Corporate governance and auditor quality – Malaysian evidence

Asian Review of Accounting
Corporate governance and auditor quality – Malaysian evidence
Azrul Ihsan Husnin, Anuar Nawawi, Ahmad Saiful Azlin Puteh Salin,
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and auditor quality – Malaysian evidence", Asian Review of Accounting, Vol. 24 Issue: 2, pp.202-230,
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Corporate governance and auditor
quality – Malaysian evidence
Azrul Ihsan Husnin and Anuar Nawawi
Department of Accounting, Universiti Teknologi MARA Shah Alam,
Shah Alam, Malaysia, and
Ahmad Saiful Azlin Puteh Salin
Faculty of Accountancy, Universiti Teknologi MARA (Perak),
Seri Iskandar, Malaysia
Abstract
Purpose – The purpose of this paper is to conduct an investigation into the relationship between a
firm’s corporate governance mechanisms (audit committee (AC) composition and operation,
block shareholder, chief executive officer duality, financial state, ownership dominance,
political connection, share price, and family control) and auditor quality selection in Malaysia,
for periods before and after the introduction of Malaysian Code of Corporate Governance
(MCCG) in 2007.
Design/methodology/approach – In total, 300 companies listed on the Malaysian Stock Exchange
from 2006 to 2008 were selected. A binary regression method was used to analyze the data collected
from both annual reports and financial databases.
Findings – The study has found that in general, MCCG 2007 influenced auditor selection through
restructuring of corporate governance tools, such as ACs and internal audit functions.
Research limitations/implications – Results have provided evidence that the restructuring of
corporate governance may contribute and drive company to enhance the quality of the audit performed
by selecting better quality auditor and/or improvising the audit-related functions within the company
such as formalizing internal audit function. This study, however, employed an archival method of
study and only used three years (2006, 2007, and 2008) of data analysis. Future research should analyze
data from a longer period and utilize a field survey to understand reasons for auditor selection from the
company perspective.
Originality/value – Building on previous studies, this study contributes to the current body of
knowledge as it also considers the objective from the perspective of the revised MCCG 2007.
It examines whether the introduction of new or revised corporate governance guidelines may
immediately impact company auditor selection. Therefore, it compares the auditor quality of the
company from pre-MCCG 2007 (2006) and post-MCCG 2007 (2008).
Keywords Corporate governance, Malaysia, Audit fee, Auditor quality,
Code of corporate governance
Paper type Research paper
Introduction
Malaysia was heavily affected by the Asian financial crisis in 1997. Since that
crisis, Hong Kong, Singapore, and Malaysia have since taken large steps toward
improving their corporate governance (Sawicki, 2009; Mitton, 2002;
Manan et al., 2013) such as greater transparency and stricter legislation
enforcement (Haat et al., 2008), as it was identified that weaker corporate
governance leads to poor transparency, while crony capitalism (Claessens and
Fan, 2002) and concentrated ownership (Fan and Wong, 2005) were responsible for
escalating the crisis.
Malaysia reached a significant milestone in the implementation of good corporate
governance with the introduction of the Malaysian Code of Corporate Governance
Asian Review of Accounting
Vol. 24 No. 2, 2016
pp. 202-230
© Emerald Group Publishing Limited
1321-7348
DOI 10.1108/ARA-11-2013-0072
Received 8 November 2013
Revised 27 April 2014
29 November 2014
Accepted 10 March 2015
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1321-7348.htm
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(MCCG) in 2000. The auditing profession was strengthened with the issuance of public
practice licences only to those genuinely qualified. They have become subject to the
rigorous regulations issued by Malaysian Institute of Accountant, a statutory body
established to regulate and develop public practice in Malaysia. Such regulation was
enhanced further in 2010, when the Audit Oversight Board was set up to oversee the
quality and reliability of the audited financial statements of public interest entities by
the auditors. This indirectly signaled a demand for audit quality, leading to a basis for
changes in the selection of auditors (Nazri et al., 2012; Beattie and Fearnley, 1995;
Schwartz and Mennon, 1985).
This effort continued in 2007 with the revised MCCG, which replaced the previous
MCCG 2001. Some key changes included making the audit committee (AC) comprised of
all non-executive directors, as well as requiring a higher frequency of meetings between
the AC and external auditors without the presence of executive board members.
Due to these changes, it is interesting to study whether these amendments give an
immediate impact to the auditors’ selection and hence, the audit quality of the
Malaysian companies. Malaysia was chosen as the setting for this study as corporate
governance practices in Malaysia are still in infancy stages as compared to developed
countries like USA and the UK. Furthermore, the capital market in Malaysia is
somewhat unique, as a majority of the companies are politically-affiliated, ethnic-
controlled, and dominated by family firms. Therefore, it would be worthwhile to
explore how these elements have a place in corporate governance reform in Malaysia.
It is expected that there will be a shift toward high-quality auditors, since there will
be an increasing demand for a high quality and reliable financial information. This is
based on the argument that a new composition of AC consisting of all non-executive
directors, as well as an increase in the number of independent directors, will less likely
to favor less quality auditor, and thus more likely to choose a high-quality auditor in
order to ensure higher credible financial information for the stakeholders.
Also, the current study is intended to explore and investigate the relationship
between the firm’s internal corporate governance mechanisms with the selection of
auditor’s quality. Apart of AC composition and operation, the study interested to
examine whether ownership concentration, chief executive officer (CEO) duality, the
financial state of the company, ownership dominance, political connection, share price,
and family control firms have a significant and immediate impact on the selection of a
higher quality auditor. Though a great deal of research has been done in the area of
corporate governance, little research has been conducted in the Malaysian market,
especially in line with this study, which focusses on dissecting the Malaysian corporate
governance mechanism and its effects toward the choice of auditors.
This paper makes several contributions. First, it deepens current understanding of
the effectiveness of Malaysian corporate governance, as well as firm corporate
governance determinants on the selections of auditor particularly on its immediate
impact after MCCG revision in 2007. Second, research concerning auditor quality in
Malaysia is very limited, though a number of studies may be found concerning this
topic, such as those by Yassin and Nelson (2012) and Wahab et al. (2009). These studies,
however, used audit fees as a proxy for audit quality. We have extended their study
using other indicators of audit quality, such as audit firm size. Finally, we have
provided analysis on the auditor selection based on the pre- and post-changes in
corporate governance code in 2007. Much of the research in this area does not consider
this factor and thus, this study is intended to fill those gaps. In addition, we examine
whether this changes is immediately responded by the company.
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The remainder of this paper is organized as follows. In the next section, we review
the existing literature and concepts regarding audit and auditor quality. We then
provide an argument for the hypotheses developed for this study. In the third section,
we explain the method use to conduct the current research followed with findings.
The fifth section contains discussion, while the last section is conclusion.
Literature review and hypotheses development
Audit quality
Audit quality is vital, as it affects the reliability of the financial report and protects the
interest of its reader. It may also enhance the transparency of a report via higher
voluntary disclosure (Barros et al., 2013) and lessen earnings manipulations (Almeida-
Santos et al., 2013). However, lower quality reports may possibly mislead and provide
incorrect information to users.
Higher audit quality is yet more essential when separation of ownership between the
owner and management leads to a divergence between management’s and owner’s
interests ( Jensen and Meckling, 1976; DeFond, 1992; Chen et al., 2007) that cause an
agency problem. Because of that, external or independent auditing is engaged to mitigate
agency problems resulting from the separation of ownership and control (Al-Ajmi, 2009).
Higher audit quality also provides an independent oversight of the companies (Francis,
2004). Stakeholders demand more reliable financial information; thus, they consider
external audits to be monitoring tools alongside the process of financial reporting
(Schwartz and Mennon, 1985; Lin and Liu, 2009). In cases in which a task has been
delegated from the principal to an agent, the agent may take advantage on asymmetrical
information existed (Dittmann, 1999). The monitoring role of the external audit will
alleviate the agency problem between management and owners (Joseph and Wong, 2005).
Many scholars have provided definitions of audit quality and hence, auditor quality.
Audit quality and auditor quality are closely related concepts. A quality auditor will
perform a high-quality audit, and vice versa. Audit quality in many ways has been
defined as an outcome conditional on the presence of auditor’s attributes (Knechel et al.,
2013). One of the most widespread is the definition given by DeAngelo (1981), defining
audit quality as the probability of an auditor will both discover and report an error or
breach in their client’s accounting system. This definition posits two important
characters of a quality auditor – competency and professionalism. The auditor should be
able to uncover any breach and violations of the client’s accounting system and then,
report the breach using appropriate channels. A minor breach will be discussed with the
AC, while a major breach will be reflected in their overall assessment of the company.
Francis (2004) suggested that audit quality is attained when the audit complies with the
minimum legal and professional requirement. Audit quality is inversely related to audit
failures, meaning the higher the failure rate, the lower the audit quality. This definition is
consistent with that of Peecher and Piercey (2008) and Casterella et al. (2009), who related
adverse outcomes from the poor audit with litigation action on the part of the auditor.
From a more positive perspective, Knechel et al. (2013) defined audit quality as
execution of a well-designed audit process by properly motivated and trained auditors
who understand the inherent uncertainty of the audit and appropriately adjust to the
unique conditions of the client. This definition is unfortunately complex, as it is difficult
to operationalize this definition compared to audit quality expressed in terms of failure.
Due to difficulty in directly determining audit quality (Francis, 2004), researchers
have used various proxies to represent audit quality, such as size of audit firm (Guy
et al., 2010; DeFond and Lennox, 2011; Sundgren and Svanström, 2013; Kim et al., 2013),
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audit engagement tenure (Al-Ajmi, 2009), audit structure (Kaplan et al., 1990), audit
fees (Haat et al., 2008), litigation actions against the listed firm and their auditors
(Mary et al., 2005; Schmidt, 2012), and auditors’ industrial expertise (Lowensohn et al.,
2007). However, the most commonly studied factor in terms of audit quality is audit
firm size (Haat et al., 2008).
Collectively, most researchers have pointed out the significant relationship between
audit quality, as well as better monitoring capability with the size of audit firm
(DeAngelo, 1981; Palmrose, 1988; Francis and Simon, 1987; Jang and Lin, 1993; Leuz
and Verrecchia, 2000; Al-Ajmi, 2008). Sundgren and Svanström (2013) stated that larger
firms have more resources and greater technical expertise than smaller firms. Small
firms may ignore important audit procedures when carrying out a large number of
jobs, therefore reducing audit quality (Sundgren and Svanström, 2014), especially
during peak season (López and Peters, 2012).
In addition, a bigger firm has a superior investment in reputational capital and is
wealthier. Therefore, bigger firms need to minimize audit errors to safeguard their
reputation (Beatty, 1989) as greater loss will be experienced due to damage resulting
from low-audit quality (Dye, 1993). Large audit firms also show more courage to
disagree with the client and are seen as more independent from the client (DeFond and
Jiambalvo, 1993).
There has been relatively limited research conducted on the factors that determine
the auditor selection especially in selecting better audit quality in Malaysia. Previous
studies on auditor choice were largely conducted in developed countries such the USA
(Pittman and Fortin, 2004; Lee et al., 2004; Hudaib and Cooke, 2005), Australia (Beatty,
1989), and the UK (Chaney et al., 2004; Abidin, 2006), while Lin and Liu (2009)
conducted a similar study in the developing country of China.
In Malaysia, studies on auditor selection have been conducted by a few researchers.
Abdul Nasser et al. (2006) studied auditor selection in terms of audit tenure, client size,
client growth, and client financial risk. Ismail et al. (2008) focussed on the factors that
lead to auditor switching, while Jaafar and Alias (2002) examined the impact on the
firm’s rotation. This study therefore extends the auditor choice literature in the
Malaysian context by examining the determinants of the auditor quality selection in
respect of internal corporate mechanism.
Internal corporate governance mechanism and selection of audit quality
Arguably, good corporate governance cannot be achieved by a company only on the
strength of regulations, but must also be based on some other internal factors
functioning as self-disciplinary mechanisms. Carcello et al. (2002) and Abbott et al.
(2003) posited that firms with stronger internal corporate governance structures
demand better audit quality. Examples of these internal corporate governance
structures includes AC, balance of power between management and board, and
company ownership.
Empirical evidence shows that AC role is very important because it is responsible
for oversight of the financial reporting process ( Johl et al., 2012) and able to prevent
fraudulent financial statements (Klein, 2002). Therefore, financial reporting integrity as
required by MCCG 2007 may be achieved by the way of monitoring roles carried out by
the AC. These roles are effectively executed when AC members are greater in number,
because every member can compensate other member weaknesses. Hashim et al. (2014),
for example found that number of directors in the board significantly impact the
strategic information disclosed by the company. Prior research has determined that the
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size of an AC has a significant relationship with its monitoring effectiveness
(DeAngelo, 1981; Leuz and Verrecchia, 2000; Al-Ajmi, 2008). Hence, the bigger the size
of the AC, the stronger the monitoring is expected; thus, higher quality auditors should
be selected.
Independent and non-executive directors are also critical in contributing to better
performance of the company (Huang and Chan, 2013; Knyazeva et al., 2013) by
enhancing the effectiveness of the audit function (Abbott et al., 2003; Carcello et al.,
2002). Directors that do not get involved in daily management operations are more
objective and able to uphold the public interest from their point of view. The revised
MCCG 2007 specifically requires the AC to be fully comprised of non-executive
directors. This reflects the importance of the AC to be more independent and free from
conflicts of interest. In the newly revised MCCG 2012, this requirement is reinforced by
limiting the tenure of independent directors up to nine years (Satkunasingam and
Cherk, 2012) so that their role in providing independent judgment can be safeguarded
(Kassim et al., 2013). Directors that are free from influence of management is crucial to
monitor the managers (Bhagat et al., 2008), mitigating collusive behavior of managers
(Upadhyay et al., 2013), reducing the likelihood of financial statement fraud (Beasley,
1996) and earnings management (Bruynseels and Cardinaels, 2013), improved financial
performance (Daily et al., 2003) and supporting the independent auditor in
management-auditor disputes (DeZoort and Salterio, 2001).
The impact of higher AC size and level of independence is greater when they engage
in more frequent meetings, because they are able to actively address more important
issues. Beattie et al. (2013), in a recent survey in the UK, found that AC activities will
enhance audit quality. With a good AC composition and operation, the committee is
able to act successfully as a monitoring tool. This will increase the possibility of
employing a high-quality auditor to ensure better safeguarding of the public interest.
Based on the previous discussions, the following hypotheses have been derived:
H1. Ceteris paribus, a firm with more AC members, higher proportion of
independent and non-executive directors on AC and meet more frequently is
more likely to choose a high-quality auditor.
H1a. Ceteris paribus, a firm with AC meets frequently is more likely to choose a
high-quality auditor.
H1b. Ceteris paribus, a firm with higher proportion of independent directors in AC is
more likely to choose a high-quality auditor.
H1c. Ceteris paribus, a firm with more members in AC is more likely to choose a
high-quality auditor.
H1d. Ceteris paribus, a firm with higher proportion of non-executive directors in AC
is more likely to choose a high-quality auditor.
A majority of companies in Malaysia have a concentrated type of shareholding
(Claessens et al., 2000). This is not healthy, as Allen (2000) and Globerman et al. (2011)
suggested, because corporate governance in Asian firms renders them unable to
function effectively due to high-concentrated ownership, especially when external
governance mechanisms are weak (Fan and Wong, 2005). Krishnamurti et al. (2005) and
Lemmon and Lins (2003) posited that during the Asian financial crisis firms with
high-control right in respect to their ownership have the ability to expropriate,
especially if legal protection of shareholders is weak. Other researchers, such as
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Rafael La et al. (1999), Copley and Douthett (2002), and Haiyan et al. (2009) have also
mentioned the similar effects of ownership concentration on the corporate governance.
When a majority of shares are in the hands of a single or a few shareholders (identified
as block shareholder)s, they have more power in decision making and the tendency to
abuse that power (Solomon, 2007) to influence the management to manipulate financial
statements for rent-seeking (Copley and Douthett, 2002; Fan and Wong, 2002).
Block shareholders can also access company’s private information and take
advantage by expropriation activities to protect their own investment (Shleifer and
Vishny, 1986; La Porta et al., 2002; Anderson et al., 2004), particularly during the crisis
to compensate for their losses (Bae et al., 2012). Based on this, it is considered supported
that the controlling shareholders had more incentive to expropriate the minority’s
wealth (Cheung et al., 2005; Burkart and Panunzi, 2006). Engaging a high-quality
auditor may limit their incentives to expropriate company’s wealth as quality auditor
will ensure the financial statements will strictly comply with the accounting standard
and relevant rules and regulations. Thus, the next hypothesis has been derived:
H2. Ceteris paribus, the higher the percentage of total shares held by the largest
owner, the less likely a high-quality auditor will be chosen.
CEOs that also serve as a chairman, well-known as CEO duality, have been of great
interest to both academic researchers and practitioners for the last two decades (Forker,
1992; Dalton et al., 1998; Kim et al., 2009). Stiles and Taylor (1993) were against CEO
duality practices, as separation of these two roles is important to provide checks and
balances over management (Haat et al., 2008) and effective corporate governance
mechanisms (Cohen et al., 2002). CEO duality allows little transparency (Imhoff, 2003)
via a lack of monitoring on the CEO’s actions, as he or she has a significant influence on
board’s decision (Lin and Liu, 2009; Kim et al., 2009). Consequently, a board of directors
is less impartial in monitoring the management (Lin and Liu, 2009). It has been found
that the company with CEO duality aggressively managing their earnings (Dechow
et al., 1996; Hudaib and Cooke, 2005) and are likely to become involved in corporate
scandals and corruption (Sharma, 2004).
However, when the chairman is a different person than the CEO, he or she able to
oversee the company in more impartial manner and hence increase oversight
effectiveness (Cohen et al., 2002; Lee et al., 2004; Wilkinson and Clements, 2006). As
hiring a quality auditor may cause his/her private intention be limited, there is less
incentive for the company with CEO duality to employ a high-quality auditor. Thus the
following hypothesis is derived:
H3. Ceteris paribus, a firm with duality of positions of CEO and Chairman is less
likely to choose a high-quality auditor.
In Malaysia, most financially troubled firms are classified as Practice Note 17 (PN17) firms.
However, loss-making companies are also considered to have high probability of facing
financial distress. There are a few reasons why financially troubled company will be
selective in choosing their auditor. First, many audit firms, especially larger firms, are likely
to issue going concern reports to the loss-making company, which will have a negative
impact on the share market (Chen and Church, 1996; Menon and Williams, 2010). To avoid
this, the company will prefer an auditor willing to issue a clean report on the financial
position of the company. Second, Kaplan and Williams (2012) found that financially
stressed companies are unable to hire larger firm because such a firm may insist on
shedding the financially distressed firm due to their higher risk nature. The potential
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litigation cost may exceed the benefits of auditing a financially troubled company (Power,
2003). Rama and Read (2006) and Landsman et al. (2009) documented that larger audit firm
will resign from high-risk clients and consequently, the company will become unable to hire
an auditor of the same size and quality (Shu, 2000). Finally, the financially distressed firms
may still want to present favorable financial statements such as “minimising loss” via
incompliance with laws and accounting standard to avoid being liquidated. Therefore, the
company will engage smaller firms of a less quality to achieve their motives. Lin and
Liu (2009), for example, found that opaqueness gain derived by the Chinese company
during the bear market from 2001 to 2004 caused them to become less likely to hire
a high-quality (large) auditor. Thus, the following hypothesis is derived:
H4. Ceteris paribus, a firm categorized as PN17 and loss making is less likely to
choose a high-quality auditor.
There are a few scholars that have studied the influence of culture and ethnicity on
business practices, such as Efferin and Hopper (2007) in Indonesia, Biggs et al. (2002)
in Kenya, Davie (2005) in Fiji, Kim (2004) in New Zealand, Blanco and De la Rosa
(2008) and Carter et al. (2010) in the USA, Hoque and Noon (1999) in the UK,
Hammond et al. (2009) in South Africa, and James and Otsuka (2009) in Australia.
Hofstede (1980) suggest that different cultures may lead to different specific behavior
and hence, business decision making. Ethnicity is a part of social fabric and may
impact economic transactions (Zagefka, 2009). Based on their findings, it is
worthwhile to examine whether the selection of auditor may also be influenced by
cultural and ethnic differences.
Malaysia is a unique country consisting of multiracial communities and its
economics segment is divided along ethnic group ( Jesudason, 1989). The country’s
biggest racial blocks belong to two major groups, the Bumiputras and the Chinese.
Although there are other ethnic groups such as the Indians, the distinction between the
two main ethnic groups (Bumiputras and Chinese) dominates most of the socio-
economic activities and political decisions (Yatim et al., 2006). Chinese are known as
successful entrepreneurs that contribute the most to the Malaysian economy. They
have strong business networks, are the main players of the audit market, and account
for the majority of members of accounting professional bodies in Malaysia (Che Ahmad
et al., 2006). Cultural and language similarities and the role of the Chinese networks that
provide market information to its members have influenced the selection of auditors
among the Chinese-controlled firms (Che Ahmad et al., 2006).
Ironically, for the same reason, the Bumiputras have also been encouraged by the
government to give priority to their fellow ethnic members in business dealings including
in selecting the auditor. Yatim et al. (2006) suggested that the domination of key decision
makers by ethnic groups in the company may lead to a different monitoring approach.
Previous studies have documented the influence of ethnicity on audit pricing (Yatim et al.,
2006; Johl et al., 2012), audit services (Che Ahmad, 2001) and disclosure practices (Haniffa
and Cooke, 2002). Based on such arguments, ownership dominance based on ethnicity in
an organization may dictate the selection of an auditor based on ethnicity preferential
and not audit quality. Thus, the following hypothesis is derived:
H5. Ceteris paribus, there is a positive relationship between the ownership
dominance of the firm with the selection of auditors.
The Malaysia business sector also influenced by the existence of connections with
political parties and government ( Johl et al., 2013; Gul, 2006) by the way of ownership
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and favoritism. Bushman et al. (2004) argued that politically connected firms will
damage the good governance of the country, because such firms may withhold
information to hide expropriation activities by politicians and their cronies in return for
control over regulatory and financial policies to favor this company, such as paying
lower effective tax rates (Adhikari et al., 2006). Bushman et al. (2004), Bushman and
Piotroski (2006), and Gul (2006) found that firms with higher government ownership
demonstrate low financial transparency and report poorer quality of earnings (Chaney
et al., 2011). These firms were also hit harder during the 1997 financial crisis because of
their weak governance ( Johnson and Mitton, 2003).
In Malaysia, researchers found that political connection caused a lower level of
financial reporting quality (Ball et al., 2003) and higher earnings management ( Johl
et al., 2013). For example, Bumiputra CEOs tend to have poor business management
and are more open to cronyism ( Johl et al., 2012). Politically owned firms are perceived
to bear higher inherent risk by auditors due to the higher possibility of business failure
and more likely to misstate financial information (Abdul Wahab et al., 2009). Hence,
a low-quality auditor who can easily be influenced may be employed. Thus, the
following hypothesis is derived:
H6. Ceteris paribus, politically connected firms are less likely to choose a high-
quality auditor.
Based on the signaling theory, the management may be able to inform shareholders the
position of its corporate governance through the choice of auditor. The selection of a
high-quality auditor may signal that good corporate governance exists within the
company, and this will be translated into higher performance in terms of share price.
Huson et al. (2000), for example, found that investors react positively in the share
market when company switches to Big Four auditors but react negatively when
company replaces the Big Four auditors to the non-Big Four auditors. Nicholas and
Smith (1983), Eichenseher et al. (1989), and Nichols and Smith (1983) found that stock
market reacts more positively on higher earnings disclosure for the company with
larger audit firms compared to company with smaller audit size. A similar positive
response was found for a company undergoing initial public offerings ( Jang and Lin,
1993) which has less possibility of encountering under-pricing (Firth and Smith, 1992).
Thus, the following hypothesis is derived:
H7. Ceteris paribus, there is a positive relationship between the choice of auditors
and share price.
Family control firms represent a large portion of the public listed firms in Bursa Malaysia
(Claessens et al., 2000; Abdul Rahman, 2006; Ibrahim and Samad, 2011c) accounted
approximately more than 40 percent of the stock exchange’s main board from 1999 to
2005 (Ibrahim and Samad, 2011a, b). The major issues with family control firms are that
these firms usually appoint their family members as directors (Ibrahim and Samad,
2011a) and that they combine the role of the CEO and the Chairman (Amran and
Che Ahmad, 2009; Ibrahim and Samad, 2011a). This may lead to a weak corporate
governance due to the large composition of non-independent directors (Amran and
Che Ahmad, 2009; Chen et al., 2008; Hashim, 2011) who are more likely to treat the
company’s property as a family asset (Mishra et al., 2001). The number of outside
directors monitoring effectiveness is also reduced in family controlled firms ( Jaggi et al.,
2009) which results in deterioration of company performance (Klein et al., 2005; Lins
et al., 2013), less value (Shleifer and Vishny, 1997; Lauterbach and Vaninsky, 1999;
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Ibrahim and Samad, 2011a), and low levels of transparency (Chau and Gray, 2002;
Akhtaruddin et al., 2009; Darmadi and Sodikin, 2013).
However, a family firm may want to offset these negative impressions by appointing
a high-quality auditor. Based on the signaling theory, family firms will appoint a bigger
firm to signal outsiders their favorable monitoring aspects (Bar-Yosef and Livnat, 1984;
Chow, 1982; Carey et al., 2000). This has been supported by Azizan and Ameer (2012),
who found family firms tend to show improvement in share price when there is an
improvement on governance activities after intervention by the shareholder monitoring
body. Claessens and Fan (2002) also suggested that the controlling shareholders can
employ a high-quality auditor to alleviate concern from the minority about the
possibility of assets expropriation. Thus, the following hypothesis is proposed:
H8. Ceteris paribus, there is a positive relationship between family control firms and
the selection of high-quality auditor.
Research method
Regression model
In order to test the hypotheses on the selection of auditors, a regression model modified
from the research of Lin and Liu (2009) has been developed as follows:
Y ¼ b0þa1X1þa2X2þa3X3þa4X4þa5X5
þa6X6þa7X7þa8X8þa10CV þe
The binomial regression method has been employed to test auditor selection based on
the predetermined quality of audit. The dependent variable is auditors’ quality, and the
independent variables are AC composition and operations, concentrated ownership,
CEO duality, company’s financial position, ownership dominance, political influence,
family control and share price. Control variables for the study include the company’s
size, growth, profitability, assets structure, financial leverage and risks. Table I
summarizes the variables and its definition used in this study.
Data collection
The population of this study includes all the companies listed on the Bursa Malaysia,
excluding companies from the financial sector due to the differences in the laws and
regulations that bind the operations and hence, governance of the company. A similar
approach was also taken by Lin and Liu (2009). The industry classifications are derived
from Worldscope, which gives thorough and detailed industry classifications. The final
samples consist of 900 firm years comprised of 300 firms for each year from 2006 to
2008. This study only used three years for the data collection period, because this study
aims to examine the immediate response of the companies on the new requirements of
MCCG 2007. Year 2006 represents the pre-amendment period and 2008 the
post-amendment period, while 2007 is chosen as the transition or cut-off period,
since 2007 was the year in which the new MCCG 2007 was introduced to the market.
Table II shows the firms’ sample based on industries (in alphabetical order).
Findings
Descriptive statistics
Table III shows the descriptive statistics used to gain understanding of the
characteristics of the sample for 2006, 2007, and 2008. It has been found that
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approximately 60 percent of the samples hire Big Four auditors for all three years of the
study. With respect to independent variables, the values for all the variables are
consistent throughout the period. The highest dispersion value belongs to only one of
the control variables, return on assets, in which the mean almost doubled in value in
2007 from 2006, but suddenly decreased by 50 percent in 2008.
Coefficients of correlation
To describe the strength of a linear relationship among the dependent and independent
variables, the coefficient of correlation has been determined through Pearson’s
correlation matrix. Table AI of correlation coefficient matrix of dependent and
independent variables (2006-2008) depicts the correlation coefficient matrix of the
dependent and independent variables.
In general, the findings clearly suggest that most independent variables were
significantly correlated with the dependent variables at either 5 or 1 percent. In relation
Symbol Variable Definition
Y Auditor’s choice A dependent variable that indicates the selection of auditor
based on the predetermined quality of audit which is divided
into Big Four and non-Big Four
X1 Audit committee
composition and operation
AC composition and operation consists of four key variables.
First, the frequency of AC meeting during the year (X1a).
Second, the proportion of independent directors in AC (X1b).
Third, the number of AC members (X1c). Fourth, the proportion
of non-executive directors in AC (X1d)
X2 Block shareholder The percentage of ownership that an individual who holds the
largest shares on an entity
X3 CEO duality A dummy variable to indicate the existense of CEO who also
holds the position as Board chairman in an entity
X4 Financial state A dummy variable to indicate whether an entity faces a
financial distress situation or not. Financial distress companies
include those companies that are listed as PN17 or those which
experienced financial loss for 3 years consecutively from 2006 to
2008
X5 Ownership dominance A variable that indicates the ownership control based on
shareholders’ ethnic majority within a specific entity whether
Chinese dominated (X5a), Bumiputra dominated (X5b) or
institutionally owned (X5c)
X6 Political influence A variable that indicates the strength of political influence
within an entity whether strong (X6a) or weak connection (X6b)
X7 Share price An entity yearly closing share price as at December 31
X8 Family controlled A dummy variable that indicates whether an entity is
controllled by a family or not
X10 Log of total assets A control variable that indicates the size of an entity
X11 Assets turnover A control variable that indicates the growth of an entity
X12 Return on assets A control variable that indicates the profitability of an entity
X13 Current assets over total
assets
A control variable that indicates asset structure of an entity
X14 Total liabilities over total
assets
A control variable that indicatesfinancial leverage of an entity
X15 β A control variable that indicates the risk of an entity;the higher
the riskier
Table I.
Summary of
variables
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to the independent variables that measured auditor selection based on audit quality,
nine out of 15 measures were statistically significant (excluding control variables).
Auditor selection was significantly correlated with AC size, r ¼ 0.14, po0.001;
proportion of non- executive directors in AC, r ¼ 0.08, po0.05; percentage of block
shareholders, r ¼ 0.19, po0.01; financial state, r ¼ −0.13, po0.01; Chinese dominance,
r ¼ −0.13, po0.01; Bumiputra dominance, r ¼ −0.07, po0.05; institutional dominance,
r ¼ −0.17, po0.01; strong political connection, r ¼ 0.21, po0.01; and yearly closing
share price, r ¼ 0.14, po0.01.
There was no indicator suggesting a harmful multicollinearity problem on the
explanatory variables. The highest correlation identified between the independent and
dependent variables was only at r ¼ 0.79, which was lower than the r ¼ 0.9 cut-off
measures as suggested by Field (2009) and used in many studies.
Regression results
Table IV consists of the three years of the regression results: 2006 (pre-MCCG 2007),
2007 (transition to MCCG 2007) and 2008 (post-MCCG 2007). The first column depicts
the variables tested. The second column depicts the predicted direction of the
coefficients based on the developed hypotheses. Wald statistics was used to test the
contribution of predictors to the predictions of the outcomes of this study. According to
Field (2009) the “Wald statistics tells us whether the b coefficient for the predictor is
significantly different from zero” (p. 270). This is because if the coefficient
is significantly different from zero, then we can assume that the predictor is making
a significant contribution to the prediction of the outcome (Y) (p. 270).
Sector Frequency
Aerospace 2
Apparel 13
Automotive 15
Beverages 5
Chemical 18
Construction 16
Diversified 16
Drugs, cosmetics and healthcare 15
Electronics 15
Food 19
Machinery and equipment 17
Metal producer 19
Metal products manufacturer 15
Miscellaneous 19
Oil, gas, coal and related industry 10
Paper 18
Printing 5
Recreation 9
Retailer 12
Textile 9
Tobacco 1
Transportation 16
Utilities 16
Total 300
Table II.
Analysis of firms’
samples based on
industries 2006-2008
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Summary statistics
Table IV provides the regression results for the study. The Pseudo R2
and χ² were
reported as R² ¼ 0.20, Model χ² ¼ 46.99 in 2006, R² ¼ 0.23, Model χ² ¼ 56.67 in 2007, and
R² ¼ 0.23, Model χ² ¼ 54.88 in 2008. This model was statistically significant at
Minimum Maximum Mean SD
2006 2007 2008 2006 2007 2008 2006 2007 2008 2006 2007 2008
Dependent variables
Big Four
auditor 0.00 0.00 0.00 1.00 1.00 1.00 0.61 0.60 0.59 0.49 0.49 0.49
Independent variables
AC meeting
frequency 0.00 1.00 2.00 16.00 17.00 17.00 4.78 4.76 5.03 1.56 1.19 1.33
Proportion of
INED in AC 0.40 0.40 0.50 1.00 1.00 1.00 0.71 0.76 0.83 0.10 0.15 0.17
AC size 3.00 3.00 2.00 7.00 7.00 9.00 3.51 3.44 3.31 0.71 0.71 0.64
Proportion of
non-executive
director in AC 0.60 0.60 0.33 1.00 1.00 1.00 0.78 0.85 0.94 0.14 0.16 0.12
Percentage of
block
shareholder 0.06 0.07 0.05 0.75 0.99 0.75 0.34 0.34 0.34 0.16 0.16 0.16
CEO duality 0.00 0.00 0.00 1.00 1.00 1.00 0.35 0.35 0.35 0.48 0.48 0.48
Financial state 0.00 0.00 0.00 1.00 1.00 1.00 0.22 0.22 0.28 0.42 0.41 0.45
Chinese
dominance 0.00 0.00 0.00 1.00 1.00 1.00 0.62 0.61 0.62 0.49 0.49 0.49
Bumiputra
dominance 0.00 0.00 0.00 1.00 1.00 1.00 0.06 0.07 0.07 0.24 0.25 0.26
Institutional
dominance 0.00 0.00 0.00 1.00 1.00 1.00 0.28 0.28 0.27 0.45 0.45 0.44
Strong
political
connection 0.00 0.00 0.00 1.00 1.00 1.00 0.14 0.13 0.13 0.35 0.34 0.34
Weak political
connection 0.00 0.00 0.00 1.00 1.00 1.00 0.12 0.12 0.12 0.32 0.32 0.32
End of year
closing share
price 0.01 0.01 0.02 43.25 41.25 44.50 1.50 1.80 1.36 3.15 3.47 3.12
Family
controlled firm 0.00 0.00 0.00 1.00 1.00 1.00 0.54 0.53 0.53 0.50 0.50 0.50
Control variables
Nature log of
total assets 2.87 2.78 2.57 11.54 11.12 11.15 5.77 5.83 5.90 1.47 1.46 1.51
Assets
turnover 0.05 0.00 0.02 4.65 3.61 6.69 0.84 0.87 0.93 0.60 0.61 0.74
Return on
assets −137.32 −27.63 −84.97 45.25 771.45 56.96 5.15 9.10 4.41 11.17 45.21 10.91
Current assets
over total
assets 0.07 0.07 0.08 0.99 1.00 0.97 0.51 0.52 0.50 0.20 0.20 0.19
Total liabilities
over total
assets 0.02 0.01 0.01 7.31 1.53 2.19 0.45 0.42 0.43 0.46 0.22 0.23
β −1.75 −1.75 −1.75 5.24 5.24 5.24 0.95 0.95 0.95 0.86 0.86 0.86
Table III.
Descriptive statistics
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po0.001 and it was able to differentiate between those firms that chose the Big Four
and the non-Big Four auditors. On this basis the model correctly classified 68 percent of
firms in 2006, 70.3 percent of firms in 2007, and 67.7 percent of firms in 2008.
As reported in various papers with the same theme, Pseudo R² was reported based
on Nagelkerke’s R² measure. Even though Field (2009) has suggested that the Pseudo
R² in terms of interpretation “can be seen as similar to the R² in linear regression in that
they provide a gauge of the substantive significance of the model” (p. 262), in this study
it was suggested that any interpretation in relation of Pseudo R² should be made with
extra caution. The low Pseudo R² values were considerably acceptable as Hosmer and
Lemeshow (2000) suggested that low-R² value was usually normal in logistic regression
cases. For the purpose of hypotheses testing, only the significance levels of 1 and 5
percent will be regarded as significant.
Hypotheses results
The regression results in Table IV showed that all the AC-related variables was not
significant in all three years of observation. AC frequency meeting (2006: β ¼ −0.13,
2006 2007 2008
Predictions β SE Wald β SE Wald β SE Wald
X1a + −0.13 0.10 1.79 −0.15 0.13 1.43 −0.05 0.13 0.13
X1b + −1.91 1.45 1.74 −0.26 1.10 0.06 0.30 0.82 0.13
X1c + 0.13 0.21 0.37 0.35 0.23 2.29 −0.07 0.23 0.10
X1d + 0.86 1.13 0.58 0.72 1.06 0.46 1.08 1.14 0.90
X2 − 0.56 0.90 0.39 2.17 0.92 5.49** 1.69 0.94 3.21*
X3(1) − 0.15 0.29 0.24 0.26 0.30 0.77 0.38 0.30 1.57
X4(1) − −0.74 0.39 3.63* −0.05 0.40 0.01 0.32 0.39 0.67
X5a(1) ? −0.32 0.74 0.19 −0.60 0.81 0.54 −0.23 0.67 0.11
X5b(1) ? −0.70 0.89 0.62 −1.55 0.95 2.67* −0.58 0.81 0.51
X5c(1) ? 0.44 0.79 0.32 −0.18 0.85 0.04 0.51 0.73 0.50
X6a(1) − 1.21 0.54 5.05** 1.09 0.55 3.98** 1.04 0.55 3.58*
X6b(1) − −0.70 0.43 2.69* −0.55 0.43 1.60 −0.38 0.44 0.77
X7 + 0.07 0.07 0.89 −0.02 0.06 0.11 −0.02 0.06 0.16
X8(1) + 0.73 0.34 4.49** 0.28 0.34 0.67 0.19 0.34 0.31
X10 ? 0.20 0.14 2.19 0.33 0.15 4.51** 0.35 0.14 6.43**
X11 ? 0.33 0.29 1.31 0.73 0.28 6.70** 0.55 0.26 4.60**
X12 ? −0.03 0.02 1.69 0.00 0.01 0.05 0.02 0.02 0.84
X13 ? −0.25 0.78 0.10 −0.51 0.77 0.44 −0.74 0.78 0.91
X14 ? −0.71 0.48 2.22 −1.00 0.76 1.73 −1.28 0.74 3.01*
X15 ? −0.04 0.16 0.06 0.07 0.16 0.17 0.03 0.16 0.03
Constant ? 0.03 1.63 0.00 −2.75 1.76 2.44 −3.01 1.80 2.81*
Model
Pseudo R² 0.20 0.23 0.23
χ2
46.99 56.67 54.88
po001 po001 po001
Notes: The variables are defined as: Y1, the selection of Big Four auditor; X1a, audit committee
meeting frequency; X1b, proportion of independent director in AC; X1c, AC size; X1d, proportion of
non-executive directors in AC; X2, percentage of block shareholder; X3, CEO and chairman duality;
X4, financial state; X5a, Chinese dominance; X5b, Bumiputra dominance; X5c, institutional
dominance; X6a, strong political connection; X6b, weak political connection; X7, yearly closing share
price; X8, family controlled firm; X10, natural log of total assets; X11, assets turnover; X12, return on
assets; X13, current assets over total assets; X14, total liabilities over total assets; X15, β.
*,**Significant at the 10 and 5 percent level, respectively
Table IV.
Binary logistics
regression results
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Wald ¼ 1.79; 2007: β ¼ −0.15, Wald ¼ 1.43; 2008: β ¼ −0.05, Wald ¼ 0.13), proportion of
independent directors in AC (2006: β ¼ −1.91, Wald ¼ 1.74; 2007: β ¼ −0.26,
Wald ¼ 0.06; 2008: β ¼ 0.30, Wald ¼ 0.13), size of AC membership (2006: β ¼ 0.13,
Wald ¼ 0.37; 2007: β ¼ 0.35, Wald ¼ 2.29; 2008: β ¼ −0.07, Wald ¼ 0.10) and the
proportion of non-executive directors in the AC (2006 β ¼ 0.86, Wald ¼ 0.58; 2007:
β ¼ 0.72, Wald ¼ 0.46; 2008: β ¼ 1.08, Wald ¼ 0.90) were not statistically significant
with the selection of a high-quality auditor. Thus, H1a, H1b, H1c, and H1d, including
the general H1, were not supported.
The regression results in Table IV suggested that H2 was not supported in 2006, as
the size of the block shareholders did not have any negative statistically significant
relationship with the selection of a high-quality auditor ( β ¼ 0.56, Wald ¼ 0.39,
pW0.05). Even though the size of the block shareholders was statistically significant
at the 5 percent level in 2007 ( β ¼ 2.17, Wald ¼ 5.49, po00.05), H2 in 2007 was not
supported due to the deviation in the actual coefficient direction with the predicted
direction. Moreover, H2 in 2008 was also not supported, as the size of block
shareholders did not have any negative significant relationship with the selection
of a high-quality auditor ( β ¼ 1.69, Wald ¼ 3.21, po00.1). The consistent positive
coefficient has suggested that during the three years observed, the size of the block
shareholders was positively related with the selection of a high-quality auditor,
different from the initial negative prediction.
The regression results suggested that CEO duality has no significant negative
relationship with the selection of a high-quality auditor during the three years observed
(2006: β ¼ 0.15, Wald ¼ 0.24, pW0.05; 2007: β ¼ 0.26, Wald ¼ 0.77, pW0.05; 2008:
β ¼ 0.38, Wald ¼ 1.57, pW0.05). Thus, H3 was not supported. It is noted that the
direction of the coefficient during all the three years observed moving positively
instead of negatively as per the initial prediction.
Table IV also shows that there was a significant negative relationship between firms
categorized as PN17 and loss making with the selection of a high-quality auditor in
2006 at the 10 percent level (2006: β ¼ −0.74, Wald ¼ 3.63, po0.10). However, there
was no such significant relationship in 2007 and 2008 (2007: β ¼ −0.05, Wald ¼ 0.01,
pW0.05; 2008: β ¼ 0.32, Wald ¼ 0.67, pW0.05). Since only the significant level below
than po0.05 was accepted thus, H4 was rejected. In addition, it was identified that
only the coefficients in 2006 and 2007 moved in line with the initial prediction, while in
2008 they moved in the opposite direction.
Ownership dominance variables (X5) consist of three sub variables. Variable X5a
denoted Chinese ownership dominance; variable X5b denoted Bumiputra ownership
dominance; while X5c denoted institutional ownership dominance. All X5 sub variables
were dichotomous where 1 referred to “yes” and 0 referred to “no.” Based on the
regression results in Table IV, there was no statistically significant relationship at the 5
percent level between Chinese-dominated firms with the selection of high-quality
auditors during the three years observed (2006: β ¼ −0.32, Wald ¼ 0.19, pW0.05; 2007:
β ¼ −0.60, Wald ¼ 0.54, pW0.05; 2008: β ¼ −0.23, Wald ¼ 0.11, pW0.05). Furthermore,
the same results were also identified between Bumiputra-dominated firms and auditor
selection (2006: β ¼ −0.70, Wald ¼ 0.62, pW0.05; 2007: β ¼ −1.55, Wald ¼ 2.67,
pW0.05; 2008: β ¼ −0.58, Wald ¼ 0.51, pW0.05). On the other hand, there was no
statistically significant relationship between institutional ownership dominance with
the selection of high-quality auditor (2006: β ¼ 0.44, Wald ¼ 0.32, pW0.05; 2007:
β ¼ −0.18, Wald ¼ 0.04, pW0.05; 2008: β ¼ 0.51, Wald ¼ 0.50, pW0.05). Based on all the
results for ownership dominance, H5 was not supported.
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The variable in relation to politically connected firms (X6) consisted of two sub
variables. X6a denoted strong political connection while X6b denoted weak political
connection. Since both variables were dummy variables, both were coded as 1 for “yes”
and 0 for “no.” The results from Table IV have suggested that strong political
connection firms (X6) had a significant positive relationship with the selection of a high-
quality auditor at the 5 percent level in 2006 as well as in 2007, and at the 10 percent
level in 2008 (2006: β ¼ 1.21, Wald ¼ 5.05, po0.05; 2007: β ¼ 1.09, Wald ¼ 3.98,
po0.05; 2008: β ¼ 1.04, Wald ¼ 3.58, po0.10). The coefficient results for the three
years however, moved in the opposite direction from the initial negative prediction.
Weak political connection firms (X6b) however, had no significant relationship with the
selection of a high-quality auditor in the three years observed (2006: β ¼ −0.70,
Wald ¼ 2.69, pW0.05; 2007: β ¼ −0.55, Wald ¼ 1.60, pW0.05; 2008: β ¼ −0.38,
Wald ¼ 0.77, pW0.05). It is worth mentioning that X6b in 2006 had a significant
level of 10 percent. Based on the results of X6a and X6b, it was concluded that H6 was
not supported.
As shown in Table IV, the closing share price did not have a statistically significant
relationship with the selection of a high-quality auditor during, pre-, and post-transition to
MCCG 2007 (2006: β ¼ 0.07, Wald¼ 0.89, pW0.05; 2007: β ¼ −0.02, Wald¼ 0.11, pW0.05;
2008: β ¼ −0.02, Wald¼ 0.16, pW0.05). Thus, H7 was not supported by this study.
The final variable, family control of firms, was significantly positive with
the selection of a high-quality auditor at the 5 percent level in the year 2006
( β ¼ 0.73, Wald ¼ 4.49, po0.05). However, it is not significant in 2007 and 2008
(2007: β ¼ 0.28, Wald ¼ 0.67, pW0.05; 2008: β ¼ 0.19, Wald ¼ 0.31, pW0.05). Taking
into consideration of all the available results, H8 was supported only for the year
2006 (Table V).
Result of the control variables
The selection of control variables was mainly based on the study of Lin and Liu (2009),
which derived the control variables from a large body of past literature. Based on Table IV,
none of them were statistically significant in 2006. However, both the natural log of total
assets (X10) and asset turnover (X11) were statistically significant at the 5 percent level in
2007 and 2008
Hypothesis 2006 (Pre-MCCG 2007) 2007 (transition to MCCG 2007) 2008 (post-MCCG 2007)
H1 Not supported Not supported Not supported
H1a Not supported Not supported Not supported
H1b Not supported Not supported Not supported
H1c Not supported Not supported Not supported
H1d Not supported Not supported Not supported
H2 Not supported Not supported** Not supported
H6 Not supported** Not supported** Not supported
H8 Supported** Not supported Not supported
Note: **Significant at po0.05 with the opposite coefficient from predicted sign
Table V.
Summary of results
of hypotheses
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Discussion
The selection of auditor in 2006 (prior to MCCG 2007)
This study found that there was no evidence suggesting the influence of the AC in the
selection of an auditor before, after or during the introduction of MCCG 2007. It is
important to note that one of the duties of the AC is to consider the appointment of the
external auditors. The fact that the AC variables did not significantly influence
the determination of the quality-differentiated auditors was possibly due to the nature of
the appointment of auditors in Malaysia, based on business networking instead of
professional business decisions. This is consistent with the view of Che Ahmad et al. (2006).
Due to this, there was no difference in the selection of an auditor, regardless of their quality.
The same argument may also explain why the ownership dominance also was not
significant in the selection of a high-quality auditor, consistent with Husnin et al. (2013).
Take note that Chinese ownership dominance represented more than half of the
samples (62 percent in 2006, 61 percent in 2007, and 62 percent in 2008). This indicated
that the overall results were determined by how the Chinese owned companies selected
their auditors. Chinese business networks have played a big role in providing market
information to its members. This argument has further reiterated the auditor selection
criteria among Chinese owned firms.
It was also found that companies with higher risk have been moving to improve
their corporate governance through the selection of a high-quality auditor. The earlier
hypothesis suggested that politically connected firms had more incentive to choose a
low-quality auditor in order to manipulate related reports. However, this was not the
case in Malaysia, as during 2006 and 2007, strong politically connected firms tended to
choose a high-quality auditor.
The selection of a high-quality auditor by strong politically connected firms may be
explained based on stakeholder protection and image. High-quality financial reports
protect the interest of the stakeholders. For example, shareholders may make a more
accurate forecast on their investments while lenders also could accurately monitor the
entity’s covenant compliance. Disclosure from a high-quality report showed that these
companies were trying to reduce information asymmetry. Politically connected firms
also may need to preserve their image through the selection of quality-differentiated
auditors. Government link companies, for example may deliver a wrong signal to the
public by employing less quality auditor. It has been identified that strong politically
connected firms in the majority employed bigger auditors in all the three years
observed (86 percent in 2006, 90 percent in 2007, and 90 percent in 2008).
Another explanation is due to the range of services provided by the audit firms. It is
the usual practice in Malaysia the audit firms also provide non-audit services to their
audit clients. Before the introduction of MCCG 2007, the regulation on internal audit
function was weak. A company may have its own department, outsource, or even not
have one. Strong politically connected firms are very big in terms of size, and in order to
outsource such a function, they should find any audit firms which are competent to
handle such a heavy task. Therefore, they may choose bigger firm due to their available
resources and competent level. This finding is consistent with that of Svanström (2013)
and suggests that provision of non-audit services does not necessarily impair auditor
independence that damages audit quality.
The same explanation could be used for family controlled firms. This study supports
the notion that there is a positive relationship between family control firms and the
selection of a high-quality auditor. Family controlled firms represent a large slice in the
sample, represented 54 percent of the total sample in 2006 then followed by 53 percent in
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both 2007 and 2008. It has been noted that family controlled firms tend to elect their own
family members as directors and management team, inflicting weak governance. More
than half of the family controlled firms identified in the sample practised CEO duality
(51.5 percent in 2006, 53.5 percent in 2007, and 52.5 percent in 2008). Since family control
firms tend to keep the business ownership and decision power to them, having a control
on business is very essential. One of the ways to improve good governance without
jeopardizing ownership and power to outsiders is the selection of a high-quality auditor.
The selection of auditors in 2008 (post-MCCG 2007)
The immediate effect of MCCG 2007 on the selection of high-quality auditors was very
obvious. Based on the regression results, there was no tested variable that was
significant with the selection of a high-quality auditor in 2008. In other words, there
was no significant difference between those who selected the Big Four and those who
did not after the introduction of MCCG 2007. The most reasonable explanation is that
MCCG 2007 had unveiled the perception of the companies toward the quality of audit
provided by the Big Four after an internal audit function was made compulsory.
Companies may find that an internal audit function is important as a monitoring tool
and early fraud detection. With the internal audit function becoming compulsory, this
without a doubt has further improved the corporate governance. As a result, companies
may perceive that the employment of a high-quality auditor is not that important as
before, compared to what an internal audit function could offer.
The other possible reason is that a company may need more time to comply with the
revised guidelines. This can become an important issue in term of the readiness of the
company to quickly respond to the dynamic and fluctuating business environment,
including changing rules and regulations. Slow response will signal to outsiders
regarding inferior management and their inability to immediately capitalize and take a
strong business opportunity when it appears. This is not favorable, especially when
competition is very intense and split second decisions are crucial to ensure that the
company performs satisfactorily.
However, based on the regression results, two classical factors that determined the
employment of the Big Four after MCCG 2007 have been introduced: size and growth.
This means that only companies that are wealthy and able to pay for the high premium
imposed by the Big Four will employ them. But, this may not be the only reason. Size
and growth could also be related to complexity. The bigger the size or the faster the
growth of a firm will usually involve more complex transactions in day-to-day
operations. These findings are actually in line with the classical studies on the selection
of the Big Four firms which were also used as a control in this study.
Conclusions
This study reports the results of the study on the relationship between corporate
governance mechanisms with the selection of auditors and audit quality. The results
indicate that only ownership concentration, political connection, and family control
have a significant relationship with audit quality, although not for all three years of
observation. Ownership concentration only influenced auditor selection during the
transition period (2007) while influencing only family controlled firms before the
transition (2006). A strong political connection was significant in both year 2006 and
2007. Interestingly, all the variables, including the aforementioned, were not significant
after the transition (2007).
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There are several implications of this study. Before introduction of MCCG 2007, the
selection of the auditor had influence on business networking, and there was no
difference in the selection between quality-differentiated auditors. However, companies
that were associated with inherently higher risks, such as politically connected and
family controlled firms, had more incentives to improve their corporate governance
through the employment of the Big Four. In all the years observed, it was found that
the largest block shareholder employed different methods of monitoring and relied less
on external audits, eventually reflecting a lesser demand for audit effort.
After the introduction of MCCG 2007, this study found evidence of diminishing
reliance on quality-differentiated auditors as the internal audit function integrated into
the companies monitoring tool. Only bigger companies could afford to pay for the high
premium imposed and those involved in complex transactions able to employ the Big
Four. Employment of independent directors set-off the risks carried by companies
practicing CEO duality.
There are some drawbacks of the study, thus open up opportunity for future
research. First, this study did not take into consideration the AC expertise. The
inclusion of the AC expertise into the AC composition and operation may further give
corroboration into the important roles of the AC with the introduction of MCCG 2007.
Second, this study only had a three year observation period, with the post-MCCG 2007
only being observed for one year. It is suggested that a future study could evaluate the
impact of MCCG 2007 in a more specific and detailed manner. The data suggested are
in a longer longitudinal time frame, so that solid evidence could be found. For example,
data can be collected from 2001 to 2013 and 2001 to 2006 to represent the
pre-amendment period, while 2008 to 2013 represents the post-amendment period. If the
companies take more time to respond, possibly the result would be differences with this
study. Third, MCCG was revised for the third time in 2012 with the introduction of
eight governance principles. Audit quality requirements have been explicitly stated
under Principle 5: uphold integrity in financial reporting. It would be interesting if a
future study could replicate this study while using new MCCG as a basis to compare
the responses of the company in terms of audit quality. Fourth, a comparative study
among the developed and developing countries is also suggested to increase the
relevance and contribution of this study. Finally, incorporation of qualitative data such
as interviews and surveys may increase the value of this study.
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(The Appendix follows overleaf.)
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quality

Appendix
Y1X1aX1bX1cX1dX2X3X4X5aX5bX5c
Y11.00
X1a0.021.00
X1b0.010.021.00
X1c0.14***0.08***−0.19***1.00
X1d0.08**0.12***0.50***−0.08**1.00
X20.19***0.02−0.050.22***0.331.00
X30.01−0.010.00−0.11***−0.15***−0.031.00
X4−0.13***0.040.04−0.17***0.03−0.19***0.001.00
X5a−0.13***−0.14***−0.02−0.20***−0.20***−0.12***0.22***−0.08***1.00
X5b−0.07***−0.030.01−0.020.030.030.01−0.01−0.34***1.00
X5c0.17***0.16***0.010.24***0.18***0.15***−0.25***−0.08**−0.79***−0.17***1.00
X6a0.21***0.24***−0.040.14***0.15***0.16***−0.12***0.00−0.23***−0.020.27***
X6b−0.01−0.11***−0.040.14***0.07*0.13***−0.01−0.12***−0.14***−0.06*0.19***
X70.14***0.050.010.23***0.13***0.22***−0.08**−0.10***−0.20***−0.05*0.16***
X80.00−0.13***−0.01−0.13***−0.14***0.07**0.39***−0.88**0.49***0.06*−0.55***
X100.26***0.25***0.06*0.26***0.18***0.24***−0.08**−0.28***−0.37***0.000.39***
X110.08**−0.050.030.020.06*0.10***−0.09**−0.05−0.07**−0.08**0.07*
X120.010.020.030.040.040.05−0.05−0.15***−0.06*−0.020.06*
X13−0.08**−0.07***−0.04−0.02−0.08**−0.01−0.05−0.050.07**−0.04−0.06*
X14−0.05*0.09***0.01−0.05−0.02−0.07*0.030.22***−0.08**0.000.07***
X15−0.020.09**0.00−0.010.04−0.10***−0.13***0.11***−0.15***0.14***0.12***
X6aX6bX7X8X10X11X12X13X14X15
Y1
X1a
X1b
X1c
X1d
X2
X3
X4
X5a
X5b
X5c
(continued)
Table AI.
Correlation
coefficient matrix of
dependent and
independent
variables (2006-2008)
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X6a1.00
X6b−0.14***1.00
X70.18***0.10***1.00
X8−0.23***0.01−0.13***1.00
X100.45***0.07*0.32***−0.10***1.00
X11−0.12***0.12***0.18***−0.04−0.07**1.00
X120.000.10***0.12***0.000.030.011.00
X13−0.18***0.11***−0.06*0.04−0.31***0.36***0.075**1.00
X140.030.050.03−0.050.10***0.13***−0.07**0.041.00
X150.07**−0.10***−0.07**−0.09**0.07*−0.15***−0.040.010.09**1.00
Notes:Thevariablesaredefinedas:Y1,theselectionofBigFourauditor;X1a,auditcommitteemeetingfrequency;X1b,proportionofindependent
directorinAC;X1c,ACsize;X1d,proportionofnon-executivedirectorsinAC;X2,percentageofblockshareholder;X3,CEOandchairmanduality;X4,
financialstate;X5a,Chinesedominance;X5b,Bumiputradominance;X5c,institutionaldominance;X6a,strongpoliticalconnection;X6b,weakpolitical
connection;X7,yearlyclosingshareprice;X8,family-controlledfirm;X10,naturallogoftotalassets;X11,assetsturnover;X12,returnonassets;X13,
currentassetsovertotalassets;X14,totalliabilitiesovertotalassets;X15,β.*,**,***Significantatthe10,5and1percentlevel,respectively
Table AI.
229
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quality

About the authors
Azrul Ihsan Husnin is a Master Degree Graduate at the Faculty of Accountancy, Universiti
Teknologi MARA, Malaysia (passed with distinction). He received his Bachelor Degree (Hons) in
Accounting from the International Islamic University Malaysia (IIUM). Currently, he is
completing his certificate as a Qualified Accountant (ACCA) from the HELP University (Part-
time). He has experience in audit with a Big Four firm and currently being employed as an
Executive in a Fortune 500 company in Kuala Lumpur. His current research interests include
areas such as corporate governance, ethics, and financial accounting.
Anuar Nawawi is a Lecturer at the Faculty of Accountancy, Universiti Teknologi MARA,
Malaysia. He received his PhD in Commerce (Accounting) from the University of Adelaide, South
Australia. He also holds a professional qualification of the Chartered Institute of Management
Accountants (Passed Finalist), an affiliate Registered Financial Planner and a Master of
Accounting (with distinction) from the Curtin University of Technology, Western Australia.
He has taught a variety of courses centered on the accountancy discipline. Among them are
financial accounting, auditing, management accounting, taxation, financial management,
strategic management, computerized accounting, and research methodology. His research
interests are diverse, including areas such as management accounting, strategic management,
forensic accounting, corporate governance, and ethics.
Ahmad Saiful Azlin Puteh Salin is a Senior Lecturer at the Faculty of Accountancy, Universiti
Teknologi MARA (UiTM) Perak and currently pursuing a PhD in corporate governance and
ethics at the Edith Cowan University, Australia. He also a Fellow Member of the Association
of Chartered Certified Accountant (ACCA), UK, a Full Member of Malaysian Institute of
Accountants (MIA), and a member of Malaysian Insurance Institute (MII), International
Economics Development Research Centre (IEDRC) and Qualitative Research Association of
Malaysia (QRAM). He has taught a variety of courses in corporate governance, business ethics,
taxation, financial accounting and reporting, management accounting, costing and integrated
case study. His research interests focus primarily in the field of governance, Islamic and
business ethics, financial reporting, management, accounting education, small medium
enterprises (SMEs) and public sector accounting. He published many articles in local and
international journals and was appointed as a reviewer in several international journals
and conferences. Ahmad Saiful Azlin Puteh Salin is the corresponding author and can be
contacted at: ahmad577@perak.uitm.edu.my
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