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New Trends in Sustainable Business and Consumption AE
THE CORRELATION BETWEEN EXTERNAL AUDIT

AND FINANCIAL PERFORMANCE OF BANKS FROM ROMANIA
Mariana Nedelcu (Bunea)1*, Marian Siminic2 and Carmen urlea3
1,3)
The Bucharest University of Economic Studies, Romania
2)
University of Craiova, Romania
Please cite this article as:

Nedelcu (Bunea), M., Siminic, M. and urlea, C., 2015. The Correlation between External
Audit and Financial Performance of Banks from Romania. Amfiteatru Economic,
17 (Special No. 9), pp. 1273-1288
Abstract
The audit function plays a particularly important role as part of the corporate mechanism, due
to the extra value it provides with the corporate governance, which is why, over the years, this
issue has been assiduously studied and became the topic of numerous studies and analyses.
The objective of this article is to provide an analysis of the potential relationships between
the quality of external audit (assessed through membership to the Big Four: the largest four
auditing firms, namely PricewaterhouseCoopers, KPMG, Ernst & Young and Deloitte) and
financial performance (assessed by profitability, assets quality and solvency) of the banking
system in Romania. Hence, the authors tried to find answers, advocated by the results of the
conducted empirical analysis, to the following questions: "Does the quality of external audit
affects the financial performance of banks in Romania? How is registered the added value
of external audit quality at credit institutions level?"
In order to test the assumptions made, it was used a predominantly quantitative research
methodology, which is based on a deductive statistical analysis. The starting point is agency
theory, the main objective is to test and identify the potential cause-effect relationships,
while analyzing their significance weight.
As a result of this research, it can be concluded that there is a positive correlation between
external audit quality and financial performance of the credit institutions in the Romanian
banking system, although it is not a significant one.
Keywords: audit quality, external audit, corporate governance, financial performance,

solvency, banking system.
JEL Classification: M40 , G20, G30
*
Corresponding author, Mariana Bunea mariana.bunea@cig.ase.ro
Vol. 17 Special No. 9 November 2015 1273

AE The Correlation between External Audit
and Financial Performance of Banks from Romania
Introduction
The recent financial crisis revealed not only the weaknesses of risk management, control
and governance processes in banks, but at the same time, proved the necessity to improve
the quality of external audits carried out by banks. The audit function plays an important
role in the corporate mechanism, particularly due to its capacity to add value to the
governing process. Therefore, over time, it became the main topic of various studies
focused on the issue of information transparency. Very often analyzed from the perspective
of audit committee, commended in terms of members number, mainly the independent
ones, as well as from the perspective of external audit quality, the audit function has mostly
proved to be positively correlated with the level of disclosed information by organizations.
The banks, by their operations nature, are exposed to a variety of risks that can have a
negative impact on their results or on their financial situation. These risk categories include,
but are not limited to, credit risk, liquidity risk, market risk, operational risk, solvency and
regulatory risk. Also, a variety of new risks may arise or significance of each risk can change
with time, due to various factors, either internal or external, that occur in banking business
area. Within audit planning and developing activities taking place in a bank, the external
auditor identifies and assesses the risks of occurrence of significant misstatements within the
contents of statements and financial reports. At the same time, the external auditor acquires a
proper understanding of the internal controls considered relevant for audit conducting,
including the control environment designed and implemented at the bank level.
Given the nature of banking activities, including those involving a high volume of
transactions, banks must implement controls aimed at addressing the potential risks arising
at the organization level, if applicable. Therefore, the external auditor of a bank shall
perform appropriate tests on relevant controls related to the preparation and presentation of
financial statements, so that to assess the extent they can rely on them in conducting the
audit mission.
The main purpose of this study is to examine if between the external audit quality, on one
hand, and the financial performance, assessed by the assets quality (in terms of non-
performing loans ratio - non-performing loan NPL) and the solvency indicators of
Romanian banking system, on the other hand, there is any possibility of interdependence.
Given the fact that in literature, audit quality was often appreciated and respected based on
the dimension of the audit firm, the external audit quality in Romanian banking system is
studied from the perspective of auditors membership to the Big Four
(PricewaterhouseCoopers, KPMG, Ernst & Young and Deloitte).
1. The external audit and the financial performance

The high quality banking audits make also an important contribution to the banking
supervision. Basel Committee for Banking Supervision issued a document on external
audits carried out by banks in order to support increasing audits quality and the efficiency
of prudential supervision, contributing to safeguarding financial stability. The guidelines
aim to ensure strengthening Audit Committee key role in promoting quality banking audit
by the means of an efficient communication with the external auditor as well as a robust
supervision of external audits performed within the bank.
1274 Amfiteatru Economic

Building and consolidating effective relations between the prudential supervision authorities
and external auditors, as well as between the prudential supervision authorities and those
bodies which supervise the audit, can contribute to increasing banking supervision. The
guidelines issued by Basel Committee for Banking Supervision have the role to create the
foundation for effective communication between prudential supervising authorities and
external auditors. There are also favoured and encouraged supervising cooperation relations
between prudential supervising authorities and audit supervising bodies for the correct
fulfillment of their responsibilities. Therefore, as part of this document issued and applicable
at European level, Basel Committee for Banking Supervision includes a series of
expectations, targets regarding banking supervision as well as relevant recommendations
related to external audits in banks, aiming at improving these audits quality.
The boards of directors and banks management are responsible for ensuring that financial
statements are prepared according to the financial reporting scope. They are also
responsible for ensuring audited annual financial statements and the fact they "carry" the
opinion of an independent external auditor. According to the international auditing
standards, an audit is conducted on the precondition that managers and, where appropriate,
those in charge with the governance, adopt some fundamental responsibilities in conducting
the audit. By auditing the financial statements, either managers or those in charge with the
governance are not exempted from facing their responsibilities.
While performing the audit, the external auditor assesses banks financial statements,
aiming at obtaining the reasonable insurance that these statements do not contain
considerable distortions, due to fraud or error. Thus, at the end of the auditing process, the
auditor will state the opinion that the financial statements are organized according to the
applicable financial reporting framework. Hence, the external auditors play a key role in
maintaining public confidence in audited financial statements. In terms of banking services,
this public role is particularly relevant in ensuring banks financial stability taking into
account their financial intermediating function played in the economy.
Audit quality is essential in maintaining and strengthening this public role. Aside from
these facts, the external auditor is required to directly report to the supervisor, the important
issues arising during bank's audit. For an optimal audit development, the external auditor
must possess solid knowledge and skills on the banking sector matters to be able to
appropriately respond to the risks generated by distortions that can be found in the audited
financial statements of the bank and to comply with the additional regulation that may be
part of the audit process. At the same time, the external auditor must be objective and
independent both in fact and appearance, during the audit process. He/she will demonstrate
professional skepticism in planning and performing the audit, taking into account all the
specific challenges that may occur.
The external auditor must identify and assess the risks of distortions within the financial
statements, given the complexity of bank's activities and the effectiveness of the internal
control system. The external auditor independence is one of the main prerequisites for the
existence of an adequate level of quality. Thus, it is necessary for the audit committee to
understand the independence requirements and to provide, at least annually, the related
measures for monitoring and assessing the independence of the external auditor in
accordance with relevant national laws, regulations and professional requirements.

In the event that the external audits are being run by the same audit firm for several years,
the risk of familiarity or personal interest might threat external auditors objectivity and
independence. However, when the bank changes the external auditor, the risk is that short
knowledge and understanding of bank's activity and systems to occur. This change may
cause the instance that the new external auditor will not fully identify the financial
statements distortions and thus he/she will not issue the appropriate recommendations, thus
affecting audit quality.
Basel Committee for Banking Supervision recommends that, commensurate with the size,
complexity and diversity of banking activities and connected to the legal and regulatory
framework where banks activate, the external auditor must possess the expertise and skills
needed to run the banking audit and, where appropriate, to co-operate with banking experts.
Possessing the necessary knowledge and skills has a significant role in external auditors
proper exercising of professional judgment and in conducting the key aspects of audit
process, such as identifying and assessing distortions risks and designing and
recommending appropriate solutions to cover those risks. Professional skepticism is defined
as "an attitude that includes a questioning attitude, being alert to conditions which may
indicate possible significant distortions due to error or fraud and a critical assessment of the
evidence" (IAASB, 2012). It is especially important for an external auditor to exercise
professional skepticism in the audit activities, particularly in the following areas:
calculation of depreciation, determination of fair value and permanence assessment
methods, including related assessment and solvency indicators liquidity. In planning and
performing the audit, the external auditor should properly apply the concept of materiality.
Determination of significance level of financial statements as a whole depends on the
external auditor's judgment on possible distortions that can occur reasonably and could
influence the economic decisions of users made based of these financial statements.
According to generally and internationally accepted auditing standards, control system
components include: control environment; risk assessment process across the organization,
information system, including related business processes relevant to financial reporting and
communication, control and monitoring activities undertaken within bank. The mechanisms
for compensation or remuneration system of a bank can be a good indicator for the
assessment of organizational culture, as they are able to influence bank staff attitude towards
risk and the quality of corporate governance. In this context, the external auditor will pay
special attention to possible risks of significant distortion in financial statements that can
occur as a result of frauds, especially when banks use specific compensation arrangements
that may encourage excessive risk-taking or other inappropriate behaviors of the employees.
International Auditing Standards recommend external auditor to get an understanding of
control activities relevant for audit execution, so that they can be properly assessed
according to the risks of significant distortion in order to establish audit strategy. An
understanding of control activities related to the financial reporting process is essential for
planning the audit procedures appropriate for the assessed risks within bank. Thus, in
identifying and assessing significant distortions risks and in evaluating controls within
bank, external auditor must take into account the following factors:
competence and knowledge of those employees responsible for the development and
presentation of financial statements and of those that are in charge of the control functions
that can impact financial reporting;

the use of complex financial instruments, that involve fair value estimates;
providing custody services related to retail and / or institutional clients;
the volume of transactions suitable to each type of activity and the presence of
certain atypical transactions;
functioning and monitoring of internal accounts;
complexity and structure of the IT systems used to run the business and to develop
financial reporting, as they can cause an increased risk of fraud or error, especially where
there is the possibility of individual extra-control or in the case of fraudulent transactions
which are difficult to identify due the high degree of diversification and complexity of
information systems;
network size, scope and the geographical spread of branches as well as the need for
complex reinforcing procedures;
existence of significant transactions with related parties;
use of off-balance sheet financing arrangements.
After identifying and assessing risks of significant distortion in financial statements, that
may occur as a result of fraud or error, when the auditor considers that there is a significant
risk of denaturation according to international auditing standards, he/she plans and
implements appropriate recommendations to cover such risks including testing of controls
in the current period. These controls are those that the auditor intends to rely on in the
development of audit process. Thus, in audit planning stage, the external auditor will
consider a set of internal or external elements that will be audited, represented by:
risk and scope assessment - assessments of banks external environment and
financial performance, business model and appetite or risks exposure.
Audit Strategy and opinions of materiality.
notes on internal controls (eg effectiveness of corporate governance, control
environment).
fraud that can be found as the effect of control environment weaknesses.
risks assessment that can occur from implementing the ongoing business
assumption.
application and changes in accounting policy.
culture implemented by management within the organization.
problems connected to previous years audits and the way they were solved within the
organization.
The appointed persons responsible for the executive management within the bank and those
responsible for corporate governance, such as the audit committee, will ensure that the
bank's internal control system is sized according to the nature, complexity and volume of
banks activities and is organized and operates according to the legal and regulatory

requirements. The internal control system of a bank must be reliable and robust so that it
can cope with crisis environments.
2. Literature review
The coordination of internal and external audit activities, experienced especially during the
last decade, a special attention due to the understanding that those robust corporate
governance systems can help minimize the devastating impact that corporate bankruptcies /
crashes can generate (Rusak and Johnson, 2007).
This idea is underlined by the recognition of internal audit role in terms of financial
reporting quality improvement. Blue Ribbon Committee Report (1999) presents the audit
committees of boards of directors, internal and external audit functions as a three-
dimensional pillar of corporate governance that contribute to the maintaining and
perpetuating of financial reports reliability.
The use of financial information by boards (on behalf of shareholders) and the contribution
of internal and external audit in enhancing the usefulness of this information, which is
provided (and equally used) by management in its decision making (Fan and Wong 2004,
Jensen and Meckling 1976, Blue Ribbon Committee, 1999) provides an integrated picture
of existing connections among the four components of corporate governance.
The activities of internal and external audit increase the efficiency of the audit committees,
which are an essential tool serving as support for boards (DeZoort et al. 2002).The internal
audit is an essential resource in the context of corporate governance, providing services to
the other components of corporate governance (Gramling, et al, 2004;. DeZoort et al 2002).
The studies focused on the mechanisms of audit as a part of the corporate governance
system at the level of developing countries are, so far, relatively limited.
Fan and Wong (2004) demonstrate the role of external audit for corporate governance in
emerging economies, based on empirical studies conducted on developing countries.
However, there is small research focused on the connections between the mechanisms of
internal and external audit activities at the level developing countries and their impact on
corporate governance mechanism. The professional audit standards, namely, International
Standards on Auditing (ISA) 610 provide guidelines in terms of external auditors work in
conducting financial statements audits.
The literature also underlines that the confidence external auditors have in the internal audit
activity could contribute to significant cost savings by reducing the time allocated to
external audit process. The external auditors assess the activity of internal auditors in order
to determine whether the internal audit function can be trusted. Such confidence is also
particularly important, given the extra value that internal audit can bring to the company
through reduced audit fees (Krishnamoorthy, 2001, 2002; Morrill and Morrill, 2003; Mihret
2010; Mihret, James and Mula 2010).
No doubt, the opportunity to reduce costs generates the interest of the other two main
components of the corporate governance mechanism (boards of directors and the
management) which are interested in promoting constant cooperation between internal and
external audit.

The efforts to diminish external audit costs, to restrict audit fees and maintain or strengthen
the competitiveness on the services market motivate external auditors decisions to rely on
internal auditors activities (Morrill and Morrill, 2003). Moreover, the detailed knowledge of
the organizations by internal auditors can provide external auditors with the means to
reduce audit risk at organizations level. Meanwhile, audited financial statements are an
important source of information made available for investors to assess the credibility of
financial reporting, and a base in making decisions on resource allocation.
The independence and audit quality play an important role in enhancing transparency of
financial reporting practices and confidence in any capital market. However, it is essential
for the audit firms to provide audit reports in a timely manner as to enable investors to
allocate resources rationally and optimally (Dahawy and Samaha, 2010).
Any delay in stating auditor's opinion on the true and fair view of financial information
drew up by company management, creates asymmetrical information submitted by
managers to shareholders, while negatively affecting the efficiency of the financial system
(Shafie and Wan-Hussin, 2010).
In terms of the auditing committee, from the perspective of agency theory it is viewed as a
"tool" that improves the quality of monitoring information flow between the owners of the
entity and its management (Forker, 1992; Ho and Wong, 2001), particularly in the area of
financial reporting, where the information level of the two stakeholders is significantly
different (Barako et al., 2006).
On the other hand, the external auditor has a crucial role in enhancing the efficiency of
corporate governance process by increasing the credibility of the information provided by
financial reporting as transparent as possible (Francis et al., 2003; Sloan, 2001). In this way
is justified why external auditors were sometimes seen as the "gatekeepers" that monitor the
managerial behavior on behalf of all stakeholders (O'Sullivan et al., 2008). In their absence,
maintaining the appropriate corporate governance structures could be endangered (Coffee,
2001).
On the basis of agency theory, large audit firms act as mechanisms for reducing the
information asymmetry and agency costs, limiting opportunistic behavior of management
through monitoring (Jensen and Meckling, 1976) and contributing to the improvement
disclosed information quality (Chung et al., 2002), thus ensuring the protection of investors
(McDaniel et al., 2002).
Thus, the audit quality was assessed frequently in the literature in terms of the audit firm
size (Barako, et al., 2006; Eng and Mak, 2003; Gul and Leung, 2004; Chau and Gray, 2010;
Al-Shammari and Al -Sultan, 2010; Akhtaruddin, et al., 2009; Haniffa and Cooke, 2002;
Huafang and Jianguo, 2007), large firms (ex. big Four) are seen as able to contribute to the
establishment of good corporate governance practices among entities, at least due to the
following reasons:
The higher quality of audit services provided compared to that of the small firms
(Leung and Horwitz, 2010), because at the level large entities "there is more wealth
gambled" (Dye, 1993).This is generally reflected in the higher audit fees charged, in the
longer time periods dedicated to audits and in the small number of subsequent processes
(DeAngelo, 1981; Palmrose, 1988, Palmrose, 1989);

The reputation in minimizing errors (DeAngelo, 1981; Beatty, 1989; Firth, 1979;
Chow, 1982; Ahmed and Nicolis, 1994). Large audit firms are willing to invest more to
maintain their reputation as suppliers of quality audit services, because if their reputation is
damaged they risk to lose more than small firms;
More experience, usually manifested through influences in encouraging the
leadership to disclose as much information to reduce the information asymmetry and
agency costs (Baiman, et al., 1987; Baiman, 1990; Wallace et al. 1994; Watts, 1977; Watts
and Zimmerman, 1986);
The higher degree of independence from the customers, given their large number,
which could compromise the quality of their work to a lesser extent than in the case of
small audit firms (Owusu-Ansah, 1998). Given their role to enhance disclosed information
level and quality, the independence status allows them to influence corporate financial
reporting to better meet the needs of external users (Barako et al., 2006).
3. Methodology
The methodology used to test the assumptions is mainly quantitative. This is based on a
deductive statistical analysis whose starting point was the agency theory, aimed at testing
and identifying the possible links of the type cause - effect, and analyzing their
significance.
This paper provides a comprehensive analysis of the connection of the external audit with
the financial performance at the level of Romanian banking system. It thus tries, by means
of empirical research, to find answers to the following question: Does the quality of the
external audit influence the financial performance of Romanian banks?
Based on the records of the previous literature, the following hypotheses were formulated:
H1: There is a significant positive association between the quality of external audit and the
financial performance of banks;
quality banks' assets;
solvency of banks.
Given the fact that in the technical literature, audit quality has often been appreciated taking
into consideration the dimension of the audit firm, the quality of external audit in Romanian
banking system is studied from the perspective of the auditor's being part of the group Big
Four.
In order to carry out the present research, we used specific tools for data processing, using
SPSS software under Windows (correlation and regression analysis tests).
At the end of 2013, the Romanian banking system had 40 credit institutions, out of which
31 were banks, Romanian legal entities (including credit cooperative organizations) and 9
were branches of foreign banks. Out of the 40 banking institutions, the sample analyzed
consisted of 21 banks, sample made up of Romanian legal entities. The 9 branches of
foreign banks were excluded from the analysis, in accordance with Regulation 25/30/2006

regarding the disclosure requirements for credit institutions and investment firms which
states that the information necessary for the study does not have to be in Romania (as it was
made public in the country of origin). The study excluded eight credit institutions,
Romanian legal persons which have not published information on their official websites,
and two credit institutions for which there was no relevant information found on their
official sites. Moreover, it also excluded 12 credit institutions for which the values of the
analysed variables were not relevant as they registered comparatively huge variations
compared to the average values.
To achieve the main objective of the research, two distinct sets of variables were defined:
dependent variables and independent variables, based on which correlations can be
analysed, if such be the case. In Table no. 1, there a detailed presentation of these variables,
including a breakdown of how to define and evaluate them.
Table no. 1: The list of analyzed variables
Variable
Symbol Definition Measurement
I. Independent Variable
The quality of the EA_QUAL The quality assessed by the 1 membership in
external auditor external auditor who is a member Big Four;
of "Big Four" 0 to the contrary
II. The dependent variables regarding the financial performance
a. The dependent variables regarding the return
1. Return on ROA Return on Assets The net result / total
Assets assets
2. Return on ROE Return on Equity Net income / equity
Equity
b. The dependent variable regarding the quality of assets
3. NPL ratio NLP The share of nonperforming Non-performing
loans in the total loan portfolio loans / total loans
c. The dependent variable regarding the solvency
4. The solvency Solv the capital adequacy ratio - the ratio of Tier 1 and 2
adequacy of own funds to the risk of the credit
weighted assets institution and its
risk- weighted assets
In order to test the possible correlations between the researched variables, we used the
Pearson coefficient calculation, commonly used to assess the intensity of the linear
dependence between the two variables.
The correlation coefficient is denoted by (X, Y) and is defined by the formula:
(X,Y)= , i= , (1)
Where:
covariance: = ; (2)

values of the correlated variables and their average;

the number of pairs of values;
the standard deviation for X, respectively Y.
The correlation coefficient is obtained by standardizing covariance.
The Pearson coefficient can have values between "+1" and "-1".
A correlation coefficient equal to +1 indicates a perfect direct connection between variables
and one equal to -1 indicates a perfect inverse connection.
If takes the value 0 zero, then there is no connection between the variables.
This analysis of possible correlations that may exist between the studied variables gives us
clues about the meaning and significance of the possible links between them, thus allowing
us to accept or reject the formulated research hypotheses.
The dependent variables analyzed are the financial performance (i.e. ROA - Return on
Assets, Return on assets - and ROE - Return on Equity, cost), the asset quality (NPL to total
loans) and the solvency ratio as a summary of the recorded bank performance.
In previous research papers with similar objectives, there is a very wide range of financial
indicators used in order to evaluate the banking performance. One of the most frequently
used proved to be Tobin's Q [ratio of (market value of equity + market value of debt) and
the replacement cost of all assets] or other various modified variants, derivatives thereof.
In the present study, we used basic indicators of performance assessment, i.e. Return on
Assets - ROA and Return on equity - ROE, all of them variables often used in previous
similar studies. This was because it is rather difficult to obtain information on the market
value of banks included in the sample as such information is not always in the content of
the published financial reports)
In order to assess the quality of the loan portfolio, we used the share of NPL (non-
performing loans) on total loans as the dependent variable, knowing that in the banking
sector, the financial and economic crisis has had a negative impact on credit quality. NPL
ratio is calculated as the share of gross exposure of non-bank credits and interest rates on
loans with debt service greater than 90 days and / or where judicial proceedings have been
initiated against the operation or the debtor on total loans and interests of the total non-bank
loans balance.
Another dependent variable used in the present research is the solvency indicator (capital
adequacy ratio - the adequacy of own funds to risk-weighted assets). It is calculated as the
ratio of Tier 1 and 2 of the credit institution and its risk-weighted assets.
Tier 1 includes (according to the NBR, 2006): subscribed social capital and paid up (with
the exception of the cumulative preferential shares or, where appropriate, the endowment
capital available to the branch in Romania of the credit institution from the third country),
share premium, fully paid, regarding the social capital, legal, statutory and other reserves,
as well as retained earnings of the previous financial years, after the distribution of profit
and net profit of the last financial year, earnings until its distribution as decided by the
General Meeting of Shareholders.

Tier 2 includes: Tier 1 instruments and Tier 2 supplementary. According to the NBR (2006)
Tier 1 instruments include: reserves from the revaluation of tangible assets, adjusted for tax
obligations, foreseeable at the time of calculation of own funds; unlimited duration titles and
other similar instruments which comply with several conditions; other items that meet the
conditions set on the elements of Tier 2 basic. Tier 2 supplementary includes fixed-term
cumulative preferential shares; capital in the form of subordinated loans. The adequacy of
capital to the risks continues to experience a very high level in the Romanian banking system
(by 6 percentage points higher than regulated), which is a consequence of prudential regulation
and supervision measures adopted by the NBR with the start of the effects of the international
financial crisis felt in Romania, namely the imposition of the 10% threshold for the solvency
indicator (compared with 8 percent minimum, regulated at national and European level) in the
case of those credit institutions considered to have a high risk profile (Bunea, 2014).
The individual values for each of the variables studied, in the case of the 21 banks analyzed
are shown in Table no. 2.
Table no. 2: The individual values of the variables analyzed
BANK EA_QUAL ROA ROE NLP Solv
B1 1 0.53 4.49 29.20 14.70
B2 1 -0.82 -7.48 28.00 14.20
B3 1 1.79 15.72 8.70 17.00
B4 1 0.27 2.66 11.08 13.30
B5 1 1.17 12.16 12.57 13.78
B6 1 0.95 9.69 34.00 12.32
B7 1 0.14 1.89 19.20 13.12
B8 1 1.24 4.86 11.30 73.70
B9 1 -1.13 -9.25 30.00 15.94
B10 1 -1.04 -8.47 28.00 16.60
B11 1 1.20 9.47 16.50 13.24
B12 1 -0.84 -9.20 10.00 16.47
B13 1 -1.50 -13.67 17.00 12.73
B14 1 1.74 27.84 0.05 76.43
B15 1 0.65 6.70 7.00 13.54
B16 1 -2.23 -25.49 14.50 13.60
B17 1 0.77 5.09 13.95 12.27
B18 1 0.18 0.93 18.20 19.08
B19 1 0.42 2.52 13.00 77.08
B20 0 -2.13 -9.29 1.32 13.08
B21 0 0.87 3.38 17.00 15.02
Media * 0.11 1.17 16.22 23.20
Source: Calculations made by the authors based on data reported by banks

The collection of the data needed for the present research was based exclusively on the
information posted on the websites of the analysed banks, of the National Bank of Romania
or through their annual financial statements and related reports of 2013 on transparency and
disclosure requirements designed in accordance with the NBR-NSC No 25/30/2014
amended and supplemented by Regulations NBR - NSC No. 21/26/2010 and 23/15/2011
and NBR Regulation No. 25 / 10.12.2010.
4. Results and discussion

For all the 21 banks analyzed, the rates of return (ROA and ROE), calculated for 2013,
registered positive average values, but rather low, the reported net profit being low
compared to the value of assets and equity. The NPL ratio recorded an average of 16.22%,
close to the average reported for the entire Romanian banking system, while the solvency
ratio had a value of 23.20%, above the minimum threshold of 10% required by the NBR.
Of the analyzed banks, 19 (90.48%) had a Big Four external auditor, while only two banks
(9.52%) had external auditor from outside the Big Four group. The large number of banks
that turned to audit large companies confirmed their concern about having been provided
with qualitative audit services.
To highlight the influence the quality of the external auditor on the financial performance
of banks in Romania, we conducted an analysis of four selected variables for each of the
two groups of banks: banks that appealed to a Big Four auditor and the other banks. The
average values for each of the dependent variables analyzed are shown in Table no. 3.
Table no. 3: The individual values of the variables analyzed
Indicator Big Four Auditor Auditor Not Big Four Total

No of banks 19 2 21
% of banks (%) 90.48 9.52 100.00
ROA (%) 0.18 -0.63 0.11
ROE (%) 1.60 -2.96 1.17
NLP (%) 16.96 9.16 16.22
The solvency indicator (%) 24.16 14.05 23.20
The return on assets (ROA) for the Big Four auditor banks recorded an average of 0.18%
positive versus a negative value of -0.63% for the auditor Not Big Four banks. The situation
is similar in terms of profitability on equity (ROE) which is positive (1.60%) for banks that
used a Big Four auditor and negative (-2.96%) for other banks. Of the 19 audited Big Four
banks, 13 banks (68.4%) reported positive values for the two rates of return, while 6 banks
(31.6%) reported losses. Concerning the two banks with Not Big Four auditor, one of them
reported profit, while the other reported loss.
These figures highlight the existence of a direct link between the quality of the external
auditor and profitability of banks in Romania.
The NPL ratio is higher for banks that used a Big Four auditor (16.96%), while in the other
banks, the NPL average value is 9.16%, which means that the exposure risks are higher for

the first group of banks. Moreover, the highest values of non-performing loans rate, and the
lowest such rate were recorded in the banks that had a Big Four auditor, which shows no
apparent correlation between the quality of the external auditor and the quality of banks'
assets.
The solvency ratio also recorded significant differences between the two categories of
banks. Thus, banks with a Big Four auditor had an average solvency ratio of 24.16% while
other banks recorded an average solvency ratio of only 14.05%, which leads to the
conclusion that there a direct link between the quality of the external auditor and solvency
of banks.
In order to deepen the analysis of the correlation between the quality of the external auditor
and the financial performance of banks in Romania, we used the Pearson correlation
coefficient, calculated using SPSS software. Their values, which illustrate the possible
correlations between all variables considered in this analysis and their significance level,
are shown in Table no. 4.
Table no. 4: The correlation matrix of the analyzed variables
The financial performance EA_QUAL

Return on assets ROA Pearson Correlation 0.338
Sig, (1 - tailed) 0.067
N 21
Return on equity ROE Pearson Correlation 0.116
Sig, (1 - tailed) 0.308
N 21
The asset quality
NPL rate NLP Pearson Correlation 0.249
Sig, (1 - tailed) 0.138
N 21
The solvency
Solvency Solv Pearson Correlation 0.133
Sig, (1 - tailed) 0.283
N 21
Following the analysis of The Pearson coefficient values, it is noted that the financial
performance achieved by the credit institutions depend, to a lesser extent, on the quality of
the external auditor, the positive correlations identified having a significant probability of
only 95%, the Pearson coefficient values recorded being positive, but rather low. The
highest value for the Pearson coefficient was recorded for the auditor's dependence between
quality and return on assets (0.338), while for the correlation regarding the return on equity
coefficient Pearson registered a value of only 0.116. In addition, the value of Sig was
higher than the limit 0.05, which means that the positive difference registered is not
significant.

The same situation can be observed regarding the existence of an external audit influence
upon loan quality and solvency of credit institutions respectively, the identified correlation
being positive but rather weak, and the Pearson coefficient being 0.249 NLP and 0.133
respectively for the solvency ratio, and the value of Sig greater than 0.05.
The correlation analysis identified for each analysed independent variable, giving reasons
for acceptance or rejection of the formulated research hypotheses has also been based on
the results of the analysis of this dependence. The Pearson coefficient values for each
combination of variables are shown in Table no. 5.
Table no. 5: The correlation coefficients of the variables of the financial performance
ROA ROE NLP Solv
ROA Pearson Correlation 1 0.838** -0.157 0.364
Sig. (2-tailed) 0.000 0.498 0.105
N 21 21 21 21
**
ROE Pearson Correlation 0.838 1 -0.271 0.380
Sig. (2-tailed) 0.000 0.236 0.089
N 21 21 21 21
NLP Pearson Correlation -0.157 -0.271 1 -0.355
Sig. (2-tailed) 0.498 0.236 0.114
N 21 21 21 21
Solv Pearson Correlation 0.364 0.380 -0.355 1
Sig. (2-tailed) 0.105 0.089 0.114
N 21 21 21 21
From the interpretation of this data, we can conclude that the only variables significantly
correlated are the return on assets (ROA) and the return on equity (ROE) for which the
Pearson coefficient is equal to 0.838 and Sig is 0. Between the NPL and the other variables
used to measure the financial performance there is a negative correlation of low intensity,
the Pearson coefficient having values between -0.157 and -0.355 and Sig being higher than
0.05. The solvency index is positively correlated with profitability (The Pearson coefficient
being 0.364 and 0.380 for the ROA and ROE) and negatively with the NPL, but no such
links are significant because Sig is higher than 0.05.
Starting from the premise that the provided services, the reputation, the experience and the
independence are defining aspects underlying the audit quality assessment, and given the
fact that auditors from the "Big Four" have all the attributes which are essential to limit
managers' opportunistic behaviour through monitoring, the following hypotheses were
tested:
financial performance of banks;
quality banks' assets;
solvency of banks.

Taking into consideration the values of the Pearson coefficient obtained using SPSS
software (which are under 0.250 and the value of Sig, which is greater than 0.05), low
intensity positive associations have been identified both for the financial performance and
the quality of assets and solvency ratios; however, this data is statistically insignificant.
Thus, as far as the testing of the three hypotheses is concerned, after the analysis, we can
conclude that although there is a positive association between the external audit quality and
the financial performance of the credit institutions in the Romanian banking system, this is
not significant.
In conclusion, the three hypotheses tested (H1, H2 and H3) are rejected, external audit
quality (expressed in terms of being members of the Big Four) being of insignificant
influence upon the dependent variables in this analysis at the level of the banking
institutions in Romania.
Conclusions
The study was designed in order to provide an analysis of possible connections between the
external audit quality (assessed through membership of the Big Four) and the financial
performance, portfolio quality and solvency of the banking system in Romania.
The testing of possible influences of the quality of the external audit upon the value of an
entity has been the subject of a wide range of research until now. In contrast, the research
performed in this study has a unique approach to this problem recorded in a specific field of
activity, the financial banking one, a field which has not been thoroughly researched from
this precise perspective until now. Furthermore, in this analysis, in addition to the
connection between the quality of external audit and financial performance, we also tried to
capture the links between this and risk management elements at the level of the banking
system (the non-performing loan ratio and the solvency indicator).
At the same time, the present study was focused on a single "key player," the external audit,
thus giving it its due consideration thanks to its role and place in the process of company
management. Moreover, the formulated hypotheses and the connections with the dependent
variables included in the analysis give the research a touch of originality and, by default,
value added.
The research also has a number of limitations, mainly caused by the sample size of the
banking institutions analysed, but also because the present study was based on information
related to a single calendar year (end of 2013); we consider all the above as challenges for
future research. Also, this study included only a few indicators that measure the
performance of the banking system, paving the way for future research of other indicators
used to analyze the performance and risk management of credit institutions (capital
adequacy of credit risk, market risk, operational risk, etc).
Despite all of these limitations, we consider that this study could be a useful source of
information and reflection for banking practitioners, representing challenges for future
research.

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New Trends in Sustainable Business and Consumption AE

THE CORRELATION BETWEEN EXTERNAL AUDIT

Please cite this article as:

Keywords: audit quality, external audit, corporate governance, financial performance,

JEL Classification: M40 , G20, G30

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1. The external audit and the financial performance

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values of the correlated variables and their average;

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4. Results and discussion

Indicator Big Four Auditor Auditor Not Big Four Total

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The financial performance EA_QUAL

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