CHAPTER IV

PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

1. Assessment of Costs of Capital of the Financial Institutions Listed in the

Philippine Stock Exchange

This section describes the dependent variable of the study which is costs of

capital. In this study, the COC of the financial institutions listed on PSE was assessed

based on the following indicators: the cost of debt, cost of equity, and weighted average

cost of capital. 1.1. Cost of Debt

The cost of debt is the needed rate of return on capital borrowed, including bonds

and loans. The COD for a business has a significant impact on its financial structure.

Simply stated, it is the total interest paid by a company or individual on each of its debts,

including securities and loans, or the effective interest rate (Riley, 2020).

Figure 2.
Cost of Capital in Terms of Cost of Debt (COD) of Financial Institutions Listed in
the Philippine Stock Exchange from Years 2013 – 2022
 43

Table 1. Descriptive Statistics of the Cost of Capital of Financial Institutions Listed

in the Philippine Stock Exchange in Terms of Cost of Debt (COD)
Year N Minimum Maximum Mean Std. Deviation
2013 16 .04 5.82 1.4281 1.41992
2014 16 .03 5.84 1.2725 1.36493
2015 16 .00 5.77 1.2725 1.33285
2016 16 .00 5.71 1.2713 1.31322
2017 16 .00 5.20 1.2438 1.18615
2018 16 .00 5.86 1.7331 1.28180
2019 16 .00 5.86 2.1444 1.29259
2020 16 .00 5.00 1.4294 1.12293
2021 16 .00 11.08 1.5381 2.75017
2022 16 .00 5.11 1.0587 1.16598
Total .00 11.08 1.4392 1.47950

Figure 2 presents the trend of the costs of capital measured by the cost of debt of

financial institutions listed on the Philippine Stock Exchange (PSE) from 2013 to 2022.

Several fluctuations can be observed in the graph of the cost of debt. From the figure

above, there is a gradual decrease in the cost of debt of financial institutions from 2013 to

2014, falling from 1.4281 to 1.2725. This is followed by consistent maintenance of the

same level from 2014 to 2015. During 2016, the cost of debt is 1.2713, and it slightly

decreases during 2017 to 1.2438. However, there is a significant increase from 2017 to

2018, climbing by 0.4893 to reach 1.7331. Moreover, throughout the period spanning

from 2018 to 2019, there is a consistent upward trend observed in the cost of debt, with a

notable increase of 0.4113 percent. This growth translates to a rise in the cost of debt

from 1.7331 to 2.1444, which was considered the highest cost of debt. Despite this

increase, there are signs of resilience as the trend significantly rebounds and exhibits a

fast recovery from 2019 to 2020 with a rate increase from 2.1444 to 1.4294. Additionally,

during the year 2021, the cost of debt is 1.5381, and it significantly decreases during 2022

to 1.0587. This pattern reflects financial conditions and economic factors influencing the
 44

cost of debt over the decade.

Shown in Table 1 are the descriptive statistics of the cost of debt, which is one of

the sub-variables of the costs of capital. Above are the number, minimum, maximum,

mean, and standard deviation of the cost of debt. The overall mean is 1.4392 and standard

deviation of 1.47950. While the overall maximum value of COD in the data set is 11.08

in 2021, and the minimum value is 0.00 in 2015 to 2022. It implies that the cost of debt is

higher than the anticipated return on investment from the projects that the debt is used to

finance. In addition, low standard deviation means that the data gathered for the years

2013-2022 is concentrated. This suggests that the data for the cost of debt is good and

more reliable than those resulting in a higher standard deviation. Moreover, the highest

mean is 2.1444, which represents the cost of debt in 2019. This means that the publicly

listed financial institutions’ cost of debt in this year is the highest among the other years,

implying that it is riskier because of economic difficulties. On the contrary, the lowest

mean is 1.0587, which represents the cost of debt in 2022 and is considered the lowest

COD among the other years, thus highlights good financial health.

The shifting trends over time were caused by a variety of factors that influence

debt costs. The declining cost of debt from 2013 to 2017 implies that the overall cost of

financing their operations through borrowed funds which is more than one (1) reflects

that financial institutions were not managing their debt effectively. The company was

paying more interest expense than the total amount of debt and had not secured the loans

at lower interest rates which resulted in weak financial health. The increasing cost of debt

since 2018 and the high cost of debt in 2019 indicate that the PSE-listed financial

institutions may be heavily indebted and may not be paying off their current debt, which

could result in an excessive amount of debt financing and worse credit scores. It implies
 45

heavy financial costs that might impede operational adaptability and expansion

possibilities. Moreover, the large decline in 2022 indicates that financial institutions were

successful in controlling their cost of debt, which helps reduce financial risks and

preserve stability in a range of market circumstances.

The lower cost of debt observed in recent years is due to the stable economic

conditions, particularly interest rates, inflation and the overall economic growth. Due to

the decline in inflation expectations, it results to lower nominal interest rates and a lower

cost of debt. Financial institutions were able to borrow at reduced price due to low

interest rates, thus enhancing their financial flexibility. In addition, the rapid growth in

the economy can enhance debt sustainability and reduce borrowing costs. However, the

increase of cost of debt in the earlier years indicates that financial institutions dedicate a

significant portion of their cash flow to paying down their debt, this circumstance may

result in more financial strain. With that, their future borrowing costs also increase as a

result, since lenders may raise interest rates to offset the perceived default risk, which

would eventually hurt the competitive market and the value of shareholders.

Economic stability, inflation rates, and political stability in the country or region of

operation can influence the cost of debt. Stable economic conditions generally result in

lower borrowing costs, whereas economic uncertainty or geopolitical risks may increase

costs due to higher perceived risks for lenders (Finschool, 2024). According to Hayes

(2024), businesses' main objective to achieve the overall goal of the company was to keep

costs down and revenue higher. With that, reducing the cost of debt can be achieved by

raising negotiating rates, financing debt, obtaining better credit scores, increasing

payments promoting corporate growth, and increasing their appeal to lenders and

investors.
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Kim (2024) asserted that if a company's cost of debt is less than one (1), it means

that its effective interest rate is below 100 percent, its entire interest expense is less than

its total debt. The business is successfully managing its debt, potentially taking advantage

of advantageous tax laws and low interest rates, which improves its financial stability and

appeals to both lenders and investors. Conversely, if the cost of debt is more than one (1)

(100 percent) it means that the effective interest costs on borrowed money are more than

the principal. Higher lending rates, more stringent terms, and a greater financial burden

presented serious difficulties for the company.

The interest rates that lenders offer might be greatly impacted by raising your credit

score. The lesser interest rates are frequently the outcome of a higher credit score, which

signals a lesser risk for the lender. By paying your bills on time and lowering your debt,

you can improve your creditworthiness and get better terms on loans (United Capital

Source, 2023).

1.2. Cost of Equity

The cost of equity is a fundamental financial concept representing the "price" a

company must pay to attract investment capital from shareholders. It encapsulates various

factors, including risk, opportunity, and market conditions, making it a critical business

metric. Shareholders demand compensation for the risk they take by investing in a

company's equity rather than choosing safer alternatives, such as risk-free bonds. This

compensation is quantified by the cost of equity, which provides businesses with insight

into how much return investors expect based on the perceived riskiness of the company.

Furthermore, companies use their cost of equity to make strategic decisions on financing

and capital structure. By comparing the cost of equity with the cost of debt, management

can assess the most efficient way to raise funds. While equity financing does not require
 47

fixed interest payments, it dilutes ownership and may increase shareholder expectations

for returns (Harshinidevi, 2024).

Figure 3.
Cost of Capital in Terms of Cost of Equity (COE) of Financial Institutions Listed in
the Philippine Stock Exchange from Years 2013 – 2022

Table 2. Descriptive Statistics of the Cost of Capital of Financial Institutions Listed

in the Philippine Stock Exchange in Terms of Cost of Equity (COE)
Year N Minimum Maximum Mean Std. Deviation
2013 16 .08 4.99 .5938 1.21536
2014 16 .03 2.44 .4006 .66174
2015 16 -.04 2.08 .3675 .61397
2016 16 .04 1.77 .3912 .57047
2017 16 .03 1.55 .3213 .44360
2018 16 .04 2.20 .4188 .62093
2019 16 .05 2.68 .4875 .73852
2020 16 .04 2.54 .5131 .79773
2021 16 -.02 2.88 .5756 .85210
2022 16 .02 5.98 .7269 1.50408
Total -.04 5.98 .4796 .84223
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Figure 3 presents the trend of the cost of equity (COE) for financial institutions

listed on the Philippine Stock Exchange (PSE) from 2013 to 2022. The graph reveals

three distinct phases in the cost of equity over the ten years. From 2013 to 2015, the COE

dropped significantly from 0.5938 in 2013 to 0.3675 in 2015. This period reflects

improving market conditions and reduced risk premiums demanded by investors. Such

declines may indicate growing confidence in the financial sector's stability or improved

macroeconomic indicators. Between 2016 and 2018, the COE remained relatively steady,

fluctuating between 0.3912 and 0.4188. The low variability during this phase suggests a

period of relative economic stability and consistent investor expectations. Notably, the

mean COE of 0.3213 in 2017 is the weakest in the dataset, and the standard deviation is

also minimal (0.44360), reflecting a homogenous perception of risk across institutions.

Starting in 2019, the COE experienced a steep upward trend, climbing from 0.4875 to

0.7269 in 2022, the highest value recorded. This rise likely reflects heightened

uncertainty and increased perceived risks. Factors contributing to this trend could include

global economic disruptions, such as the COVID-19 pandemic, inflationary pressures, or

geopolitical tensions. The increasing standard deviation, peaking at 1.50408 in 2022,

indicates greater variability in the COE across institutions, suggesting that some

companies faced significantly higher risks than others.

Table 2 provides complementary descriptive statistics, offering a detailed

breakdown of the cost of equity for financial institutions during the same period. The

overall mean COE from 2013 to 2022 was 0.4796, with a standard deviation of 0.84223.

While the average COE is significantly lower than typical costs of equity observed

globally
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(6-14 percent), the increasing spread in values over the years highlights a growing

disparity in risk perceptions among financial institutions. The highest COE observed was

5.98 in 2022, while the lowest was -0.04 in 2015. The negative minimum in 2015 may

reflect unique outliers or anomalies, possibly due to overly optimistic growth projections

or favorable valuation adjustments for certain institutions. On the other hand, the peak in

2022 underscores significant investor concerns over financial stability during uncertain

economic conditions. Year-by-year, 2013 displayed a relatively high mean COE of

0.5938 and a substantial standard deviation (1.21536), suggesting variability in risk

perceptions, likely influenced by the residual effects of global financial crises. In 2017,

the lowest mean COE (0.3213) and minimal standard deviation (0.44360) reflected

investor confidence and a stable economic environment. Meanwhile, 2022 shows the

highest mean COE (0.7269) and significant variability (standard deviation of 1.50408),

highlighting the impact of external shocks and investor wariness.

The declining trend from 2013 to 2015 can be attributed to favorable market

conditions that reduced the risk premium demanded by equity holders. This period likely

represents a phase of stabilization and confidence in financial institutions' performance.

In contrast, the moderate fluctuations between 2016 and 2018 may reflect short-term

market adjustments due to factors like changes in interest rates, external economic

pressures, or liquidity measures, which did not significantly impact overall investor

sentiment. The notable increase from 2019 onward suggests growing uncertainty or risk

in financial institutions, potentially driven by global economic disruptions, regulatory

changes, or other macroeconomic factors that heightened investors' demand for higher

returns.
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The trends in the cost of equity highlight the sensitivity of financial institutions to

both internal and external economic factors. The stability observed in earlier years

underscores the importance of consistent market conditions and sound financial practices

in fostering investor confidence. On the other hand, the sharp increase in recent years

may reflect concerns over financial stability, possibly due to external shocks such as

global pandemics, geopolitical tensions, or other crises. These concerns emphasize the

need for financial institutions to strengthen their capital positions and risk management

strategies to mitigate investor apprehensions and maintain lower funding costs.

According to Belkhir et al. (2021), there was evidence supporting the notion that a

lower cost of equity signals a more stable capital structure and reduced investor risk

perceptions, allowing financial institutions to secure equity at more favorable terms.

Stronger capital positions also reduce vulnerabilities during economic uncertainty,

enabling banks to expand credit effectively. The decline in the cost of equity from 2013

to 2015 reflects this stability and supports broader economic growth by facilitating

lending at lower credit costs. Villanova and Arturo (2024) suggested that minor

fluctuations in COE during stable economic periods reflect short-term market

adjustments, such as changes in monetary policy or external pressures.

Harshinidevi (2024) complemented this perspective by emphasizing the

challenges posed by a rising cost of equity. According to the author, a higher cost of

equity indicates that investors perceive greater risks, compelling them to demand higher

returns. This can have several implications for financial institutions. Firstly, it increases

the hurdle rate for investment decisions, making it harder for banks to pursue projects that

generate sufficient returns to satisfy investor expectations. Secondly, it raises the discount

rate applied to future cash flows, reducing the present value of the bank’s assets and
 51

leading to lower market valuations. Lastly, a higher cost of equity may create a

competitive disadvantage, as investors could view such institutions as riskier or less

efficient compared to their peers. This aligns with the sharp upward trend in the cost of

equity from 2019 to 2022, where external uncertainties likely compounded perceived

risks, highlighting the importance of robust financial management and regulatory policies

in mitigating these effects.

1.3. Weighted Average Cost of Capital

The Weighted Average Cost of Capital (WACC) measures a company's overall

financing cost by considering the relative proportions of debt and equity within its capital

structure. It provides managers with a comprehensive understanding of the company's

borrowing expenses, serving as a benchmark to assess the minimum return required for

new projects to generate value. Additionally, WACC plays a crucial role in optimizing

capital structure, helping firms determine the right mix of debt and equity to minimize

costs and maximize shareholder value. For investors, WACC serves as an essential

indicator of a company's financial health and risk profile, allowing them to evaluate

whether potential returns justify the associated risks. A lower WACC generally signals

lower risk and efficient capital management, whereas a higher WACC may indicate

greater financial risk or inefficient funding strategies. Ultimately, understanding and

managing WACC effectively contributes to more informed corporate financial planning

and improved decision-making for both companies and investors (Jadeja, 2024).
 52

Figure 4.
Cost of Capital in Terms of Weighted Average Cost of Capital (WACC) of
Financial Institutions Listed in the Philippine Stock Exchange from Years 2013 –
2022
Table 3. Descriptive Statistics of Costs of Capital of Financial Institutions Listed in
the Philippine Stock Exchange in Terms of Weighted Average Cost of Capital
(WACC)
Year N Minimum Maximum Mean Std. Deviation
2013 16 -17.76 .30 -1.0650 4.45253
2014 16 -10.06 .45 -.5794 2.53042
2015 16 -10.01 .41 -.5756 2.51791
2016 16 -7.85 .45 -.4413 1.97854
2017 16 -1.71 .39 -.0613 .44920
2018 16 .01 2.01 .1756 .49800
2019 16 .01 2.51 .2125 .62162
2020 16 .01 2.23 .1988 .55718
2021 16 .00 2.48 .2219 .61827
2022 16 .01 4.52 .3413 1.12141
Total -17.76 4.52 -.1572 1.97719

Figure 4 illustrates the trend of the cost of capital in terms of WACC of financial

institutions listed on the Philippine Stock Exchange (PSE) from 2013 to 2022. As
 53

presented in the graph, the WACC almost consistently increased in ten years but there

was also a minimal decline that occurred. In the years 2013 to 2014, there was a 0.4856

significant increase in the WACC from -1.0650 to -0.5794. During the year 2015, there

was a very minimal increase in the WACC to -0.5756 before it escalated in 2016 to 2018

from -0.4413 to 0.1756, suggesting an increased risk that may affect the perception of

both investors and debtholders into investing and lending. However, there was a decrease

in the WACC from 0.2125 to 0.1988 in the years 2019 to 2020. This was seeded by the

disturbance caused by the pandemic which affected the financial industry. Eventually, for

2021 to 2022 there was again an increase from 0.2219 to 0.3413 in the WACC.

The descriptive statistics of the WACC, which is one of the sub-variables of the

costs of capital, are shown in Table 3. The results revealed that the overall mean and

standard deviation of the WACC of financial institutions listed in the Philippine Stock

Exchange are -0.1572 and 1.97719, respectively. This highlights the preference for

having a lower WACC instead of a higher one since it also gives a competitive

advantage. This further implies that financial institutions, as companies, pursued new

investments and made financing decisions, which are inevitable, to keep their operations,

protect their position in the industry and expand. It is to be noted that the negative values

of the WACC of MEDCO Holdings, Inc., from the years 2013 to 2017 influenced the

value of the overall mean. Despite that, the data sets for the WACC of financial

institutions are still close to each other which suggests that it is reliable for the study.

While the overall maximum value of WACC in the data set is 4.52 and the minimum

value is -17.76.

The increasing trend among the financial institutions from 2013 to 2014 can be

brought about by various market fluctuations in the industry as well as shifts in interest
 54

rates. This implies that they incur more costs through either debt or equity financing

which affects the WACC since it weighs both sources resulting in the increase. The

minimal fluctuation in 2015 indicates that the operations were almost funded in a similar

proportion as the previous year. The significant rise from 2016 to 2018 suggests that they

obtained more capital funds to support their ongoing operations and their investments

during those years. The minimal decline in 2019 to 2020 shows that there was not much

need to further procure more capital funds as of these years since they will be focusing

more on staying stable due to the effect of the pandemic. The increase from 2021 to 2020

reflects the attempt to recover and once again, strive for investments and projects which

can bring greater returns. The fluctuations reveal that WACC, as a metric to quantify the

costs of capital and weigh the composition of debt and equity, is influenced by financial

decisions made as well as the movement of the industry.

Moreover, the highest mean is 0.3413, which represents the WACC for the year

2022. This implies that even though the financial institutions are stable, they tend to

either finance their operations with more equity or more debt and not necessarily at a

point where it can decrease the WACC instead of increase it. Since if either gets too high,

the WACC percentage will certainly follow which will even affect the value of the

financial institutions. On the other hand, the lowest mean was -1.0650 in 2013,

representing the lowest WACC in the year. The cause of the negative mean is the

negative WACC percentage of MEDCO Holdings Inc. due to negative equity. This

suggests that they could procure funds at lower costs to support its operations. It is then

safe for investors to invest during this year since there are fewer risks. As well as for debt

holders to lend to financial institutions as there is a higher chance to receive payments.

 55

According to The Funding Family (2024), there is no threshold that is universally

accepted for a WACC percentage to be considered “good”, rather it is compared with the

WACC of those within the same industries. Given this, the WACC changes due to

changes in interest rates, stock market volatility and funding strategies made, or an

increase in the expected operational risk. Since it presents the amount of profit that must

be earned within its operations to meet the demands of the creditors, owners or investors,

it is to be utilized when making financing decisions. Despite being influenced by various

factors, in general, WACC is lower for robust companies with steady revenue and strong

earnings as compared to those of weaker firms (Fydenkevez, 2023). Hence, an increase in

WACC entails greater business risk, decrease in the company's valuation and viable

investments. With a higher perceived risk, investors and creditors will resort to requiring

higher returns in exchange for any possible unwanted outcomes from the investment. On

the other hand, a decrease in

WACC entails lower risk, more growth opportunities, and an increased company

valuation. The lowest viable WACC is preferred since it allows growth through new

investments and maximizing shareholder value (Poli, 2023).

This was further supported by the study of Ijaz et al. (2016), wherein the WACC

has a negative influence on the investment decisions made by companies. It is due to the

fact that a high cost of capital implies that there will be less returns to the stakeholders for

them to encourage them to continue investing. Hence, instead of being able to garner

more investments and attract more investors, this may lead them to turn away since there

is no high or promising returns to be received. The study by Rahman (2022) reiterated the

negative influence of WACC on profitability. Especially, if a firm focuses on either debt

 56

or equity financing only as a funding source. Thus, investment decisions may hamper the

growth of the firms when it is not made prudently.

2. Level of Audit Quality of the Financial Institutions Listed in the Philippine Stock

Exchange

2.1. Audit firm specialization

Audit firm specialization refers to the expertise auditors develop by working

extensively with clients in a particular industry, granting them a competitive advantage

over those with limited sector-specific exposure. Specialized auditors possess in-depth

knowledge of the industry's operations, regulations, and financial reporting standards,

enabling them to assess complex transactions and risks more effectively. This familiarity

enhances their ability to detect errors, irregularities, and fraud, resulting in more reliable

and higher-quality audits compared to non-specialist auditors ultimately leading to

improved trust and transparency in the financial reporting process (Sari, 2018).

Table 4. Level of Audit Quality of the Financial Institutions Listed in the Philippine
Stock Exchange in Terms of Audit Firm Specialization
Audit Firm Specialization Frequency Percentage (%)
More than 5 years of experience 160 100.0
Total 160 100.0

Shown in Table 4 is the level of audit quality in terms of the audit firm

specialization of the financial institutions listed in the Philippine Stock Exchange. As

presented, all the audit firms that audit the financial institutions have more than five (5)

years of experience. It is concluded that these audit firms uphold their work with utmost

integrity and thus, contribute greatly to the audit quality. With more than five (5) years of

experience, the auditor’s knowledge and skills are more likely to enable to work swiftly

and to efficiently handle problems with regards to financial statements and other relevant
 57

issues in the engagement. This also implies that they can identify and assess risks better,

making sound decisions that will be crucial to the audit process.

Achieving a high-quality audit will highlight the financial statements’ integrity,

which will then protect the interests of the financial institutions as well as their

stakeholders. This will allow them to receive more trust from their clients and investors

that the money or whatever they will be investing will be appropriated well and that no

anomalies are happening. Hence, a high degree of audit quality can be achieved with a

pool of highly qualified professionals who are well-versed in the financial industry.

Given the reputation of the financial institutions that they uphold, they tend to lean on

audit firms with specialization as it is expected that through their years of experience, and

skills honed through continuous development and knowledge, they can provide an audit

engagement of a better quality. Aside from that, as those with specializations are held in

high regard, superior performance and the ability to resolve complex issues about

financial reporting are anticipated by the financial institutions.

According to Mulyadi et al. (2022), the competence or skill that auditors possess

along with the training they go through aids them in providing audit services of high

quality. It is the capability and knowledge of the auditor of the client’s sector or industry

that enables them to perform proficiently ensuring great results and financial statements'

integrity. Similarly, Ajape et al. (2022) emphasized that specialization when it comes to

auditing helps different industries to maintain a consistently good audit quality. This

specialization was more often linked to those audit firms that are part of the Big 4, but it

was also noted that even those audit firms that are non-Big 4 have the capacity and can

have an equal chance with expertise in certain industries.

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On the contrary, the research article of Sari (2018) mentioned that auditors with

specialization negatively influences audit quality which was because of the amount of

workload given to these auditors resulting in a decline in the audit quality. The

exploitation of this specialization may result in excessive responsibilities which will

probably end up with the auditors not being able to fully utilize their expertise

appropriately. This also entails time pressure which may lead them to resort to procedures

that are efficient but may not be too in-depth, hence, reducing the advantage and

distinction of those with specialization from those with not.

2.2. Audit fees

Audit fees represent the expenses that companies incur when they hire public

accounting firms to examine and verify their financial statements. In everyday business

operations, these fees can sometimes pose a challenge for auditors who need to maintain

their independence while conducting their work. Higher audit fees can usually mean that

the audit is more thorough, with auditors performing a deeper, more detailed job,

especially when companies follow stricter rules or face complex financial situations

(Binus University, 2019). Additionally, audit fees often vary based on company size,

industry, and the scope of the audit engagement, with higher financial risks or intricate

accounting systems leading to increased fees.

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Figure 5.
Level of Audit Quality of the Financial Institutions Listed in the Philippine Stock
Exchange in Terms of Audit Fees

Table 5. Descriptive Statistics of Audit Quality of Financial Institutions Listed in the

Philippine Stock Exchange in Terms of Audit Fees
Year N Minimum Maximum Mean Std. Deviation
2013 16 13.70 16.34 14.8171 .82651
2014 16 13.89 17.14 14.9549 .97758
2015 16 13.82 17.07 15.0670 .97084
2016 16 13.84 16.94 15.1681 .98388
2017 16 13.99 16.49 15.2589 .86358
2018 16 13.32 16.64 15.3396 1.00356
2019 16 13.32 17.55 15.4480 1.13383
2020 16 13.53 17.01 15.4353 1.05322
2021 16 13.71 16.86 15.4791 .99242
2022 16 13.29 16.83 15.5104 1.05515
Total 13.29 17.55 15.2478 .98796

Figure 5 illustrates the trend in audit fees for financial institutions listed on the

Philippine Stock Exchange (PSE) from 2013 to 2022. The graph shows a gradual increase

in audit fees from 14.8171 in 2013 to 15.3396 in 2018, indicating consistent growth

during this period. A significant spike was observed in 2019, where fees rose to 15.448,

followed by a slight dip in 2020 to 15.4353, likely attributable to the economic

disruptions caused by the COVID-19 pandemic. However, audit fees recovered in 2021

and 2022, reaching their peak at 15.5104 in the latter year, signaling a return to normalcy

and heightened audit demands. The steady increase in audit fees over the years reflects
 60

the growing complexity of regulatory and compliance requirements, as well as the

evolving financial reporting standards that demand more detailed and extensive audits.

Table 5 complements the graphical trend by providing descriptive statistics for

audit fees over the ten-year period. The data reveals that audit fees ranged from a

minimum of 13.29 to a maximum of 17.55, with an overall mean of 15.2478 and a

standard deviation of 0.98796, indicating moderate variability across the years. The

lowest mean audit fee was recorded in 2013 at 14.8171, while the highest was observed

in 2022 at 15.5104. Notably, variability in audit fees increased in later years, as evidenced

by larger standard deviations in 2019 and 2022. This suggests that while some firms may

have faced relatively stable audit costs, others incurred significantly higher fees, possibly

due to differences in operational complexity, regulatory challenges, or the scale of their

activities. The gradual rise from 2013 to 2018 can be interpreted as a reflection of stricter

regulatory requirements, such as those introduced under Basel III, which demanded more

robust audits to ensure compliance with capital adequacy and liquidity standards. The dip

in 2020, during the peak of the pandemic, likely reflects cost-cutting measures or limited

audit scopes due to operational constraints. The subsequent recovery in 2021 and 2022

demonstrates the resilience of financial institutions and their renewed focus on

compliance, as well as the broader economic recovery.

The overall trend suggests that financial institutions are allocating increasing

resources to external audits over time, driven by both regulatory pressures and the

inherent complexity of their operations. The consistent rise in audit fees, with a 4.68

percent increase from 2013 to 2022, indicates that audits have become more resource-

intensive, necessitating greater expertise, larger audit teams, and longer audit

engagements. The upward trajectory in audit fees from 2021 onwards reflects a return to
 61

normalcy and the resumption of regulatory pressures that demand meticulous audits. This

aligns with the broader observation that financial institutions are continuously striving to

ensure compliance and manage risks in an increasingly complex environment.

The findings of the study of Amran et al. (2021) provided a strong basis for

understanding the trend of increasing audit fees, as financial institutions not only grow in

size but also operate in increasingly complex regulatory environments. This study

highlights that the complexity of a company directly and significantly influences audit

fees. As businesses grow and expand their operations, particularly through the addition of

subsidiaries or the execution of complex transactions, auditors face heightened

challenges. These include preparing consolidated financial statements, reviewing intricate

transaction records, and ensuring compliance with evolving regulations. Such complexity

necessitates more time, specialized expertise, and larger audit teams, all of which

contribute to higher fees. Similarly, this also highlights that the size of the company plays

a pivotal role in driving up audit costs. Larger firms, with their extensive resources and

higher transaction volumes, demand comprehensive audit procedures. These require

additional manpower, extended audit periods, and the engagement of prestigious auditing

firms, which naturally charge higher fees.

Innovation frequently adds complexity to a firm's operations, which in turn can

have a substantial effect on the audit process, often resulting in increased audit fees. As

noted by Park et al. (2021), firms that engage in innovative activities, such as ramping up

their R&D efforts and securing patents, typically face greater business risks that auditors

must address. The process of innovating, whether developing new products, entering new

markets, or implementing advanced technologies, complicates financial reporting and

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internal controls. Auditors need to invest more time and resources to assess these new

risk areas, making innovation a key driver of audit complexity.

2.3. Audit firm size

Audit firm size refers to the size of the firm conducting the audit, which can be

either local or part of the Big Four. The Big Four audit firms vary greatly in scale, with

disparities in audit quality and fees linked to their size, including revenues, office counts,

and staff numbers. (Omeiza et al. 2021).

Table 6. Level of Audit Quality of the Financial Institutions Listed in the Philippine
Stock Exchange in Terms of Audit Firm Size
Audit Firm Size Frequency Percentage (%)
Not part of Big 4 80 50.0
Part of Big 4 80 50.0
Total 160 100.0

Shown in the table is the level of audit quality in terms of the audit firm size of the

financial institution listed in the Philippine Stock Exchange. Based on the table, there are

two classifications of audit firm size from 16 publicly listed financial institutions. This

comprises both the financial institution’s part and not part of the big 4 with a frequency of

80, which represents 50 percent.

Based on the findings, the researchers conclude that audit quality is not

significantly impacted by the size of the audit firm as indicated by being part of the big 4

or not. Regardless of the audit firm's size, achieving a high degree of audit quality is

possible as it is dependent on the individual competence of the auditor. Large audit firms

tend to hire the best individuals to identify and correct errors or misstatements because of

their higher financial and human resources. It calls for work from the audit firm to supply

highly qualified personnel with an objective attitude as well as from professional bodies

to establish appropriate auditing standards.

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The results of this study are consistent with the findings of research carried out by

Priyanti and Dewi (2019) in which the regression test results showed that public auditing

firm size does not affect the quality of the audit. The audit quality is unaffected by the

size of the auditing firm, regardless of whether it is affiliated with a Big4 auditing firm.

Because a public auditing firm must adhere to sound audit standards while reviewing a

company's financial statements, the size of a public auditing office cannot be used as a

basis for the quality of the audit. A high-quality audit will be achieved since the auditing

firm consistently adheres to the audit procedures. It also acknowledged that both the audit

company and professional bodies must work to provide highly qualified personnel with

an objective attitude to achieve a high degree of audit quality.

3. Effect of Audit Quality on Costs of Capital of the Financial Institutions Listed in

the Philippine Stock Exchange

This section discusses the problem and objective of the study, which is to

determine the effects of audit quality on the costs of capital. As observed, audit quality is

represented by three sub-variables such as audit firm specialization, audit fees, and audit

firm size. On the other hand, the dependent variable, audit quality, was proxied by three

variables, including the cost of debt, cost of equity, and weighted average cost of capital.

Understanding these relationships can provide valuable insights into how audit quality

influences a company's financial health and decision-making processes.

Table 7. Effect of Audit Quality on Cost of Debt of the Financial Institutions Listed
in the Philippine Stock Exchange from Years 2013 - 2022
Std. p- Decision on
Cost of Debt B t-value Interpretation
Error value Ho
Failed to Not
Constant 1.224 1.849 .662 .509
reject Significant
Failed to Not
Audit Fees .038 .124 .309 .758
reject Significant
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Audit Firm Size -.735 .243 -3.020 .003 Reject Significant

Model Summary: R = .242; R2 = .058
Regression Model: F = 4.886; p = .009
The cost of debt and the two sub-variables of audit quality were examined using

linear regression analysis to distinguish the impact of audit quality on the cost of debt of

financial institutions listed in PSE. The table presents the significant effect of audit

quality on the costs of capital of financial institutions in the Philippines, particularly in

terms of Cost of Debt (COD). The regression model is statistically significant, as

indicated by a p-value of .009, suggesting a meaningful relationship between audit quality

variables and Cost of Debt. The R-value of .058 implies that about 5.8 percent of the

variability in COD can be explained by the audit fees and audit firm size. For the audit

fees, the B coefficient is .038, with a t-value of 0. 309 and a p-value of .758, indicating

that the relationship is not significant. The audit firm size has a negative B coefficient of

-.735, a t-value of -3.020, and a p-value of .003, confirming its statistical significance and

indicating that higher audit firm size negatively impacts the cost of debt.

Specifically, audit firm size significantly affects the cost of debt. With a p-value of

0.003, it recommends that the null hypothesis must be rejected. Also, it can be seen in the

table that the independent variables result in a negative unstandardized beta (B) of -0.735

which indicates that it affects the cost of debt negatively. Whereas, in every one-unit

increase in audit firm size, the cost of debt will decrease by 0.735. It implies that the

larger the audit firms, the lower the cost of debt. The higher quality assurance of a

company's financial health is provided by respectable auditors of larger firms which

includes Big 4 firms, and this might result in lower perceived risk and permits loans with

lesser interest rates. The primary causes of this are their apparent reliability and

credibility, which could increase the transparency of the financial statements since they
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are less inclined to compromise their standards due to the need to protect their reputation

and the confidence of their clients. Moreover, larger audit firms are better able to oversee

and manage the audit process since they have more auditors and are larger, which is

associated with lower debt costs.

The result relates to the study conducted by Coffie et al. (2018) which discovered

a negative correlation between audit quality and the cost of debt. Because of the high

standards and vast resources these firms use, companies audited by larger firms are

frequently seen as having greater credibility. Lenders may view this increased credibility

as less risky, which would reduce the cost of debt and improve the reliability of financial

reporting as it decreases interest rates and provides more advantageous lending

conditions.

Contrarily, the study findings reveal that audit fees don't have a significant effect

on the cost of debt, as evidenced by p-values of 0.758. This indicates that the null

hypothesis must be rejected, suggesting that there is insufficient evidence in the sample

data to support the existence of an effect. Furthermore, the table displays negative

unstandardized beta (B) coefficients of 0.038, indicating that the audit fees have a

negative impact on the cost of debt. However, despite the negative influence on costs of

capital, the effect is still not statistically significant.

The study by Gandia and Huguet (2022) found that there is no significant

association between audit fees and mandatory audits. This suggests that lenders do not

believe that mandatory audits offer the same degree of transparency or assurance as

voluntary audits. Because mandatory audits are mandated by law, they, are not given the

same weight in terms of perceived quality. Therefore, in these situations, lenders are not

permitted to modify their risk assessments in light of audit fees. Mandatory audits don't
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offer the same advantages in terms of reducing borrowing costs as lenders can consider it

to be a standard requirement rather than an indication of quality.

Table 8. Effect of Audit Quality on Cost of Equity of the Financial Institutions

Listed in the Philippine Stock Exchange from Years 2013 - 2022
Std. p- Decision on
Cost of Equity B Error t-value value Interpretation
Ho
Constant 6.031 .905 6.661 <.001 Reject Significant
Audit Fees -.350 .061 -5.789 <.001 Reject Significant
Audit Firm
-.422 .119 -3.545 .001 Reject Significant
Size
Model Summary: R = .551; R2 = .303
Regression Model: F = 34.205; p = .000
The regression analysis provides meaningful insights into the relationship

between audit quality and the cost of equity for financial institutions listed on the

Philippine Stock Exchange from 2013 to 2022. The R-value of .551 indicates a moderate

positive association between the independent variables which are the audit fees and audit

firm size, and the dependent variable, the cost of equity. The R² value of .303 suggests

that these variables can explain 30.3 percent of the variation in the cost of equity. In

comparison, the remaining 69.7 percent is influenced by other factors not captured in this

study. The F-statistic of 34.205 and the highly significant p-value (p = .000) confirm that

the overall model is statistically significant, meaning the explanatory variables

collectively have a meaningful impact on the cost of equity.

Examining the coefficients, the B value for audit fees is -0.350, indicating that for

every unit increase in audit fees, the cost of equity decreases by 0.350 units, holding all

other factors constant. This negative relationship suggests that higher audit fees might

reflect a more thorough audit process, where auditors allocate more time, expertise, and

resources to ensure the accuracy and reliability of financial statements. This can enhance

investor confidence, as more reliable financial statements reduce perceived risks and
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uncertainty about a firm's financial health. Consequently, this decrease in perceived risk

translates to a lower cost of equity for the firm. The p-value for this relationship is less

than 0.001, demonstrating that the observed association is highly statistically significant

and unlikely to have occurred by chance. This highlights the potential importance of audit

fees as a factor influencing how investors assess a firm’s financial stability and

credibility.

Similarly, the B value for audit firm size is -0.422, suggesting that as the size of

the audit firm increases, the cost of equity decreases by 0.422 units, holding other factors

constant. This relationship emphasizes the potential role of larger audit firms in fostering

investor confidence. Larger audit firms are often perceived as more capable due to their

greater resources, advanced tools, and ability to handle complex audits. These firms are

also typically subject to greater scrutiny, which could enhance the perceived reliability of

their audits. For investors, this perceived reliability reduces uncertainty, which lowers the

cost of equity. The p-value of 0.001 reinforces the statistical significance of this

relationship, confirming that the observed effect is not random. However, while larger

audit firms may inspire greater confidence, this does not necessarily imply that smaller

firms are incapable of providing reliable and high-quality audits. The size of the firm may

influence perceptions of audit quality rather than directly correlating with the quality of

the audit work itself.

The findings underscore the significance of audit quality in shaping investor

confidence and perceptions of risk. Audit fees, which can reflect the complexity and

thoroughness of the audit process, serve as a proxy for audit quality. Higher fees are

likely associated with greater assurance that financial statements are free from material

misstatements, thereby enhancing investor confidence. Additionally, the size of the audit
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firm provides another layer of assurance. Larger audit firms, with their capacity to handle

complex audits, are also perceived to possess a strong reputation for independence and

reliability. Despite the negative relationship between audit firm size and the cost of

equity, which highlights the reputational advantage of larger firms, it does not negate the

ability of smaller audit firms to deliver high-quality audits.

Supporting these findings, Cai et al. (2024) suggested that high-quality audits,

often indicated by higher audit fees, reassure investors by ensuring the accuracy and

transparency of financial reporting, thus reducing the perceived investment risks. Higher

audit fees are often associated with more rigorous assessments, reflecting the auditor’s

efforts to mitigate risks of material misstatements or fraudulent reporting. However, it is

essential to recognize that audit fees can also be influenced by other factors, such as the

size and complexity of the audited firm, geographical operations, and industry-specific

risks. Larger, multinational companies generally face greater regulatory scrutiny and

require more extensive audit procedures, resulting in higher fees. Additionally,

companies operating in volatile industries may experience elevated audit costs due to the

increased risks and uncertainties auditors must address. This perspective aligns with the

moderate R² value of the model, which suggests that while audit quality significantly

impacts the cost of equity, other variables also contribute. Furthermore, Le et al. (2021)

emphasized the connection between larger audit firms and higher audit quality due to

their extensive resources, industry expertise, and established reputation. Big Four firms,

for example, are often perceived as more capable of conducting complex audits, reducing

the likelihood of financial misstatements and enhancing investor confidence. This

reputational advantage tends to result in a lower cost of equity for their clients. However,

it is also acknowledged that smaller audit firms can provide high-quality audits,
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especially when specializing in niche industries or maintaining rigorous quality control

procedures. Despite lacking the same brand recognition, these firms can deliver reliable

financial reporting, contributing to investor trust. Therefore, while audit fees and firm

size are relevant factors, investors should consider multiple indicators of audit quality

when evaluating a company’s financial transparency and the associated cost of equity.

Table 9. Effect of Audit Quality on Weighted Average Cost of Capital of the

Financial Institutions Listed in the Philippine Stock Exchange from Years 2013 -
2022
Weighted
Std. t- p-
Average Cost B Decision on Ho Interpretation
Error value value
of Capital
Failed to Not
Constant -2.694 2.529 -1.065 .288
reject Significant
Audit Fees .158 .169 .934 .352 Failed to reject Not Significant
Audit Firm Not Significant
.260 .333 .781 .436 Failed to reject
Size
Model Summary: R = .119; R2 = .014
Regression Model: F = 1.127; p = .326
The regression analysis was utilized to determine the effect of audit quality on the

weighted average cost of capital of the financial institutions listed in the Philippine Stock

Exchange from 2013 to 2022. As shown, the table indicates that the audit quality

variables, audit fees and audit firm size, do not significantly affect the weighted average

cost of capital. With a p-value of 0.352 and 0.436 respectively, which is greater than 0.05,

the null hypothesis failed to be rejected. This usually implies insufficient data to draw a

conclusion about the presence of such an effect or that there is not enough evidence to

support the alternative hypothesis. The R² value of 0.014 suggests that only 1.4 percent of

the variability in the costs of capital can be explained by audit fees and audit firm size. In

addition to that, with an unstandardized beta (B) of 0.158 for audit fees and 0.260 for the

audit firm size, this indicates that audit quality positively affects WACC. Whereas the
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higher the audit fees of an engagement are or the bigger the audit firm size is, the WACC

will increase concerning it. Even if audit quality has a positive effect, the effect is deemed

to be insignificant against WACC.

The results suggest that the changes in the financial institution's WACC were

mostly due to their debt and equity financing decisions made in consideration of the

market conditions and other relevant and significant external factors. Also, the

insignificance of the effect entails that audit fees may not be the most appropriate

measure to accurately capture audit quality’s effect on WACC as supported by the R²

value of 0.014 and the p-value higher than the threshold of 0.05. Aside from that, audit

fees are expenses incurred that do not directly impact the capital structure of the financial

institutions. Which results in having no influence on the interest rates to be paid to debt

holders or the expected returns to provide to investors. This implies that even if audit fees

affect their reputation or how investors and debt holders perceive them as risky or not, it

does not necessarily alter the weighted average cost of capital.

As for audit firm size, its insignificance suggests that audit quality’s effect may

either be obscured by interactions between the variables or dominated by market

conditions. Moreover, this implies that audit firm size may not have a huge bearing for

audit quality, given the R² value of 0.014 and a p-value higher than 0.05, which results in

a non-significant result when tested against other variables, like the WACC. Also,

because the size of the audit firm performing the audit engagement for the financial

institutions is not directly used in determining the costs of capital. This suggests that

investors and debt holders are still more likely to focus on the overall financial

performance or risks of the financial institutions rather than the auditing process that they

go through. Despite the credibility proved after going through an audit, risks are assessed
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considering different business factors or market conditions and not just audit-related

variables.

The study conducted by Mali and Lim (2020) emphasized that the fees paid for

the audit serve as an indirect determinant of audit quality. Since it serves as a

conventional measure, if it is to be tested against another variable the effect may be

lessened. This is in contrast to direct drivers of audit quality like audit effort which can

have a more pronounced effect. Similarly, Priyanti and Dewi (2019) highlighted that

audit firm size does not impact audit quality. Thus, a high-quality audit can be achieved

by audit firms that consistently conform and perform audit procedures with utmost

integrity. In relation to the positive effect, though insignificant, the study of Najjarpour,

et. al. (2017) also revealed that audit fees positively affect the capital structure, which

presents the blend of debt and equity of a company for its ongoing operations and future

expansions. This shows that the increase of either portion of debt and equity in the capital

structure can also increase the calculated WACC.

Table 10. Effect of Audit Firm Specialization on Costs of Capital of the Financial
Institutions Listed in the Philippine Stock Exchange from Years 2013 - 2022
Audit Firm p- Decision
t-value Interpretation
Specialization value on Ho
Cost of Debt 12.304 <.001 Reject Significant
Cost of Equity 7.203 <.001 Reject Significant
Weighted Average Cost Failed to
-1.006 .316 Not Significant
of Capital reject

In this analysis, the t-test was used instead of regression because audit firm

specialization is a constant variable, meaning it does not vary across observations in the

dataset, thus making it incompatible with a regression analysis. The table shows that audit

firm specialization has a significant effect on the cost of debt. With a p-value of .001,

which proposes that the null hypothesis must be rejected. This implies that industry-
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specific audit firms provide better services that reduce a company's debt costs because

they have more experience and greater knowledge of the particular risks and complexities

of the financial system related to that sector. The result was supported and consistent with

the result of the study of Nana et.al (2023) which claimed that the cost of debt was shown

to be negatively correlated with specialization, suggesting that audit firms that have more

years of experience lower the cost of debt. Furthermore, because of their experience, they

can offer audits of a better quality, which lessens the knowledge asymmetry that exists

between the company and its lenders. Financial statements from companies that have

undergone expert auditing are more likely to be trusted by lenders, which lowers

perceived risk and, in turn, lowers the cost of debt.

Focusing on the cost of equity, the results reveal a significant t-value of 7.203 and

a p-value of <0.001, leading to the rejection of the null hypothesis. This indicates that

audit firm specialization has a statistically significant effect on the cost of equity. This

suggests that firms audited by specialized auditors may experience a reduction in their

cost of equity. Audit firm specialization, which could be associated with accumulated

experience and focused expertise in a specific industry, may enhance the perceived

credibility and reliability of financial reporting. Investors might interpret this as reducing

information asymmetry, thereby lowering the perceived risk and the equity risk premium.

Vita et al. (2018) note that industry-specialized auditors often invest in advanced training,

recruitment, and auditing technologies, which may contribute to higher audit quality. The

association between specialization and audit quality, as suggested by this study, aligns

with the idea that auditors with industry-specific knowledge are better equipped to

identify and address risks relevant to the audited firm.

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Regarding audit firm specialization’s impact on the WACC, the null hypothesis

failed to be rejected with a p-value of 0.316 which is higher than 0.05. This implies that

even with a high audit quality due to audit firm specialization because of the presence of

professional and skilled auditors, the WACC will just fluctuate as it is. Also, a t-value of

1.006 indicates a negative direction, though even if this effect exists, audit firm

specialization remains to have no significant influence on how the WACC of the financial

institutions move as a consequence of their operations and decisions. Similarly, Coffie et

al. (2018) emphasized a negative connection between audit quality and WACC and that

auditors are essential when it comes to identifying possible distortion, improving the

quality of information, and eventually reducing risks aiding in operational decision-

making. With the assurance of high-quality audits, investors tend to expect less regarding

the number of returns.

4. Information, Education, and Communication Materials

Following a review of the data collected from the study using publicly listed

financial institutions in the Philippines over ten years (2013–2022), the researchers

developed Informational, Educational, and Communicational (IEC) material aimed the

interested individuals in the impact of audit quality on the costs of capital of financial

institutions. This material covers key topics on audit quality, including its measurement

such as audit firm specialization, audit fees, and audit firm size, as well as the costs of

capital indicators such as cost of debt, cost of equity, and weighted average cost of

capital. The section of the brochure includes the problems that financial institutions were

facing, the definition and measurement of costs of capital and audit quality, the

importance of audit quality, and strategies for reducing and improving the costs of
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capital. In addition to helping accounting students learn terms and concepts related to the

topic, this will also educate students about the firms' audit quality and capital costs.

Figure 6.
Information, Education, and Communication Materials