almost all cases that we investigated, the generalshareholder meeting approved the external auditor basedon a proposal of the board of directors.
30
According to the American Institute of Certified Public
Accountants (http://www.aicpa.org/) and the European
Federation of Accountants (http://www.fee.be/), the numberof certified accountants per one million population in thesame period is about 1,100 in the United States (total
330,000 accountants and 298,000,000 population) andabout 930 in the 32 European countries (total 500,000
accountants and 540,000,000 population). In contrast, the84Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

During this period, international audit firms entered
Russia one after another after Ernst & Young’s
advance in 1989. By 2005, approximately 25 foreign
audit firms opened branch offices or establishedsubsidiaries in Russia (Bulgakova, 2005; Smirnov,
2005; Samsonova, 2009). In this way, the Russian
audit industry was created in a shorter period of timethan that in Western countries.
The presence of foreign-affiliated companies in
the Russian audit market is prominent. Most of them
are at the top of the sales ranking of audit firms, fromPricewaterhouseCoopers down (Iwasaki, 2007a).
Reports indicate that these foreign audit firms are
performing an enlightening and educational role in theindustry. They have established a reputation for theirwork quality and independence from clients. In
particular, the strategic advantage of hiring a leadinginternational audit firm as an external auditor is
widely acknowledged among Russian investors andmanagement executives. Meanwhile, the major clientsof international audit firms are limited to thesubsidiaries of multinational enterprises coming fromdeveloped economies and Russian big businesses(Sucher and Bychkova, 2001; Samsonova, 2009).
Among domestic audit firms, there are morethan a dozen national major firms that have head
offices in the capital of Moscow and in SaintPetersburg. They are engaged in fierce competition
for customer acquisition with one another or with thelocal small and medium-sized audit firms. However,
the market evaluations of Russian audit firms are
generally low irrespectively of the company size andbusiness scale (McGee and Preobragenskaya, 2005;
Guttsait, 2007). Therefore, at least in the first half of2005, when our survey was implemented, it was hardto say that these national major audit firms had
established a good reputation and were evidently
superior to the local small and middle-sized audit
firms in terms of expertise and independence fromclient companies. The insufficiency of market
selection and differentiation in the audit industry
clearly reflect the short history of external auditing in
Russia.

Hitotsubashi University and the Higher School of
Economics.31 Between February and June 2005,
professional interviewers from the Yuri Levada
Analytical Center (the former All-USSR Public
Opinion Poll Center) spoke with 859 industrial andcommunications enterprises from 64 federal districts.
The survey team received 822 responses from highranking company managers. Of these, 94.8% werecompany presidents, CEOs, general directors, or vicepresidents. The remaining respondents were board
chairmen (1.6%) or senior managers responsible forcorporate governance affairs (3.6%).32
All firms are JSCs. The average number ofworkers for each surveyed firm was 1,884 (median:465), and the total number of workers of the 822 firms
was 1,549,008, which accounted for 10.3% of thetotal workforce in both the industrial and thecommunication sectors through 2004 according to
official statistics (Rosstat, 2005). The sample isrepresentative of the national population of middlesized and large firms in its regional and sectoralcomposition.33
Of the 822 executives in the companies
surveyed, 690 officers (83.9%) gave detailed answers
to our questions concerning the audit committee of
their companies in terms of the number of audit
committee members and their basic attributes. As
shown in Table 1, the audit committee of a Russian
joint-stock company is composed of an average
number of 3.5 corporate auditors (median: 3).
According to the survey results of the preceding 22
studies on the composition of the auditing body of
5,052 companies in 25 countries around the world(Table 2), these companies set up an audit committee
or a board of corporate/statutory auditors averaging 3
to 4 auditors. In this sense, Russian joint-stockcompanies organize an audit committee that meets theinternational practices in terms of its personnel size.
The above 690 companies have appointed a totalof 2,438 corporate auditors. In this paper, audit
committee members selected from among rank-andfile employees, labor union members, andmanagement staff, excluding executive officers, who
are prohibited from concurrently holding a position in

3. The Audit System of Russian Firms
from Information Obtained In the 2005
Enterprise Survey

31

See Dolgopyatova and Iwasaki (2006) and Dologopyatova
et al. (2009, Appendix) about the details of the survey.
32
The questionnaire used for the joint survey was carefully
designed by the project members and experts of theLevada Center based on similar surveys conducted in thepast, although it is impossible to completely avoid bias andmoral hazard problems with respect to self-reporting. In
addition, the fact that one of three companies that we
initially contacted refused to participate in the survey may
have a potential bias of initial non-response.
33
The detailed sectoral breakdown of the 822 companies is
as follows: (1) Fuel and energy (66 firms; 8.0%), (2)Metallurgy (36 firms; 4.4%), (3) Machine-building and metal
working (255 firms; 31.0%), (4) Chemical and petroleum (33firms; 4.0%), (5) Wood, paper, and paper products (63firms; 7.7%), (6) Light industry (51 firms; 6.2%), (7) Foodindustry (169 firms; 20.6%), (8) Construction materials (78firms; 9.5%), and (9) Communications (71 firms; 8.6%).

As reported in the previous section, the legal
framework and market environment surrounding thecorporate audit in Russia are very different from thosein advanced countries. With this in mind, in thepresent section, we describe the data used for thisstudy and review the actual state of the audit system
in Russian companies.
The data in our empirical analysis are based on
the results of an enterprise survey sponsored bysame figure in Russia with a total population of 143,000,000
in 2005 is only about 210, suggesting theunderdevelopment of the audit industry in this country.

85

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014
the audit committee, are defined as “insider auditors,”
and those selected from individuals other than thosereported above are defined as “outsider auditors”(Due to constraints of the methodology used in the
joint survey, no distinction was made between
affiliated and non-affiliated individuals with regard tooutsider audit committee members. In addition, we
acknowledge that there may be other unobserved
connections that do not permit these individuals to be
independent of the managerial and/or controlling
owner power). Table 1 and Figure 1 report the
breakdown of the 2,438 audit committee membersclassified according to six attributes as well as basic
statistics of their attributes. As shown in Figure 1,

insider auditors account for the majority of auditors(56.0%). In addition, most of the insider auditors are
selected from those who represent the interests ofrank-and-file employees and the labor union. On theother hand, the most prominent group among outsider
auditors is composed of representatives of private
shareholders and accounts for 43.9% of outsider
auditors. The expert auditors selected from specialist
occupations, including lawyers, accountants, andother professionals, form the second group with adifference of 6.4%. Auditors sent from thegovernment account for only 5.1% of all audit
committee members and 11.8% of outsider auditors.

Table 1. Descriptive statistics on the total number of audit committee members and the number of corporate
auditors by their attributes in 690 joint-stock companies
25
75
percentile percentile
40
3
4
30
1
3
30
0
3
5
0
0
12
0
3
9
0
1
10
0
1
5
0
0
7
0
0

Mean S. D. Median Min. Max.
Total number of audit committee members
Insider auditors
Auditors representing rank-and-file employees and labor unions
Other insider auditors
Outsider auditors
Auditors representing private shareholders
Expert auditors
Auditors representing the government
Other outsider auditors

3.53
1.98
1.76
0.22
1.55
0.68
0.58
0.18
0.11

2.14
1.97
1.97
0.78
1.77
1.28
1.18
0.58
0.56

3
2
2
0
1
0
0
0
0

1
0
0
0
0
0
0
0
0

Notes: This table contains descriptive statistics on the total number of audit committee members and the number of corporate
auditors by their attributes of 690 Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey
conducted in 2005. Sample companies were randomly selected among firms with more than 100 workers in the industrial andcommunications sectors. For more details, see Section 3 of the paper.

Figure 1. Classification of 2,438 corporate auditors of 690 companies by their attributes

Notes: The samples are Russian joint-stock companies that participated in the Japan-Russia joint enterprise survey conducted in 2005. "Insider
auditor" denotes an auditor selected from among rank-and-file employees, labor union members, and management staff, and "outsider
director" denotes an auditor selected from among persons other than the above-mentioned ones defined as insider auditors.

From the above results, we can ascertain that,among the companies surveyed, the means (median)of the proportion of outsider auditors and that ofexpert auditors to all audit committee members,
which are typical indices measuring the independence

and expertise of an audit committee, are 42.8%(33.0%) and 16.7% (0.0%), respectively. As describedin the previous section, in Russia, the Law on JSCs
prohibits corporate auditors from concurrently
holding the position of board member or other86Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

company executive. It also prohibits directors andother executive officers from exercising their voting
rights when electing audit committee members.
Nevertheless, according to the international
comparison on the proportion of outsider auditors
shown in Table 2, the audit committee in Russian
joint-stock companies is notably inferior not only to
North American and European enterprises but also to
Asian Pacific enterprises in terms of its independence.
However, the matter does not end here. As illustrated
in Figure 2, the remarkable feature of the audit
committee of Russian joint-stock companies is thepolarization of its composition due to the proportionof outsider auditors. This polarization phenomenon is
also evident in the composition of the board of
directors (Iwasaki, 2008) and is a distinctive

characteristic of the Russian corporate governance notpresent in other former socialist economies.
The survey results comprise information on
audit firms with which 771 surveyed companies had
made a contract to implement an external audit. As
described in the previous section, among nearly 3,000
audit firms operating in Russia, there is no questionthat the international audit firms pride themselves inhaving the highest reputation in terms of the quality of
their auditing work and independence from clients.
With regard to domestic audit firms, unlike
researchers of such issues in developed countries,
specialists have not reached a consensus, either
currently or at the time of the survey, with regard towhether the selection of a national major audit firm
clearly reflects the will of the clients to seek a better
external audit.

Table 2. International comparison of the total number of corporate auditors and proportion of outsider auditors
Analysis
periodNorth America
U.S. listed firms 1
U.S. major firms 2
U.S. listed firms 3
U.S. commercial banks 4Canadian non-financial firms 5
Canadian major firms 6
Canadian listed firms 7 a
EuropeListed firms in 15 EU countries 8
U.K. non-financial listed firms 9 a
U.K. major firms 10
German listed firms 11
Austrian listed firms 11
Belgian listed firms 12 b
Spanish non-financial listed firms 13
Spanish listed firms 14 b c
Swiss listed firms 15 a
Russian joint-stock companies 16
Asian-PacificJapanese listed firms 17
Chinese IPO firms 18
Chinese Hong Kong listed firms 19 a
Singaporean and Malaysian listed firms 20 aAustralian listed firms 21 aAustralian firms 22 a
New Zealand firms 22 a
New Zealand listed firms 23 b

Samplesize

1992-93
1992-96
2000
2000-01
1993-97
1994
1997-2003

692
282
167
989
66
627
72

2008
2001-02
2006
2007
2007
2001-02
1998-2001
2003
2004
2005

270
259
71
150
56
29
75
69
167
690

2009
2001-04
2007
2000
1997
2001
2001
2004-05

215
184
46
252
109
81
28
96

Total number of corporate Proportion of outsider
auditors
auditors(%)
Mean S. D. Median Mean S. D. Median

4.53
4.48
4.31

79.6
85
1.47

4
4

3.5
3.56

0.98

3
3

88.0
86.6
82.3
91.1

3.12
4.11
4.0
4.13
3.69
3.47

0.05
2.75

3

73
34.7

0.99

3

3.3
3.53

2.14

3

4.2
4.41
3.63

2.08
1.00

3
3

3.6
4.58
4.61
3.46

0.99
2.14
1.50
0.94

3

83
90
91
67
42.8

16.8
16.2
15.7

100.0
100.0
75.0
100.0

34.1

33.0

18

100
100

40.7

33.0

17.1
10.4
27.4
40.8
39.0
13.6

81.7
66.7
66.7

72.7

3

83.2
69.7
65.9
57.2
62.7
94.1

100

Notes: This table lists the total number of corporate auditors and the proportion of outsider auditors in North-American, European, andAsian-Pacific companies based on the following 23 studies: 1: Klein (2002b); 2: Xie et al. (2003); 3: Chan and Li (2008); 4: Zhou and Chen
(2004); 5: Erickson et al. (2005); 6: Beasley and Salterio (2001); 7: Charitou et al. (2007); 8: RiskMetrics Group (2009); 9: Mangena andTautingana (2007); 10: Adelopo and Jallow (2008); 11: Velte (2010); l2: Willekens et al. (2004); 13: Ruiz-Barbadillo et al. (2003); 14:
Méndez and García (2007); 15: Canepa and Ruigrok (2005); 16: this study; 17: Fujishima (2010); 18: Lin and Liu (2009); 19: Lin et al.
(2009); 20: Bradbury et al. (2004); 21: Cotter and Silvester (2003); 22: Goodwin (2003); 23: Sharma et al. (2009).
aProportion of independent auditors.
Proportion of non-executive officers.
c
The proportion of outsider auditors is calculated using the data of the proportion of executive officers.
b

87Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Figure 2. Proportion of outsider auditors in the audit committee of 690 Russian joint-stock companies

Notes: The samples are Russian joint-stock companies that participated in the Japan-Russia joint enterprise survey conducted
in 2005. The proportion of outsider auditors is measured by dividing the number of outsider auditors by the total members of
the audit committee for each sample firm. The basic statistics of the proportion of outsider auditors are as follows: mean:
42.82; standard deviation: 40.70; median: 33; skewness: 0.25; kurtosis: 1.45.

With attention to these facts, we asked thesurveyed companies the following questions about
their audit firm as the second-best way to objectively
measure their needs for the quality of external audits:(1) Is it an international audit firm? (2) Is it a Russian
audit firm with its head office separate from thecompany location? (3) Is it a local Russian audit firm?
In our opinion and in that of Russian experts, theaction of a company boldly appointing aninternational audit firm or a non-local Russian audit
firm as its external auditor could, in many cases, beregarded as the expression of its management attitudeof seeking a better external audit.34 The survey results
are shown in Figure 3. Of 771 surveyed companies,
64, or 8.3% of the total, appoint an international audit
firm as their external auditor, and 179, or 23.2%, enter
into an external audit contract with a non-local
Russian audit firm. Thus, as expected, most of thesurveyed companies choose a local Russian audit
firm, even though such firms are reported to haveproblems from the viewpoint of the quality of theirauditing work and independence from clients (McGeeand Preobragenskaya, 2005).
Based on the discussion above, our empiricalanalysis relies on the aforementioned proportions ofoutsider auditors (AUDCOM) and expert auditors(AUDEXP) to the total members of the audit
committee and an ordinal variable, which takes avalue of 0 for companies entrusting their external
audit to a local Russian audit firm, 1 for those
appointing a non-local Russian audit firm as theirexternal auditor, and 2 for those making an external
audit contract with an international audit firm, as theaudit firm attribute variable (AUDFIR). For brevity,
these terms are hereinafter referred to as the “audit
system variables.”According to Hotelling’s T2 test, there is astatistically significant difference at the 1% level inthe mean vector of the audit system variables between
industrial enterprises and communications enterprises(T2=82.199, F=27.316, p=0.000). The results of amore detailed comparison among industries areshown in Table 3. In terms of the proportion ofoutsider auditors and the attributes of audit firms,
communications enterprises are superior to industrial
enterprises at the 1% significance level. Meanwhile,no statistical difference in the proportion of expert
auditors is confirmed between the two sectors. A
multiple comparison of eight industrial sectors and thecommunications sector regarding the two variables of
AUDCOM and AUDFIR rejects the null hypothesisthat the mean values of these nine sectors are equal at
the 1% significance level. These facts strongly
suggest that it is necessary to pay attention to thedifferences among sectors when empiricallyexamining the determinants of audit independence
and expertise in Russia.

34

Although this is true for local companies, it is never applied to thecompanies operating in the capital and Saint Petersburg, where thenational major audit firms are concentrated. Accordingly, if an audit
firm is a domestic one, a survey that asks whether such an audit firm
is a non-local firm removed from the client company or a local one
could lead to an underestimation of the management attitude about
the quality and independence of the external audit of companies inlarge cities. However, we believe that this will not diminish thepersuasiveness of the empirical results of this study or substantiallydistort the implication, although it is a disadvantage of our analysis.

88Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Figure 3. Classification of external auditors (audit firms) of 771 joint-stock companies by their attributes

Notes: This figure classifies the audit firms that conclude an external audit contract with 771 Russian joint-stock companies
that participated in a Japan-Russia joint enterprise survey conducted in 2005. "Local Russian audit firm" denotes a domestic
audit firm located in the same federal district of the surveyed company.

Table 3. Industry-to-industry comparison of audit independence and expertise

Industrial sector
Fuel and energy
Metallurgy
Machine-building and metal working
Chemical and petrochemical
Wood. paper. and wood productsLight industry
Food industry
Construction materials
Communications sector
N
Comparison between the industrial and communications sectors
t test on the equality of means
Wilcoxon rank sum test
Multiple comparison among 9 industries
ANOVA (F)
Bartlett test (χ2)
Kruskal-Wallis test (χ2)

Audit system variables
Proportion of
Proportion of
Audit firm
outsider auditors expert auditors
attributes(AUDCOM)(AUDEXP)(AUDFIR)
0.404
0.162
0.337
0.707
0.264
0.710
0.569
0.223
0.735
0.427
0.166
0.280
0.441
0.258
0.290
0.419
0.222
0.356
0.211
0.081
0.273
0.325
0.119
0.296
0.277
0.095
0.153
0.726
0.230
1.078
690
690
771
-5.554 ***-5.385 ***-1.456-0.798-9.406 ***-7.436 ***12.480 ***3.831
79.795 ***2.770 ***
38.626 ***12.25918.140 ***62.954 ***67.303 ***Notes: This table presents results from an industry-to-industry comparative analysis of audit independence and expertise in
Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey conducted in 2005. The proportionof outsider (expert) auditors, AUDCOM (AUDEXP), is measured by dividing the number of outsider (expert) auditors by the
total members of the audit committee for each sample firm, and it is a continuous variable taking values of 0.00≤x≤1.00. The
audit firm attribute, AUDFIR, is the ordinal variable that gives a value of 0 to a company hiring a local Russian audit firm as
its external auditor, 1 to a company hiring a non-local Russian audit firm, and 2 to a company hiring an international audit
firm. "Local Russian audit firm" denotes a domestic audit firm located in the same federal district of the surveyed company.
The result of the Welch test is reported instead of the t test when the null hypothesis in which the population variance is equal
is rejected by an F test on homoskedasticity. *** denotes statistical significance at the 1% level.

89Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

As the notable features of the audit system in
Russian joint-stock companies, the four following
points have become apparent: first, Russian firms
organize their audit committees conforming tointernational practice in terms of the total number ofcorporate auditors. Second, the audit committee
independence measured by the proportion of outsider
auditors, however, falls well below the average ofenterprises operating in foreign countries, and, among
Russian enterprises, remarkable polarization takes
place from this viewpoint. Third, the appointment of
an international audit firm as the external auditor isvery limited in Russian practice, and most companies
lean toward external audit contracts with a local
Russian firm. Fourth, regarding the degree of audit
independence and expertise, there is a significant
difference between the industrial sector and thecommunications sector as well as among subgroups ofthe industrial sector.

between company managers and major shareholders
over the shape of its own audit system (RuizBarbadillo et al., 2007). Accordingly, the board
composition becomes the most important internalorganizational factor determining audit independence
and expertise in the company.
There is persuasive logic demanding an audit
system with a high degree of independence andexpertise whereby the outsider board directors fulfill astronger monitoring function than the insider
directors. First, it is necessary to reduce theinformation asymmetry between the outsider directors
and the executive officers to achieve effective
management supervision (Linck et al., 2008). The
realization of high-level audit independence andexpertise can become an effective means to achieve
this objective through a functional synergy effect withthe board of directors (Adams, 1997; Beasley andPetroni, 2001). Second, the board of directors, whose
important responsibilities are the evaluation andapproval of management strategy, must accept acertain number of employees, who have specialized
knowledge and in-house information, as board
members. Hence, by improving the effectiveness of
the audit committee and the external auditor, theoutsider directors can achieve a balance between thenecessity of management supervision and the demand
for specialized knowledge and information forstrategic decision making (Klein, 2002a). Third, theoutsider directors have a strong motive to attempt tomaintain and improve their reputation as astockholder agent for their own career development.
The revelation of false statements in annual securities
reports and other corporate disclosure information andblunders, including the correction and restatement offinancial statements, will lead to a reduction in
confidence. In the worst-case scenario, it is possiblethat they will be exposed to a shareholder lawsuit
regarding negligence of their duties (Cotter andSilvester, 2003; Ruiz-Barbadillo et al., 2007). To
minimize this risk, the outsider directors aim at higher
audit quality to improve the possibility that auditors
will detect and disclose a breach in the accounting
system of their company (Beasley and Petroni, 2001).
Accordingly, as Rainsbury et al. (2008), Baxter(2010), and García-Sánchez et al. (2012) affirm, we
expect that, in Russia, there is a close relationshipbetween the composition of the board of directors andthe independence and expertise of the audit committee
and external auditor in the following sense:
H1: The stronger the presence of outsiders on
the board of directors, the higher independence andexpertise of the audit committee and external auditorof the company required.
According to the agency theory, large
shareholding renders supervision by the statutoryorgans of the company less necessary because
controlling shareholders have a sufficient incentive
and capability to effectively monitor and discipline
the top management of their companies (Rediker and4. Determinants of Audit Independence
and Expertise in Transition Russia:
Hypothesis Development
Based on the motivation described in the Introduction,
as potential factors greatly affecting audit
independence and expertise in Russian firms, we pay
special attention to (a) the composition of the board of
directors; (b) large shareholding; (c) foreign
investment; (d) ownership by the government; and (e)affiliation with a business group through stock
ownership. In this section, we present testable
hypotheses regarding the causal relationship between
these five factors and audit independence andexpertise in a Russian joint stock company with thestructural features revealed in the previous section.
We also present other possible determinants toconsider in an empirical analysis.
As reported in Section 2, in Russia, the board of
directors has, by law and practice, the exclusive rightto submit a proposal for the approval of an external
auditor at the general shareholder meeting. However,with some conditions, the board of directors is alsoable to select candidates at its sole discretion andrecommend them as audit committee members. In
other words, the board of directors is given theauthority to play a highly active role in theorganization of the company’s audit system. The
authority of the board of directors in this function isincreasingly strengthened because the top manager(CEO or company president) and other executives in acompany, who are forbidden from exercising theirvoting rights at the general shareholder meeting, will
try to influence the decision making on the audit
system at the board of directors. Outsider directors arealso sure to act similarly to these executive officers.
Since the vast majority of outsider directors are therepresentatives of private shareholders and thegovernment (Iwasaki, 2008), the board of directors
becomes a main battlefield for the bargaining game90

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Seth, 1995). However, in the countries in which thecorporate control market is underdeveloped or in acase in which the exit cost by selling stock is verysignificant for some reason, major shareholders
possibly exert their bargaining power to enhance themonitoring function of company supervisory bodies
to improve their ability to collect managerial
information or strengthen their authority to dismiss
management executives who fail to increase thecorporate value (Whidbee, 1997). In fact, Piot (2001),
on the basis of his empirical findings from France,
maintains that the Anglo-American principal-agent
model has little explanatory power in the concentrated
ownership framework of corporate governance. It is
likely that the “bargaining hypothesis” (Hermalin andWeisbach, 1998) is more appropriate in Russia, where
social distrust of company managers is particularly
strong.35
Regarding the impact of large shareholding on
audit firm choice, Rusmin et al. (2009) report a
positive
relationshipbetweenownershipconcentration and audit quality from three Asia
Pacific stock markets. Furthermore, Beasley andSalterio (2001) propose and verify their hypothesisthat stockholders who increase opportunities for
effectiveness of the board of directors through theinclusion of greater proportions of outsiders andthrough the segregation of the board chairperson and
CEO positions are more likely to create boards
strongly motivated in appointing audit committee
members with far-reaching experience in accounting
and auditing from outside. Given the high ownershipconcentration, dominant shareholders, who possess atleast 50 percent of shares with voting rights, represent
such company owners in Russia. In fact,
Dolgopyatova et al. (2009) provide supporting
evidence of the positive linkage between dominant
shareholding and good corporate governance practices
in this country. Thus, we expect that, in Russia, thedominant shareholders tend to promote audit
independence and expertise in their companies:
H2: The presence of a dominant shareholder ispositively associated with independence and expertiseof the audit committee and external auditor of thecompany he or she invested in.
The next noteworthy factor in the context of a
Russian transition economy is foreign investment.
Since the start of the new millennium, Russia’s
economy has been booming, and the country has
become a major emerging market. As a result, Russia
is attracting considerable attention from overseas
investors. However, the accumulated foreign direct
investment per capita from 1989, when theCommunist Bloc collapsed, to 2005 was only 459 US
dollars, far short of that of Central and Eastern Europe
countries that became new EU members during thisperiod (Iwasaki and Suganuma, 2009). Domestic
35

enterprises are closed to foreign investors, whose
presence is still weak in the Russian business
community. Furthermore, it is not easy for foreign
investors to communicate with Russian management
executives for several reasons. Consequently, many
overseas investors recognize the serious information
asymmetry with executive officers more thandomestic investors do and deeply fear the damage tothe corporate value due to the opportunistic behavior
of company managers. Hence, it is natural that foreign
stockholders ask their company’s supervisory bodies
to monitor and check the management morethoroughly than domestic shareholders do. The strong
demand for the preparation of financial statements
conforming to the international accounting standards
and high-quality auditing is a direct reflection of theabove. In this respect, Sucher and Bychkova (2001)
reported that, in Russia, foreign investors tend toforce companies to have an external audit by a leadinginternational audit firm. To sum up, the above
arguments lead us to the following hypothesis about
the impact of foreign investment on audit
independence and expertise of Russian companies:
H3: The investment by foreigners enhances
independence and expertise of the audit committee
and external auditor of the company they own.
In the preceding studies, the positive correlation
between foreign ownership and the probability ofhiring international audit firms has been repeatedly
verified (Citron and Manalis, 2001; Guedhami et al.,2009). It is likely that our empirical analysis of
Russian firms will yield a similar result.
In Russia, we cannot overlook the role ofgovernment in corporate governance. Wang et al.
(2008) report a close relationship between
government ownership and the probability of hiring
small local audit firms in China. Guedhami et al.
(2009) find, from an empirical analysis of 176
privatized companies in 32 countries, a significantly
negative correlation between government ownershipand the probability of hiring big four international
audit firms. Meanwhile, according to an empirical
study, which examined the role of state
representatives on a corporate board in corporate
governance, the behavioral pattern of government
directors is greatly different depending on whether
they have been sent by the federal government or a
local one (Frye and Iwasaki, 2011). In this paper, theauthors find that the presence of board directors
representing the federal government significantly
improves the quality of corporate governancemeasured as the degree of compliance with the CG
Code in the company to which such directors havebeen sent. At the same time, representatives ofregional and local governments do not appear to exert
the same effect in their companies. Based on theempirical evidence presented above, we propose to
test the following hypothesis:

In fact, our empirical evidence on the determinants ofboard composition strongly indicates the applicability of thebargaining hypothesis in Russia (Iwasaki, 2008; 2009).

91Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

H4: Shareholding by the regional and local
governments relaxes independence and expertise of
the audit committee and external auditor of thecompany they own, and, in contrast, that by thefederal government strengthens them.
One noteworthy feature of the Russian transition
economy is the burgeoning business integration
among domestic enterprises. In Russia, through stockacquisitions by commercial banks and majorindustrial enterprises, the crossholdings of stocks
among enterprises, and the hostile takeovers by newly
emerged financial cliques led by “oligarchs,” manybusiness groups have been formed at both the federal
and regional levels (Mizobata, 2004; Avdasheva,2005). In fact, the results of our survey indicate that323 (39.3%) of the 822 surveyed companies areaffiliated with a certain business group throughshareholding. This is accompanied by difficult
problems in theoretically forecasting the impact of theaffiliation with business groups on the managerial
discipline and corporate governance of member
companies. However, a series of previous studies hasrepeatedly verified the relatively good management
performance and intensive restructuring activities of
Russian group companies relative to those of
independent companies not belonging to any businessgroup (Kuznetsov and Muravjev, 2000; Perotti andGelfer, 2001; Guriev and Rachinsky, 2005). As an
explanation of the background of this situation, there
is a common understanding among researchers that
relatively more sound corporate governance hasmaterialized within the business group of Russia than
within independent companies (Iwasaki, 2007b). In
addition, from our survey results, evidence supporting
this view has been obtained (Avdasheva, 2007;
Dolgopyatova et al., 2009). Accordingly, it is highly
likely that Russian business groups behave as
institutional investors in the U.S. that influencecompanies in which they invest to improve theirreporting quality by using reputable auditors(Velury et al., 2003). Furthermore, a core groupcompany has a strong motive to establish a unified
and technologically sophisticated audit network
among group companies to effectively perform theauditing of group companies’ accounts subject toconsolidated accounting. Thus, the following
hypothesis can be made about the relationshipbetween the participation in a business group throughstock ownership and audit independence and expertiseof the member company:
H5: Affiliation with a business group improves
independence and expertise of the audit committee
and external auditor of the member company.
As other potential factors affecting audit
independence and expertise in Russian firms, we also
give attention to the effect of the establishment of anopen joint-stock company as a legal form ofincorporation, the succession of state assets, company
size, business diversification, fund procurement fromthe capital market, use of bank credits, past financial
performance, and business internationalization.
In accordance with our findings concerning therelationship between the above factors andmanagement supervision in Russian firms (Iwasaki,
2007b; 2008) as well as the arguments on thedeterminants of audit committee composition andaudit firm choice in the previously described study
and other literature (Abbott and Parker, 2000; Beasleyand Salterio, 2001; Deli and Gillan, 2001; Fan andWong, 2005; Hope et al., 2008; Rainsbury et al.,2008; Baxter, 2010), we expect that the establishmentof an open joint-stock company mitigates the need foraudit independence and expertise because the hightransferability of stocks in an open as opposed to aclosed company replaces the governance function by
the statutory organs of the company. On the other
hand, we predict that all seven factors, namely,company size, business diversification, businessinternationalization, succession of state assets, fundprocurement from the capital market, use of bankcredits, and past poor financial performance, arepositively correlated with audit independence andexpertise. This is due to the fact that the first threefactors induce complexity in company management
and agency problems and the last four factors tend toraise the monitoring pressure on top managementfrom the governments, general public, shareholders,and external fund providers.
In an empirical analysis, in addition to thefactors presented above, we examine the impact of thesize of the audit committee on its independence andexpertise. We also examine the effects of clientdemand for consulting services and the physicaldistance between the capital region and the location of
the company on the audit firm choice. If it isreasonable to expect that, as committee size increases,
a firm’s probability to appoint more independent
auditors with relevant knowledge and experiences
also increases, the size of the audit committee may
positively correlate with its independence andexpertise.36 With regard to the client demand for
consulting services, recent studies on whether theprovision of non-audit services impairs auditor
independence and quality have reached mixed results,
depending on the proxy for audit independence andquality used, the country studied, and the period of
empirical analysis (Kinney et al., 2004; Hay et al.,2006; Lim and Tan, 2008; Duh et al., 2009; Zaman etal., 2011). Thus, the effect of the need for consulting
services is theoretically unpredictable. Further, as
described in Section 2, international audit firms andnational major audit firms are concentrated in thecapital region, and their domestic branch networks
were insufficient in the first half of 2005. Therefore, it
is expensive, in terms of time and money, for a
36

See Beasley and Salterio (2001) and García-Sánchez et al. (2012),
who discuss the positive relationship between the size of the boardof directors and the audit committee independence and expertise in
the context of the Canadian and Spanish economies.

92

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Russian company to entrust an external audit to aleading firm because of the vastness of Russia and the
10-hour difference from the westernmost to theeasternmost region. Accordingly, the greater the
distance between the capital region and a clientcompany, the lesser the likelihood of hiring a nonlocal Russian audit firm.
The theoretical arguments presented in thissection are summarized in Table 4.

Table 4. Theoretical predictions of the impacts of firm organization and business activities on independence andexpertise of the audit committee and external auditor in the context of a Russian transition economy

Presence of outsiders on the board of directors
Presence of a dominant shareholder
Foreign investment
Shareholding by the federal government
Shareholding by the regional and local governments
Affiliation with a business group
Establishment of an open joint-stock company as the corporate form
Succession of state assets
Company size
Business diversification
Fund procurement from the capital market
Use of bank credits
Poor financial performance
Business internationalization
Size of the audit committee
Demand for consulting services
Physical distance between the capital region and the location of the company

Predicted sign
+
+
+
+
+
+
+
+
+
+
+
+
+
?
-

Notes: This table is a summary of the theoretical predictions of the impact of potential factors on independence and expertiseof the audit committee and external auditor in Russia on the basis of the discussion in Section 4 of the paper. The sign '+'denotes a positive correlation between a given factor and audit independence and expertise, '-,' for a negative correlation, and'?' indicates that the effect is unpredictable. The size of the audit committee is regarded as a special factor concerning its
independence and expertise, and the demand for consulting services and the physical distance between the capital region andthe location of the company are considered as special factors affecting the independence and expertise of the external auditor(audit firm).

5. Empirical Analysis

by the regional and local governments, and affiliation
with a business group using DOMSHA with a value of
1 if the company has a shareholder whose ownershipshare exceeds 50 percent in total shares with voting
rights, FORFIR with a value of 1 if the company
accepts foreign investment, FEDGOV with a value of
1 if the company is owned by the federal government,
REGGOV with a value of 1 if the company is amunicipal enterprise, and GROFIR with a value of 1
for firms belonging to a certain business groupthrough stock ownership.
The impacts of the establishment of an open
joint-stock company as a legal form of incorporation
on audit independence and expertise are examinedusing a dummy variable that captures open joint-stockcompanies with 1 (OPECOM). The impact of thesuccession of state assets is captured by the dummy
variables, which indicate whether the company is aformer state-owned (ex-municipal) privatizedcompany (PRICOM) or a newly established company
spun off from a state-owned (municipal) company ora privatized company (SPIOFF). The company size ismeasured by the average annual number of employees(COMSIZ). The extent of business diversification isrepresented by the number of business lines of the

In this section, we test the hypotheses regarding
independence and expertise of the audit committee
and external auditor in Russia. First, we select thevariables to be used in the empirical analysis and thenreport the results of our estimation. Finally, we checkthe overall robustness of the estimation results.
5.1 Variable selection
The focal point of our empirical analysis is the effecton audit independence and expertise of thecomposition of the board of directors, presence of adominant shareholder, foreign investment, andshareholding by the government as well as affiliation
with a business group. Corresponding to thediscussion in the previous section, we estimate theimpact of board composition by using the proportionof outsider directors to the total board members(BOACOM). The effects of the last four factors are
examined with dichotomous dummy variables.
Namely, we test the impact of the presence of adominant
shareholder,foreigninvestment,
shareholding by the federal government, shareholding

93Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

company in accordance with the 2-digit industrial
classifications in the Russian All-Union Classifier of
the National Economy Branches (BUSLIN). The
impact of the fund procurement from the capital
market and the use of bank credits is estimated byusing a dummy variable that has a value of 1 if thecompany issued shares or bonds in the overseas ordomestic stock exchange (MARFIN) and a variable
for the length of the lending period of bank credits
borrowed by surveyed firms from 2001 to 2004
(BANCRE), respectively. We examine the impact ofpast financial performance using the industry-adjusted
value of the annual average of return on equity for the
past four years prior to the survey (ROAAVE).37 As aproxy for the degree of business internationalization,
we use the share of exports in total sales (EXPSHA).
The effect of the size of the audit committee on
its independence and expertise is examined by the
total number of audit committee members (AUDSIZ).
The impact of the demand for consulting services on
audit firm choice is estimated using an ordinalvariable with a value of 0 for companies that did notconclude a consulting agreement with the audit firmat the time of the survey, a value of 1 for companies
with a consulting service agreement and using theservices occasionally, and a value of 2 for companies
with a consulting service agreement and using theservices frequently (CONSUL). The impact of thephysical distance between the capital region and thecompany location is estimated by the natural
logarithm of the linear distance between Moscow andthe capital of the federal district (autonomous
republic, territory, and province) where the surveyed
company is located (DISCAP).
The probability of companies located in thecapital or Saint Petersburg entrusting the external
audit to a non-local Russian audit firm is inevitably
low compared to that of companies operating in otherareas for the reason reported in Section 3. To
overcome this possible downward bias that companies
with their headquarters in these large cities affect theestimation result of the regression model with thevariable of audit firm attributes (AUDFIR) as adependent variable, the dummy variable thatdesignates the companies located in the capital orSaint Petersburg with a value of 1 (CAPITAL) is
added to the right-hand side of the regression equation
together with DISCAP. As reported in Section 3, there
is a remarkable difference among industrial sectors interms of audit independence and expertise. Although,for the most part, such a difference can be explainedby the above variables, the impact of factors
unobservable for econometricians remains. Hence, we
control the fixed effects in each industry using eight
dummy variables with the communications sector as adefault category.

37

Table 5 contains the definition and descriptive
statistics of the above selected variables along withthe correlation coefficient with the audit systemvariables. The correlation matrix of these 19 variables
is shown in Table 6. As shown in Table 5, among 6
key variables of our empirical test, BOACOM,FORFIR, FEDGOV, and GROFIR are positively
associated with all three elements of the audit systemvariables at the 10% significance level or less, andthey support the theoretical hypothesis stated in theprevious section. The correlation coefficients between
DOMSHA and the audit system variables also have apositive sign, but only the correlation with AUDFIR
reaches the 10% significance level. REGGOV is alsosignificantly related to the audit system variables.
Nevertheless, their signs do not correspond with our
prediction.
Among control variables, COMSIZ, BUSLIN,
and MARFIN significantly correlate with all three ofthe audit system variables, and BANCRE, ROAAVE,
and EXPSHA are significantly related to some of theaudit system variables, in line with our expectations.
Although OPECOM and PRICOM are alsosignificantly associated with the audit systemvariables, their signs do not support our theoreticalprediction. The remaining SPIOFF does not
significantly correlate with any of the audit systemvariables, as in the case of AUDSIZ, CONSUL,DISCAP, and CAPITAL. The aim of the multivariate
regression analysis is to verify whether or not therelationship between the audit structure and its
potential determinants can be replicated while
simultaneously controlling the latter. In other words,
the goal of our empirical analysis is to estimate aregression equation that takes an audit structure
variable of the i th firm (yi) as a dependent variable in
the form:∑

where is a constant term, β, γ, δ, θ, μ, ρ, and σ areparameters of independent variables to be estimated,
xj is the j th control variable from OPECOM through
CAPITAL, φk is the fixed effects of the k th industry,
to which the i th firm belongs, and i is an error term.

ROAAVE represents the distance from the medianperformance in each industry computed on the basis of amethod proposed by Eisenberg et al. (1998).

94Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Table 5. Definition and descriptive statistics of the variables used in empirical analysis and correlation coefficient with the audit system variables
Descriptive statistics
Definition of variable (variable name)
Mean

S. D.

MedianMin.

Max.

Proportion of outsider directors (BOACOM)
0.49
0.35
0.56
0.00 1.00
Dummy for firms with a dominant shareholder (DOMSHA)
0.87
0.33
1
0
1
Dummy for firms with foreign investment (FORFIR)
0.14
0.35
0
0
1
Dummy for firms owned by the federal government (FEDGOV)
0.13
0.34
0
1
0
Dummy for firms owned by the regional and local governments (REGGOV)
0.09
0.28
0
1
0
Business group member dummy (GROFIR)
0.39
0.49
0
0
1
Open joint-stock company dummy (OPECOM)
0.68
0.47
1
0
1
Dummy for former state-owned or ex-municipal privatized companies (PRICOM)
0.69
0.46
1
0
1
Dummy for firms separated from state-owned or privatized enterprises (SPIOFF)
0.10
0.29
0
0
1
Total number of employees (COMSIZ)
1884.44 5570.00
465
106 74000
Number of business lines (BUSLIN)
2.15
2.05
1
1
12
Dummy for firms that issued shares or bonds in the overseas or domestic stock exchange (MARFIN)
0.13
0.34
0
0
1
Firms that used bank credits and their average lending period (BANCRE)
2.53
1.45
3
0
5
Annual average of ROA in 2001-2004 (ROAAVE)
0.12
0.90
0.00
-8.08 4.26
Share of exports in total sales (EXPSHA)
0.88
1.20
0
0
5
Size of the audit committee (AUDSIZ)
3.53
2.14
3
1
40
Firms that conclude consulting agreement with audit firm and frequency of their use of services (CONSUL)
1.07
0.78
1
0
2
Linear distance between Moscow and the capital of the federal district where the company is located (DISCAP) 1091.17 1242.34 702.86 6773.13 0.00
Dummy for firms located in Moscow or Saint Petersburg (CAPITAL)
0.08
0.28
0
0
1

Correlation coefficientwith the audit system variables
Proportion Proportion
Audit firmof outsider of expert
attributes
auditors
auditors(AUDFIR)(AUDCOM) (AUDEXP)
0.493 *** 0.176 *** 0.305 ***
0.025
0.037
0.062 *
***
***
0.203
0.118
0.398 ***
**
*
0.094
0.075
0.175 ***
**
0.093
0.022
0.063 *
***
***
0.310
0.183
0.367 ***
*
0.061
0.068
0.034
-0.118 *** -0.056-0.0370.037-0.010-0.0430.187 *** 0.076 ** 0.346 ***0.111 *** 0.080 ** 0.101 ***0.258 *** 0.088 ** 0.461 ***
0.037
0.033
0.121 ***
-0.087 ** -0.007
0.033
0.010
0.049
0.083 **
0.046
-0.020-0.0440.005
0.046

Notes: This table presents the definition, descriptive statistics, and data source of variables used in the empirical analyses and the correlation coefficients with the audit system variables. See Table 3 for a definition of
the audit system variables. The samples are Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey conducted in 2005. The number of business lines (BUSLIN) originates in the SKRIN
open database. ROA (ROAAVE) originates in the SPARK open database. The linear distance between Moscow and the capital of the federal district where the company is located (DISCAP) is computed using thematerials provided by Kazuhiro Kumo. All other variables were created on the basis of the results of the 2005 joint enterprise survey. The natural logarithm of COMSIZ, AUDSIZ, and DISCAP is used in the regression
analysis. ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.
The following are the supplementary variable definitions: BOACOM, a continuous variable measured by dividing the number of outsider directors by the total number of board members; GROFIR, a dichotomous
variable that assigns a value of 1 to member firms of a business group; OPECOM, a dichotomous variable that equals 1 if the company was established as an open joint-stock company; BUSLIN, a proxy for the level ofbusiness diversification measured by the Russian All-Union Classifier of the National Economy Branches (OKONKh) two-digit classification; BANCRE, "firms that used bank credits and their average lending period"
fall under one of the following 6 categories: 0, did not use any bank credits during the period from 2001 to 2004; 1, used bank credits and their average lending period was less than 3 months; 2, used bank credits andtheir average lending period ranged from 3 months to less than 6 months; 3, used bank credits and their average lending period ranged from 6 months to less than one year; 4, used bank credits and their average lending
period ranged from one year to less than 3 years; 5, used bank credits and their average lending period was more than 3 years; ROAAVE, industry-adjusted using a method proposed by Eisenberg et al. (1998); EXPSHA,"share of exports in total sales" falls under one of the following 6 categories: 0, 0%; 1, 10% or less; 2, 10.1 to 25.0%; 3, 25.1 to 50.0%; 4, 50.1 to 75.0%; 5, more than 75%; AUDSIZ: total members of the audit
committee; CONSUL, "firms that conclude consulting agreement with audit firm and frequency of their use of services" fall under one of the following 3 categories: 0, did not conclude any agreement with the audit firm
adopted as the accounting auditor at the time of the survey; 1, concluded a consulting agreement and occasionally used its services; 2, concluded a consulting agreement and frequently used its services; DISCAP, theunit is kilometers.

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Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Table 6. Correlation matrix of the variables used in the empirical analyses
[a]

[b]

[c]

[d]

[e]

[a]

BOACOM

1.000[b]

DOMSHA

0.093 **

1.000

[c]

FORFIR

0.275 ***

-0.0051.000[d]

FEDGOV

0.212 ***

-0.0470.179 ***

1.000

[e]

REGGOV

0.092 **

0.066 *

0.074 *

0.130 ***[f]

GROFIR

0.344

***

**

0.193

[g]

OPECOM

0.021

0.067 *[h]

PRICOM-0.045[i]

SPIOFF

[j]
[k]
[l]
[m]

[g]

[h]

[i]

[j]

[k]

[l]

[m]

0.041

-0.0280.054-0.040

0.054

1.000

0.001

0.023

0.047

-0.032-0.151 ***-0.0081.000-0.001-0.021-0.051-0.0430.067 *

0.042

-0.007-0.490 ***1.000

COMSIZ

0.276 ***

-0.0210.355 ***

0.227 ***

0.075 **

0.221 ***

-0.100 ***0.085 **

-0.0241.000

BUSLIN

0.165 ***

-0.0080.156 ***

0.118 ***

0.014

0.109 ***

-0.0030.064 *

0.010

0.266 ***

1.000

MARFIN

0.281

***

0.029

0.455

***

***

0.288

***

0.019

0.029

-0.016

0.543 ***

0.167 ***

1.000

0.093

**

0.128

***

0.093

***

-0.0180.302***

0.079 **

0.180 ***

1.000

***

-0.001-0.010-0.036-0.031-0.055BANCRE[n]ROAAVE-0.114[o]

EXPSHA

[p]

0.165

***

0.298
0.017

[n]

[o]

[p]

[q]

[r]

[s]

1.000

0.124 ***

0.080

***

[f]

0.091

1.000

**

0.060

-0.056

0.008
*

0.020

0.004

-0.006-0.009

0.050

0.015

-0.0710.072 *

0.052

0.148 ***

-0.064 *

0.003

0.033

-0.048-0.0250.092 ***

0.223 ***

0.048

-0.004

0.108 ***

1.000
0.097 **

1.000

AUDSIZ

0.175 ***

-0.0210.172 ***

0.180 ***

0.044

0.095 **

-0.0410.082 **

-0.074 **0.332 ***

0.139 ***

0.254 ***

0.026

-0.060-0.003

1.000[q]

CONSUL-0.028-0.049-0.057-0.018-0.055-0.038

0.018

0.031

0.037

0.004

0.057

-0.028

0.018

0.037

-0.015

0.029

1.000

[r]

DISCAP

0.073 **

0.005

0.012

-0.012 *

0.029

0.040

0.125 ***

0.003

0.031

-0.019-0.089 **0.012-0.034-0.033-0.0260.019-0.061 1.000[s]

CAPITAL-0.002-0.0120.108 ***

0.007

-0.064 *

0.017

0.000

-0.084 **-0.0240.027

0.116 ***

0.064 *

0.031

0.096 **

0.049

-0.0050.039 -0.539 *** 1.000

Notes: This table presents the correlation matrix of 19 independent variables used in the empirical analyses. Table 5 provides the definitions of the variables. ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.

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Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014
5.2 Estimation results

significance level even though the coefficient is
positive, in line with our predictions. Shareholding by
the governments (FEDGOV and REGGOV) does nothave significant estimates either on the federal or theregional level.
The estimation result of the variables of relianceon market financing (MARFIN) and use of bankcredits (BANCRE) indicates that the fund procurementfrom the capital market and banks greatly affects theaudit committee independence. Contrary to our
prediction, the dummy variable for privatizedcompanies (PRICOM) is estimated to be negative andsignificant at the 5% level in Model [1] in Table 7.
This result suggests that, in general, the former stateowned (ex-municipal) privatized enterprises possibly
have not achieved sufficient accountability, in theform of the fairness of corporate auditing, to the stateand general public even though they are thesuccessors of state assets that were declared as the“common property of the working class” undersocialism.

Our empirical analysis is carried out by taking thefollowing four steps. In the first three subsections, we
scrutinize the factors affecting the audit committee
independence, the audit committee expertise, and theaudit firm choice. Then, in the fourth subsection, we
examine the determinants of the comprehensive
choice of audit system.
5.2.1 Audit committee independence
Table 7 contains the estimation results on thedeterminants of the audit committee independence.38
The table reports the Tobit estimation39 with theproportion of outsider auditors (AUDCOM) as adependent variable and, to check the statisticalrobustness of each independent variable, theestimation results of the Logit model with dependent
variables, such as the dummy variable that specifies
companies whose outsider members account for the
majority of the audit committee by 1 (INDAUD) andthe dummy variable that assigns a value of 1 tocompanies whose audit committee members are alloutsiders (PERIND). To compute standard errors, we
use White’s heteroskedasticity-consistent estimator.
As shown in Table 7, the proportion of outsider
directors (BOACOM) is positively estimated at the 1%
significance level in any of these three models, and it
verifies that the presence of outsiders on the board of
directors is a crucial factor that promotes theindependence of the audit committee. In fact, thecoefficient of BOACOM largely exceeds 1.0 in Model[1], indicating an extremely high elasticity. This result
is entirely consistent with the finding stated in Section
3 that both the proportion of outsider directors andthat of outsider audit committee members show a
noticeable polarization trend. The impact of affiliation
with a business group (GROFIR) is estimated to bepositive and significant at the 10% level in Model [1].
This estimate suggests that affiliation with a businessgroup increases the proportion of outsider auditors by
19.1% on average in member companies, ceterisparibus. Meanwhile, the impacts of the presence of adominant shareholder (DOMSHA) and foreign
investment (FORFIR) do not reach the 10%

5.2.2 Audit committee expertise
Table 8 contains the results from the regression
analysis of the audit committee expertise. Here, in
addition to estimating the Tobit model taking the
proportion of expert audit committee members(AUDEXP) as a dependent variable, we estimated the
Poisson model and the Logit model, which have thetotal number of expert auditors (NUMEXP) and thedummy variable for companies that hire one or moreexpert auditors (EXPAPP) in the left-hand side of
their estimation equation, respectively. As shown in
the table, the proportion of outsider directors on theboard has a positive and significant impact not only
on the independence but also on the expertise of theaudit committee. For instance, the coefficient of the
proportion of outsider directors (BOACOM) has avalue of 0.69 with statistical significance at the 5%
level in Model [1]. The business group affiliation
dummy variable (GROFIR) is estimated with apositive sign at a significance level not less than
BOACOM, suggesting that experts are more actively
appointed by business groups than independent
enterprises in order to conduct a high-quality audit foraffiliated companies. The estimate of GROFIR in
Model [1] indicates that the proportion of outsider
audit committee members in group companies is
46.8% higher than that of independent firms on
average. The dummy variable for firms with foreign
investment (FORFIR) is estimated to be significant
and positive in Model [2]. This result is affirmed tohave a certain positive effect on the appointment ofexpert auditors from the presence of foreign investors
as well. The positive and significant estimate ofshareholding by the federal government (FEDGOV),in contrast with the insignificant estimate ofshareholding by the regional and local governments(REGGOV), strongly suggests a more active role of38

The number of observations used for the estimations
reported in Tables 7 to 10 is far less than 690, which is thetotal number of officers who gave detailed information about
the audit system of their companies. This is simply due tothe lack of data on some surveyed firms. Nevertheless, interms of basic attributes, including ownership structure,
there is no statistically significant difference between firmsthat were dropped from the observations and those thatwere included in the estimations. Therefore, our estimation
results are considered to be only modestly biased, if at all,by the partial omission of samples.
39
The Tobit model, reported in Tables 7 and 8, is theestimation result of the log likelihood function, whose
dependent variable has the lower limit (0) and the upper
limit (1) as the threshold.

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Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

the federal government in the corporate governance ofstate-owned enterprises than that of regional and local
governments. As in the estimation results of the audit
committee independence, the coefficient of dominant
shareholder dummy variable (DOMSHA) shows apositive sign; however, again, it does not reach the
10% significance level.

Table 7. Regression analysis of audit committee independence
Model
Estimator
Dependent variable
Proportion of outsider directors (BOACOM) (+)
Presence of a dominant shareholder (DOMSHA) (+)
Foreign investment (FORFIR) (+)
Shareholding by the federal government (FEDGOV) (+)
Shareholding by the regional and local governments (REGGOV) (-)
Affiliation with a business group (GROFIR) (+)
Establishment of an open joint-stock company (OPECOM) (-)
Privatization of a state-owned or municipal enterprise (PRICOM) (+)
Separation from a state-owned or privatized enterprise (SPIOFF) (+)
Company size (COMSIZ) (+)
Extent of business diversification (BUSLIN) (+)
Reliance on market financing (MARFIN) (+)
Use of bank credits (BANCRE) (+)
Past financial performance (ROAAVE) (-)
Degree of business internationalization (EXPSHA) (+)
Size of the audit committee (AUDSIZ) (+)
Const.
Industry dummies
N
Pseudo R2
Log likelihood
F test/Wald test (χ2)

[1]
Tobit
AUDCOM
1.1636 ***(0.151)0.0573(0.117)0.0116(0.140)-0.0214(0.108)0.0552(0.113)0.1909 *(0.099)0.0361(0.083)-0.3362 **(0.135)-0.1837(0.168)-0.0198(0.044)0.0158(0.018)0.3735 **(0.151)0.0201(0.032)-0.0335(0.049)0.0437(0.041)-0.2398(0.156)0.3144(0.400)
Yes
424
0.20
-354.12
6.27 ***[2]
Logit
INDAUD
3.4454 ***(0.464)-0.1171(0.394)0.1056(0.437)-0.3184(0.407)0.3916(0.487)0.4369(0.296)0.1360(0.274)-0.6449(0.415)-0.3031(0.528)-0.0446(0.160)-0.0649(0.063)
2.1393 ***(0.614)0.2387 **(0.107)-0.0328(0.137)0.0242(0.120)-0.5035(0.501)0.4544(1.303)
Yes
424
0.31
-194.32
125.09 ***

[3]
Logit
PERIND3.3427 ***(0.588)0.1641(0.417)0.1293(0.456)-0.4911(0.473)-0.9053(0.605)0.4491(0.355)0.1823(0.332)-0.5045(0.442)-0.2996(0.577)0.0597(0.176)
0.0432(0.075)0.2709(0.589)0.0399(0.128)-0.2195(0.180)0.1478(0.150)-2.6752 ***(0.686)
0.4099(1.470)
Yes
424
0.27
-153.03
85.04 ***

Notes: This table contains the results from the regressions of audit committee independence on the variables reflecting firm organization andbusiness activities. The samples are Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey conducted in
2005. The proportion of outsider auditors (AUDCOM), the dummy variable for firms whose outsider auditors account for the majority of theaudit committee (INDAUD), and the dummy variable that gives a value of 1 if a company whose corporate auditors are all outside persons(PERIND) are used as dependent variables. Table 5 provides the definitions of the independent variables. The predicted signs are indicated inparentheses following the abbreviation of the independent variables. Standard errors are computed using White’s heteroskedasticityconsistent estimator and given in parentheses beneath the regression coefficients. The F and the Wald tests test the null hypothesis in which
all coefficients are zero. ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively.

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Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Table 8. Regression analysis of audit committee expertise
Model
Estimator
Dependent variable
Proportion of outsider directors (BOACOM) (+)

[1]
Tobit
AUDEXP
0.6948 **(0.313)Presence of a dominant shareholder (DOMSHA) (+)
0.4361(0.285)
Foreign investment (FORFIR) (+)
0.4490(0.290)Shareholding by the federal government (FEDGOV) (+)
0.4546 *(0.251)
Shareholding by the regional and local governments (REGGOV) (-)-0.3372(0.303)Affiliation with a business group (GROFIR) (+)
0.4683 **(0.212)
Establishment of an open joint-stock company (OPECOM) (-)
0.0477(0.188)
Privatization of a state-owned or municipal enterprise (PRICOM) (+) -0.4806 *(0.257)
Separation from a state-owned or privatized enterprise (SPIOFF) (+) -0.5719(0.355)Company size (COMSIZ) (+)-0.2123 **(0.102)
Extent of business diversification (BUSLIN) (+)
0.0328(0.043)
Reliance on market financing (MARFIN) (+)
0.1505(0.357)
Use of bank credits (BANCRE) (+)
0.0511(0.067)
Past financial performance (ROAAVE) (-)-0.0809(0.085)Degree of business internationalization (EXPSHA) (+)
0.1663 *(0.091)Size of the audit committee (AUDSIZ) (+)-0.1570(0.329)Const.
-0.9331(0.950)Industry dummies
Yes
N
424
Pseudo R2
0.09
Log likelihood-260.00
F test/Wald test (χ2)
1.64 **[2]
PoissonNUMEXP
1.0600 ***(0.364)0.5079(0.371)0.4423 *(0.269)0.4616 *(0.249)-0.4997(0.376)
0.5023 **(0.241)0.1582(0.219)-0.5571 **(0.249)-0.9411 **(0.412)-0.1708 *(0.104)0.0536(0.046)-0.0146(0.352)0.0452(0.080)-0.0670(0.107)0.2062 **(0.089)1.3182 ***(0.243)-3.5816 ***(1.059)
Yes
424
0.18
-372.35
129.49 ***

[3]
Logit
EXPAPP
0.8150 *(0.423)0.5963(0.439)0.4954(0.369)0.7271 *(0.384)-0.3829(0.499)0.7221 **(0.295)-0.0517(0.278)-0.6946 *(0.363)-0.7014(0.523)-0.2896 *(0.152)0.0404(0.063)0.2600(0.523)0.0122(0.100)-0.1486(0.138)0.1639(0.134)0.3157(0.478)-2.0715(1.393)
Yes
424
0.10
-203.60
43.93 ***

Notes: This table contains the results from the regressions of audit committee expertise on the variables reflecting firm organization andbusiness activities. The samples are Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey conducted in
2005. The proportion of expert auditors (AUDEXP), the total number of expert auditors (NUMEXP), and the dummy variable that assigns avalue of 1 if a company that appoints more than one expert auditor from the outside (EXPAPP) are used as dependent variables. Table 5
provides the definitions of the independent variables. The predicted signs are indicated in parentheses following the abbreviation of the
independent variables. Standard errors are computed using White’s heteroskedasticity-consistent estimator and given in parentheses beneaththe regression coefficients. The F and the Wald tests test the null hypothesis in which all coefficients are zero. ***, **, and * denotestatistical significance at the 1%, 5%, and 10% levels, respectively.

The negative and significant estimate of thedummy variable for privatized companies (PRICOM)
exposes the unfavorable attitude of former-socialist
enterprises toward the establishment of an audit
committee equipped with outside experts. A similar
trend is evident in the newly established companies
spun off from state-owned (municipal) companies or
privatized companies. Company size (COMSIZ) is

negatively estimated in all models with a statisticalsignificance at the 10% level or below. This result
suggests that, in Russia, contrary to conventional
understanding, the larger the organization of acompany, the greater the negative attitude toward theuse of experts as audit committee members. The
impact of business internationalization (EXPSHA) isestimated to be significant and positive in Models [1]99Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

and [2] in Table 8, in line with our expectations,suggesting that overseas business development is afactor urging Russian companies to improve theexpertise of their audit committee, which has toaddress international standardization of finance andaccounting.

probability of entrusting its external auditing to a nonlocal Russian audit firm. Furthermore, distance fromthe capital region (DISCAP) has a negative andsignificant coefficient at the 5% level in Models [1]and [2] reported in Table 9. This result suggests thatthe cost and time burden represented by the physicaldistance from the capital is a serious factor that
inhibits the appointment of non-local Russian audit
firms.

5.2.3 Audit firm choice
The estimation results regarding the determinants ofan audit firm choice are presented in Table 9. Here, in
addition to the order Logit estimation with thevariable of audit firm attributes (AUDFIR) as adependent variable, we report the estimation result of
the Logit model taking NONLOC, a dummy variablefor companies not using a local Russian audit firm,and INTAUD, a dummy variable that is equal to 1 if acompany chooses an external auditor from amonginternational firms, as dependent variables.
From the estimation results in Table 9, we findthat the presence of outsiders on a corporate board
strongly influences their company’s decision making
when appointing an audit firm for an external audit.
The estimate of the proportion of outsider directors(BOACOM) demonstrates that, along with an increasein the proportion of outsider directors to all board
members, the probability of hiring an audit firm withmore preferable attributes as an external auditor
significantly increases. Although affiliation with abusiness group produces the same effects as board
composition, this factor is not significantly related tothe probability of hiring international audit firms. In
contrast to the business group affiliation dummy
variable (GROFIR), the dummy variable for firms
with foreign investment (FORFIR) is estimated at the
1% significance level with a positive sign in Model[3]. This evidence empirically supports a finding bySucher and Bychkova (2001), namely, that foreign
investors venturing into Russia have a strong
tendency to press the company in which they haveinvested to perform an external audit by a leadinginternational audit firm. The coefficients of thepresence of a dominant shareholder (DOMSHA) andshareholding by the federal government (FEDGOV)
are insignificant. Thus, the assumption that dominant
shareholders and the federal government greatly
influence decision making by their own companies
regarding audit firm choice is not empiricallysupported. In contrast, the coefficient of shareholding
by the regional and local governments (REGGOV) is
negative and significant at the 5% level in Model [3],indicating an unfavorable attitude of municipal
enterprises towards the use of an international audit
firm in order to check and control the quality of theirfinancial statements.
According to the estimation results of thevariables of company size (COMSIZ) and reliance onmarket financing (MARFIN), a company that has alarge-scale organization and procures funds from thecapital market by issuing shares or bonds has a high5.2.4 Comprehensive choice of audit system
Since the audit committee and the external auditor
institutionally complement one another, a person withappointive power must have a deep interest in the
combination of the two auditing bodies, in otherwords, the overall shape of the audit system. The
significance of this strategic choice is not inferior to
the individual attribute and capability of the membersof the audit committee and the audit firm.
In Figure 4, the audit systems of 660 surveyed
companies are sorted into four types with reference tothe outsider audit committee member proportion of
50% and indicators of whether or not a local Russian
firm is used for the external audit. The figure showsthat only 17.6% (116 of 660 companies) establishedan A-type audit system, which is most preferable interms of both the independence of the audit
committee and the attributes of the audit firm.
Meanwhile, as many as 300 companies, or 45.5%,
chose a D-type audit system, in which the majority ofaudit committee posts are given to insiders and which
relies on local Russian audit firms for the external
audit. In terms of the quality of the audit system, 244
companies, or 37.0%, fall between the A- and Dtypes.
To pinpoint the factors that create the situations
demonstrated in Figure 4, we estimate a multinomial
Logit model of discrete choice. In this model, acompany choosing the D-type audit system of Figure
4 is designated as the base category (j=0), and,similarly, companies belonging to the A-, B-, and Ctypes are designated as the first, second, and third
categories (j=1, 2, 3), respectively. This multinomial
Logit model is expressed by the following formula:P yi  j  

' x

e ji

k 0 e k xi
3', j  0,1,2,3,

where x is the data vector of the independent variablesand β is the vector of the parameters.

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Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Table 9. Regression analysis of audit firm choice
Model
Estimator
Dependent variable
Proportion of outsider directors (BOACOM) (+)
Presence of a dominant shareholder (DOMSHA) (+)
Foreign investment (FORFIR) (+)
Shareholding by the federal government (FEDGOV) (+)
Shareholding by the regional and local governments (REGGOV) (-)
Affiliation with a business group (GROFIR) (+)
Establishment of an open joint-stock company (OPECOM) (-)
Privatization of a state-owned or municipal enterprise (PRICOM) (+)
Separation from a state-owned or privatized enterprise (SPIOFF) (+)
Company size (COMSIZ) (+)
Extent of business diversification (BUSLIN) (+)
Reliance on market financing (MARFIN) (+)
Use of bank credits (BANCRE) (+)
Past financial performance (ROAAVE) (-)
Degree of business internationalization (EXPSHA) (+)
Demand for consulting services (CONSUL) (?)
Distance from the capital region (DISCAP) (-)
Location in Moscow or Saint Petersburg (CAPITAL) (-)
Const.
Industry dummies
N
Pseudo R2
Log likelihood
Wald test (χ2)[1]Ordered Logit
AUDFIR
1.0342 ***(0.372)0.5012(0.410)0.7064 *(0.371)-0.0605(0.374)-0.1460(0.385)0.7141 ***(0.271)-0.0619(0.260)-0.3147(0.337)0.5376(0.435)0.4866 ***(0.138)-0.0831(0.068)1.2127 **(0.533)0.0423(0.104)0.1789(0.162)
0.0969(0.119)0.0472(0.160)-0.2125 **(0.103)-0.5793(0.686)
(-)
Yes
438
0.24
-260.86133.61 ***

[2]
Logit
NONLOC1.2181 ***(0.395)0.4049(0.422)0.3519(0.394)0.0738(0.406)0.0725(0.444)0.7859 ***(0.266)-0.0412(0.274)-0.3723(0.356)0.7355(0.477)0.5537 ***(0.153)-0.1065(0.070)0.9747 **(0.447)-0.0173(0.102)0.1488(0.155)0.0634(0.129)0.0299(0.166)-0.2029 **(0.103)-1.0991 *(0.624)-3.1881 **(1.284)
Yes
438
0.26
-199.2289.48 ***

[3]
Logit
INTAUD
1.5474 *(0.864)0.6421(1.161)
1.9633 ***(0.720)0.1046(0.732)-1.3958 **(0.630)0.7313(0.879)0.4926(0.597)-0.4940(0.686)-1.5425(0.987)0.2771(0.227)0.1470(0.181)
1.9923 **(0.921)0.0066(0.369)0.0909(0.342)0.1395(0.339)0.2048(0.339)-0.3780(0.244)2.5885 *(1.429)-2.4953(2.539)
Yes
132
0.43
-44.4238.24 **

Notes: This table contains the results from the regressions of audit firm choice on the variables reflecting firm organization
and business activities. The samples are Russian joint-stock companies that participated in a Japan-Russia joint enterprisesurvey conducted in 2005. The ordinal variable that gives a value of 0 to companies adopting a local Russian audit firm as its
accounting auditor, 1 to companies adopting a non-local Russian audit firm, and 2 to companies adopting an international
audit firm (AUDFIR), the dummy variable that captures companies not adopting a local Russian audit firm (NONLOC), andthe dummy variables for firms that made choice of the company’s external auditor from international firms (INTAUD) areused as dependent variables. "Local Russian audit firm" denotes a domestic audit firm located in the same federal district of
the surveyed company. Table 5 provides the definitions of the independent variables. The predicted signs are indicated inparentheses following the abbreviation of the independent variables. Standard errors are computed using White’sheteroskedasticity-consistent estimator and given in parentheses beneath the regression coefficients. The Wald test tests thenull hypothesis in which all coefficients are zero. ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels,
respectively.

101Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

From the estimation results shown in Table 10,
we conclude that the expansion of company size
promotes the establishment of an audit system that iscomprehensively preferable. Business diversification,in contrast, suppresses such firm behavior. Moreover,fund procurement from the capital market and banks
has a similar impact to the board composition andincreases the probability of choosing an audit systemthat secures the superiority of outsider audit
committee members (As an alternative regression
model for the comprehensive choice of the audit
system, we also estimated an ordered Logit model inwhich the dependent variable gives a value of 0, 1, 2,
or 3 to a company choosing the D-, C-, B-, or A-typeaudit system, respectively, assuming that theassurance value/utility of the audit system increases
by each step (i.e., D-C-B-A), and we confirmed that,in this model, independent variables estimated withstatistical significance at the 10% level or less arelimited to BOACOM, GROFIR, COMSIZ, MARFIN,
and DISCAP and the signs of these five variables
correspond with those in the multinomial Logit model
reported in Table 10).

Figure 4. Classification of the audit system in 660 joint-stock companies by a combination of audit
committee composition and audit firm attributes
Audit committee composition
Proportion of outsider
Proportion of outsider
auditors, 50% or more
auditors, less than 50%

Audit firm
attributes

International
audit firm or
non-local
Russian audit
firm
Local Russian
audit firm

Type-A
116 companies (17.6%)

Type-B88 companies (13.3%)

Type-C
156 companies (23.6%)

Type-D300 companies (45.5%)

Notes: This figure classifies the audit system of 660 Russian joint-stock companies that participated in a Japan-Russia joint
enterprise survey conducted in 2005 in accordance with the audit committee composition and the audit firm attributes. The
proportion of outsider auditors is measured by dividing the number of outsider auditors by the total members of the audit
committee for each sample firm. "Local Russian audit firm" denotes a domestic audit firm located in the same federal districtof the surveyed company.

federal government, and regional and local
governments are used instead of ownership dummy
variables, namely, FORFIR, FEDGOV, andREGGOV, respectively, and obtained no distinctive
differences from the estimation results reported in
Subsection 5.2 by these variable changes. We also
examined the possible impacts of other ownershipaspects that may affect demand for auditing, including
the presence of large managerial shareholding and a
block shareholder(s), imposition of an upper limit onownership share and voting rights of shareholders,and changes in principal owners in the recent past,and found no statistically significant and systematic
correlation between these factors and the audit systemvariables, as is the case with the presence of adominant shareholder.
Furthermore, we performed supplemental
regressions using the industry-adjusted value of thefrequency of dividend payment and the gross profit tosales as the proxy for past financial performance andconfirmed that these two alternative indices also havethe same sign and statistical significance as an annual
average of ROA.
On the basis of the above findings, we
confidently report that the results of regression
analysis conducted in this paper are robust across thevarious specifications.

5.3 Robustness check
To check the overall robustness of the empiricalresults reported in Tables 7 through 10, we conducteda supplemental estimation to impose a variety ofsample restrictions on each regression model andconfirmed that these restrictions do not cause any
major changes in the estimation results. Morespecifically, supplemental regressions were performed
with the following eight settings: (1) limiting thesamples to industrial enterprises; (2) excluding
companies operating in fuel/energy, metallurgy, andcommunications sectors, which are subject to uniquegovernment regulations regarding firm organization
and business activities; (3) limiting the samples tothose with a company size within the mean ±1
standard deviation to exclude very large enterprises
from observations; (4) limiting the samples tocompanies in which the size of the audit committee is
within the mean ±1 standard deviation; (5) limiting
the samples to companies that have not issued
securities; (6) limiting the samples to non-groupaffiliated firms; (7) dividing the samples into open
and closed joint-stock companies; and (8) excluding
companies located in Moscow and Saint Petersburg
from observations.
Moreover, we re-estimated models in which thepercentages of shareholding by foreign investors, the102Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014

Table 10. Regression analysis of comprehensive choice of the audit system
Estimator
Dependent variable (type of audit system)
Proportion of outsider directors (BOACOM) (+)
Presence of a dominant shareholder (DOMSHA) (+)
Foreign investment (FORFIR) (+)
Shareholding by the federal government (FEDGOV) (+)
Shareholding by the regional and local governments (REGGOV) (-)
Affiliation with a business group (GROFIR) (+)
Establishment of an open joint-stock company (OPECOM) (-)
Privatization of a state-owned or municipal enterprise (PRICOM) (+)
Separation from a state-owned or privatized enterprise (SPIOFF) (+)
Company size (COMSIZ) (+)
Extent of business diversification (BUSLIN) (+)
Reliance on market financing (MARFIN) (+)
Use of bank credits (BANCRE) (+)
Past financial performance (ROAAVE) (-)
Degree of business internationalization (EXPSHA) (+)
Size of the audit committee (AUDSIZ) (+)
Demand for consulting services (CONSUL) (?)
Distance from the capital region (DISCAP) (-)
Location in Moscow or Saint Petersburg (CAPITAL) (-)
Const.
Industry dummies
N
Pseudo R2
Log likelihood
Wald test (χ2)

Multinomial Logit
Type-A
Type-B
Type-C
4.6823 ***0.9924 *3.5474 ***(0.875)(0.542)(0.570)-0.24120.81290.0509(0.627)(0.587)(0.432)0.71090.85700.1842(0.641)(0.653)(0.545)-0.69630.1302-0.2512(0.550)(0.566)(0.574)0.4892-0.02760.3304(0.768)(0.576)(0.622)
1.1583 **0.7966 **0.4975(0.458)(0.366)(0.364)0.5977-0.3359-0.0204(0.472)(0.354)(0.318)-0.9391-0.1187-0.4158(0.673)(0.573)(0.480)0.0352
1.3461 **0.1218(0.860)(0.687)(0.612)0.6713 **0.2434-0.2943(0.273)(0.216)(0.209)-0.2157 **-0.0512-0.0845(0.108)(0.091)(0.089)1.9884 ***-1.05391.4884 *(0.744)(1.547)(0.774)-0.3539 *-0.0599-0.2655 **(0.194)(0.128)(0.119)-0.0709
0.2805-0.0856(0.265)(0.189)(0.152)0.1323-0.0355-0.0227(0.227)(0.222)(0.158)0.49450.0527-0.9431(0.618)(0.612)(0.594)-0.0699-0.0489-0.1357(0.269)(0.229)(0.191)-0.2093-0.3992 ** -0.0527(0.157)(0.191)(0.115)0.1141-36.9535 *** 0.2412(0.922)(1.185)(0.641)-5.0376 **-0.9751
2.1740(2.515)(2.086)(1.775)
Yes
Yes
Yes
406
0.31
-347.79
18406.20 ***Notes: This table reports the Logit estimation result of the multiple-choice model of the audit system. The samples are
Russian joint-stock companies that participated in a Japan-Russia joint enterprise survey conducted in 2005. In this model, acompany choosing the D-type audit system of Figure 4 is designated as the base category, and companies belonging to the A, B-, and C-types are designated as the first, second, and third category, respectively. For details of the estimation
methodology, see Subsection 5.2.4 of the paper. Table 5 provides the definitions of the independent variables. The predicted
signs are indicated in parentheses following the abbreviation of the independent variables. Standard errors are computed
using White’s heteroskedasticity-consistent estimator and given in parentheses beneath the regression coefficients. The Wald
test tests the null hypothesis in which all coefficients are zero. ***, **, and * denote statistical significance at the 1%, 5%,
and 10% levels, respectively.

103

Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014
6. Conclusion

choice. Meanwhile, management integration with abusiness group exerts a noteworthy effect on theassignment of outside experts as audit committee
members and the choice of an audit firm from nonlocal Russian firms by an affiliated company, andforeign investment has a strong promotional effect,
especially on the appointment of an international audit
firm.
Our empirical evidence also indicated that,consistently with the findings in Frye and Iwasaki(2011) on the role of state representatives on theboard of directors in corporate governance,
shareholding by the federal government tends toincrease the possibility of hiring expert auditors fromthe outside by state-owned enterprises. We conjecturethat the federal government attempts to promotesound corporate auditing in domestic firms.
Meanwhile, we could not obtain any supporting
evidence of a close relationship between the presenceof dominant shareholders and audit independence andexpertise in their companies. One possible
interpretation of this result is that the audit system in a
typical Russian company clearly reflects the intentionof the company’s dominant shareholder through theboard of directors and, hence, the need to exert direct
and incremental control over audit activities of acompany is very limited in practice. Needless to say,further empirical examination of this point isnecessary.
Moreover, from the empirical results of thisstudy, we found that company size, fund procurementfrom the capital market and banks, and overseas
business advancement have significant impacts on
audit independence and expertise in Russia. We also
found that former state-owned (ex-municipal)
privatized enterprises and newly establishedcompanies spun off from state-owned (municipal)
companies or privatized enterprises tend to have anegative attitude toward the establishment of an open
corporate audit system, ceteris paribus.40
Soundness of company management thatsustains the market economy at the firm level is oneof the economic endeavors that Russia has to takeseriously. As reported above, the establishment of arigid and fair corporate audit system is an effective
measure for overcoming this issue. 41 However, ourempirical evidence suggests that it is not an easy task.
Persistent efforts of the Russian government andcitizenry are required, as well as technical andfinancial assistance by the international community.

In this paper, we empirically analyze the firm-level
determinants of audit independence and expertise as
well as the comprehensive choice of corporate audit
system in transition Russia using the results of aJapan-Russia enterprise survey conducted throughout
the country in 2005.
The survey results show that Russian joint-stockcompanies, in comparison with those of Western andAsian Pacific countries, have a questionable audit
system. More specifically, the independence of theaudit committee in Russian firms is well below theaverage level for companies in the above countries. In
addition, the appointment of an international audit
firm as an external auditor is very limited, and mostRussian companies have a strong tendency to makeexternal audit contracts with local Russian audit
firms. Moreover, Russian firms are generally negative
about the appointment of outside experts as audit
committee members. Furthermore, from the viewpointof the independence of the audit committee,
remarkable polarization among Russian companies is
occurred.
The empirical analysis in this paper presents
evidence that is consistent with that in past studies
regarding the impacts of outsider directorship andforeign investment on corporate auditing in othercountries as well as with that in preceding works on
business integration and corporate governance ofgroup companies in Russia, referenced in Section 4.
In other words, we verified that the following types of
Russian companies are more likely to establish acomparatively desirable audit system than other firms:
a company in which the outsider directors take astrong initiative within the corporate board; acompany that has accepted foreign investment; and acompany that performs business integration with a
specific business group through stock ownership.
From another perspective, we conclude that the lessindependent and professional audit system of Russian
firms than the international practice is deeply rooted
in a weak countervailing power of outsider board
directors against management executives, low foreign
direct investment within the country, and a loose
management discipline of independent companies thatare operating in isolation in terms of their capital
relationship.
As reported above, the composition of the boardof directors, foreign investment, and affiliation with abusiness group through shareholding are highly
important determinants of audit independence andexpertise of Russian companies. The extent of the
impact of these three factors, however, differs greatly
between them. Although the presence of outsiders on
the corporate board has a significantly positive impact
on every aspect concerning the independence andexpertise of a corporate audit, there is a tendency forthe main emphasis to be focused on the audit
committee composition rather than the audit firm

40This is probably due to the self-contained and exclusive
organizational culture cultivated during the socialist era(Abe and Iwasaki, 2010).
41
In fact, according to Iwasaki (2013), Russian firms with asound audit system enjoyed a higher probability of survival
before and after the 2008 global financial crisis, suggestingthat promotion of corporate auditing may have a positive
policy impact in Russia.

104Corporate Ownership & Control / Volume 11, Issue 2, Winter 2014
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