How Audit Quality Affects the Firm Performance with the Moderating Role of the Product Market Competition: Empirical Evidence from Pakistani Manufacturing Firms

Abstract

Audit quality (AQ) is a crucial instrument for ensuring transparency and accountability in both the public and private sectors. If the AQ is responsible for the maximization or minimization of profit, then what are the circumstances that make these possible? In this study, we examined the role of the product market competition (PMC) in the relation between the AQ and firm performance (FP). The PMC on the manufacturing firms of Pakistan was divided into two categories—low product market competition (LPMC) and high product market competition (HPMC). This division was calculated using the Herfindahl–Hirschman index (HHI). Then, we used ordinary least squares (OLS), the fixed-effect model, and the generalized method of moment (GMM) to examine the role of PMC on the association between the AQ and FP. The results of the study revealed that the financial performance of firms was enhanced with the quality of the audit. Highly competitive firms demonstrated higher chances to capture the maximum profit and have a positive relationship with FP, while less competitive firms were negatively associated with FP. Furthermore, the HPMC played a vital role in boosting the profit of the firms. On one hand, the connection between the AQ and FP was positively affected by the HPMC. On the other hand, the connection between the AQ and FP was negatively affected by the LPMC. Thus, the findings of this investigation have various implications for owners, investors, shareholders, and governments. This study can help the governments of developing economies to enhance economic conditions by focusing on the industrial sector. This study also contributes to the literature by supporting the agency theory that PMC can mitigate the agency issue between owners and agents.