Managerial Auditing Journal Auditor-client relationship: the case of audit tenure and auditor switching in Malaysia Abu Thahir Abdul Nasser Emelin Abdul Wahid Sharifah Nazatul Faiza Syed Mustapha Nazri Mohammad Hudaib Article information: To cite this document: Abu Thahir Abdul Nasser Emelin Abdul Wahid Sharifah Nazatul Faiza Syed Mustapha Nazri Mohammad Hudaib, (2006),"Auditor-client relationship: the case of audit tenure and auditor switching in Malaysia", Managerial Auditing Journal, Vol. 21 Iss 7 pp. 724 - 737 Permanent link to this document: http://dx.doi.org/10.1108/02686900610680512 Downloaded on: 22 December 2014, At: 05:19 (PT) References: this document contains references to 28 other documents. To copy this document: permissions@emeraldinsight.com The fulltext of this document has been downloaded 3369 times since 2006* Users who downloaded this article also downloaded: Winifred D. Scott, Willie E. Gist, (2013),"Forced auditor change, industry specialization and audit fees", Managerial Auditing Journal, Vol. 28 Iss 8 pp. 708-734 http://dx.doi.org/10.1108/MAJ-11-2012-0779 Rani Hoitash, Ariel Markelevich, Charles A. Barragato, (2007),"Auditor fees and audit quality", Managerial Auditing Journal, Vol. 22 Iss 8 pp. 761-786 http://dx.doi.org/10.1108/02686900710819634 Andrew B. Jackson, Michael Moldrich, Peter Roebuck, (2008),"Mandatory audit firm rotation and audit quality", Managerial Auditing Journal, Vol. 23 Iss 5 pp. 420-437 http:// dx.doi.org/10.1108/02686900810875271 Access to this document was granted through an Emerald subscription provided by 123705 [] For Authors If you would like to write for this, or any other Emerald publication, then please use our Emerald for Authors service information about how to choose which publication to write for and submission guidelines are available for all. Please visit www.emeraldinsight.com/authors for more information. About Emerald www.emeraldinsight.com Emerald is a global publisher linking research and practice to the benefit of society. The company manages a portfolio of more than 290 journals and over 2,350 books and book series volumes, as well as providing an extensive range of online products and additional customer resources and services. Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of the Committee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative for digital archive preservation. *Related content and download information correct at time of download. Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) Auditor-client relationship: the case of audit tenure and auditor switching in Malaysia Abu Thahir Abdul Nasser and Emelin Abdul Wahid Faculty of Accountancy, University Technology Mara, Johor, Malaysia Sharifah Nazatul Faiza Syed Mustapha Nazri Faculty of Accountancy, University Technology Mara, Selangor, Malaysia, and Mohammad Hudaib Department of Accounting and Finance, Bradford University School of Management, Bradford, UK Abstract Purpose – The main purpose of this paper is to examine one aspect of auditor-client relationship, namely audit tenure and switching behaviour, and factors affecting it. Lengthy audit tenure with the same client has been cited as one of the threats to auditor independence. Given the importance of this issue, this research attempts to shed some light on the effect of audit tenure and switching behaviour on auditor independence in Malaysia. Design/methodology/approach – This study evaluates the effects of various independent variables on switching behaviour and audit tenure using logistic regression analysis. Findings – An examination of 297 companies listed on the Kuala Lumpur Stock Exchange over a period of 11 years reveals audit firm switching to be significantly associated with distressed large clients and that the length and direction of switch depend upon the type of audit firm. Research limitations/implications – A number of important variables such as corporate governance characteristics, audit and non-audit fees and types of audit opinion that could enhance our understanding of audit tenure and auditor switching in Malaysia, were not incorporated into our regression models. Hence, future studies may consider such variables. Originality/value – This study is the first conducted using Malaysian data where audit tenure and switching are used as dependent variables. The results have important implications on the auditing profession and regulators in Malaysia. Keywords Auditors, Auditing, Customer relations, Malaysia Paper type Research paper 1. Introduction Auditor independence is the cornerstone of the auditing profession. In general, auditor independence can be of two forms: “independence in fact” and “independence in appearance”. The former requires auditors to form and express an opinion in the audit report as a disinterested and expert observer, uninfluenced by personal bias, while the latter expects auditors to avoid situations that might cause others to conclude that they are not maintaining an unbiased objective attitude of mind (Porter et al., 2003). The current issue and full text archive of this journal is available at www.emeraldinsight.com/0268-6902.htm The authors acknowledge the research funding from IRDC of University Teknologi Mara, Malaysia in conducting this research. MAJ 21,7 724 Managerial Auditing Journal Vol. 21 No. 7, 2006 pp. 724-737 q Emerald Group Publishing Limited 0268-6902 DOI 10.1108/02686900610680512 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) Flint (1988) argued that independence will be lost if the auditor is involved in a personal relationship with the client, as this may influence their mental attitude and opinion. One of such threats is lengthy tenure. He contends that lengthy tenure in office may cause the auditors to develop “over-cosy relationships” as well as strong loyalty or emotional relationships with their clients, which could reach a stage where auditor independence is threatened. Lengthy tenure also results in “over familiarity” and consequently, the quality and competence of auditors’ work may decline when they start to make unjustified assumptions instead of objective evaluation of current evidence. The GPES 1.201 (para 2.5) of the ICAEW (2001) recognised that this problem may be perceived as a threat to auditor independence and recommends that auditors avoid situations that may lead them to become over-influenced or to be too trusting of the client’s directors and key personnel which could consequently lead to audit staff being too sympathetic to the client interest. Since, the relationship between the auditor and his client can be close in one way or another regardless of the number of years in office, there is little the profession can do with regard to this matter (Dunn, 1996). In other words, the profession does not object to auditors serving their clients for a long period of time, but the objection seems to be over the worry that long period of service may lead to “cosy relationships” that may threaten auditor independence. Hence, to maintain public confidence in the audit function and to protect auditors’ objectivity, the profession through a series of clauses proscribes auditors from having personal relationships with their clients that may give rise to a potential conflict of interests. One of the proposals is to have mandatory auditor rotation (AICPA, 1978a, b) as it may increase auditors’ ability in protecting the public via the increase in alertness to any possible improprieties, increase in quality service and prevent closer relationship with client (Mautz, 1974; Winters, 1976; Hoyle, 1978; Brody and Moscove, 1998). However, some are against the idea because they believe that the costs outweigh the benefits. Frequent rotation and switching would result in increased audit fees as the benefits to be gained from subsequent lower cost after the initial years of any audit would not be fully realised. Another disadvantage is that the knowledge gained over time in improving quality of audit work would be wasted with the appointment of a new auditor (AICPA, 1992). Nevertheless, in 1994, the professional bodies in the UK introduced a seven year rotation policy for the audit engagement partners auditing public listed companies (Porter et al., 2003). A similar rotation policy was also introduced for audit engagement partners involved in auditing SEC registered companies (Wood and Sommer, 1985; Brody and Moscove, 1998). In Malaysia, the issue of audit tenure and interval rotation of audit firms or audit partners were not explicitly addressed in any of the relevant Malaysian official documents such as the Companies Act 1965, the Security Commission regulations, approved auditing standards, etc. Lack of official pronouncements on this issue could be due to the rejection of such rotation idea by the business community. Jaffar and Alias (2002) found only 35 per cent of the audit firms’ partners and only 32.4 per cent of the chief finance officers surveyed favoured audit firm rotation every three years of engagement. However, in light of the Enron case, the Chairman of the Malaysian Accounting Standard Board announced the intention of the board to make it mandatory to rotate the audit firm once every five years (The Edge, 2002). While some countries are either considering or have already imposed the five-year restriction to rotate the audit firms, the length of audit tenure and the possible effect of switching on Auditor-client relationship 725 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) auditor independence in Malaysia is still unclear. Hence, the results would highlight if audit tenure and switching should be of concerned before any rotation length is imposed. This is our main contribution to the literature. Our analysis involves an examination of 297 Malaysian listed companies between 1990 and 2000 using logistic regression. Results indicate the probability of switching the audit firm is greatest for distressed large client and that the direction of switch and length of tenure are dependent on type of audit firm. This implies that auditors in such environment fear losing their tenure and being switched, hence their independence and objectivity may be impaired. As such, we assert that rotation policy should be partially imposed on distressed clients as a first step forward in protecting auditor independence in the country. The paper proceeds as follows. The next section discusses the literature review and the development of the hypotheses. Sections 3 and 4 present the research method and results, respectively. Section 5 presents the summary and conclusions. 2. Literature review and development of hypo theses It has been suggested in the literature that larger audit firms (Big 4) are usually perceived as more capable of maintaining an adequate degree of independence than their smaller counterparts because they usually provide a range of services to a large number of clients, hence reducing their dependence on certain clients (Dopuch, 1984; Wilson and Grimlund, 1990). In addition, larger audit firms are generally perceived as the provider of high audit quality and enjoy a high reputation in the business environment and as such, would strive to maintain their independence to keep up their image (DeAngelo, 1981; Dopuch, 1984; Wilson and Grimlund, 1990). Furthermore, larger audit firms are also perceived to be more independent than their smaller counterparts in withstanding management’s pressure in the event of disputes as they normally have more clients and can afford to give up some of their more “difficult” clients (Chow and Rice, 1982). In Malaysia, high dependence on a few clients has been found to affect perception of independence (Teoh and Lim, 1996). This is not surprising as the market for audit services for public companies in Malaysia is dominated by the international Big 4 (previously the Big 6) audit firms. In fact, Che-Ahmad and Derashid (1996) report that the Big 6 (and their affiliates) audited 75.9 per cent of the Bursa Malaysia (Main Board) listed companies in 1991. Based on the above arguments, we expect the length of tenure by Big 4 audit firms to be significantly longer as their clients would be less likely to switch them compared to their smaller counterparts. Hence, the H1 is stated as follows: H1. The probability of switching big audit firms (Big 4) is significantly lower than the probability of switching smaller audit firms, ceteris paribus. Besides the possible effect of the type of audit firms on the length of tenure, the choice of audit firm can be related to the size of the auditee and the type of services needed. It has been argued that larger auditees, due to the complexity of their operations and the increase in the separation between management and ownership, demand highly independent audit firm to reduce agency costs (Watts and Zimmerman, 1986) and auditors’ self-interest threat (Hudaib and Cooke, 2005). Furthermore, as the size of the companies increases, it is likely that the number of agency conflicts also increases and this might increase the demand for quality-differentiated auditors (Palmrose, 1984), i.e. Big 4 audit firms. MAJ 21,7 726 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) Based on the above arguments, we expect the length of tenure of auditors of large clients to be longer than that of auditors of smaller clients in Malaysia. In other words, we expect the propensity to switch auditors to be lower for large clients than their smaller counterparts. This leads us to the following hypothesis: H2. The probability of large clients switching audit firms is significantly lower than the probability of small clients switching audit firms, ceteris paribus. When businesses continue to grow, the demand for the highly independent and qualified audit firm to reduce agency costs and to provide non-audit services needed for the expansion of the firm increases. Therefore, growing businesses are expected to be more likely to retain their audit firms than their lower growth counterparts. Sinason et al. (2001) examined 16,976 COMPUSTAT companies in the US over a period of 20 years and found that audit tenure is significantly affected by client’s growth rate. Since, the literature indicates that audit tenure is affected by the client’s growth rate, we hypothesised the length of tenure of auditors of high growth clients in Malaysia to be longer than low growth clients. In other words, high growth clients are less likely to switch their auditors. As such, our next hypothesis is: H3. The probability of high growth clients switching audit firms is significantly lower than the probability of low growth clients switching audit firms, ceteris paribus. The financial position of auditees may have important implications on decisions in retaining the audit firm. Auditees who are insolvent (have high gearing ratios) and are experiencing an unhealthy financial position are more likely to engage auditors having high independence to boost the confidence of shareholders and creditors as well as to reduce the risk of litigation (Francis and Wilson, 1988). In addition, financially stressed clients are more likely to replace their audit firms compared to their healthier counterparts (Schwartz and Menon, 1985; Hudaib and Cooke, 2005). As such, we expect auditors of distressed clients to have shorter tenure compared to their counterparts auditing healthier clients and will in turn be less likely to be switched. The next hypothesis is stated as follows: H4. The probability of distressed clients switching audit firms is significantly higher than the probability of healthier clients switching audit firms, ceteris paribus. Sinason et al. (2001) found the length of audit tenure to be positively affected by the type of audit firm. In other words, smaller audit firms experience shorter tenure compared to their larger counterparts who often enjoy lengthy tenure. Differences in the length of tenure between the two types of audit firms could impair independence because in the long run, small audit firms will find it difficult to keep their existing clients and at the same time maintain a high degree of independence and objectivity due to increased competition and size mismatch. Ideally, the size of audit firm should match the size of auditee. A size mismatch between large auditees audited by small audit firms could cause termination of the audit engagement (Hudaib and Cooke, 2005), i.e. a switch of auditor. Since, there are four possibilities of switching auditors, viz. switch from non-Big 4 to non-Big 4, from non-Big 4 to Big 4, from Big 4 to non-Big 4 and from Big 4 to Big 4, Auditor-client relationship 727 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) we expect the lengths of tenure for the four types of switches to be significantly different. Specifically, we hypothesise that: H5. The length of audit tenure for non-Big 4 replaced by Big 4 ( m 2 ) is significantly shorter than the length of audit tenure for non-Big 4 replaced by another non-Big 4 ( m 1 ). Hence, m 1 – m 2 – m 3 – m 4 . where, m 1 , switched from non-Big 4 to non-Big 4; m 2 , switched from non-Big 4 to Big 4; m 3 , switched from Big 4 to non-Big 4; m 4 , switched from Big 4 to Big 4. 3. Research method 3.1 Data sources There were 810 listed companies on both the main and second board of the Kuala Lumpur Stock Exchange (KLSE) or Bursa Malaysia as at 10 June 2002. The sample of this study consists of 297 randomly selected companies listed on both boards. Based on the sample error formula (Burns and Bush, 2003), a sample size of 297 is deemed appropriate. The relevant data had been collected from KLSE Research Institute Database for a period of 11 years from 1990 to 2000. Besides the relevant financial statements, the relevant audit reports of the sample firms available at KLSE were also used in this research. The dependent variables are auditor switching (SWITCH t ) and the four directions of switch ( m xt ) which are noted from the audit reports during the study period. The independent variables consist of book value of equity (BVE) and market value of equity (MVE), client size (CLI.SIZE), changes in total assets (Ln DTA), changes in sales (Ln DS), type of audit firm (AUDIT), changes in income from continuing operations in the two years preceding the audit change (Ln DR t2 2 ), financial distress of the client company (Ln DZ ),[1] interactive effects of length of tenure held by Big 4 and non-Big 4 before being switched (TENU * AUDIT xt ) and the interactive effects of length of tenure before the first switch (TENU * B1.SWI). 3.2 Data analysis Logistic regression was adopted to assess the relationships since the dependent variables are dichotomous. The model parameters are estimated using the maximum-likelihood method whereby the coefficients that make the observed results most “likely” are selected on the basis of an iterative algorithm. Furthermore, the maximum-likelihood method has also the advantage of asymptotic normality (Hudaib and Cooke, 2005). Model 1 has the dependent variable as switching/non-switching (SWITCH t ) and Model 2, direction of switching/otherwise ( m xt ). Model 1 provides answers to the research hypotheses associated with audit tenure and switching while Model 2 investigates the impact of independent variables on the directions of auditor switching. 3.3 Model specification 3.3.1 Model 1. We use the following logistic regression model to test for the relationships between auditor switching (SWITCH t ) and type of audit firm (AUDIT), client size (CLI.SIZE), client growth (Ln DS), client financial risk (Ln Z), the interactive effects of length of tenure of remaining in the office before being switched (TENU * AUDIT xt ), the change in operating income (Ln DR t2 2 ), change in market value of equity (Ln DMVE) as well as change in total assets (Ln DTA): MAJ 21,7 728 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) SWITCH t ¼ a 0 þ b 1 AUDIT þ b 2 CLI:SIZE þ b 3 Ln DS þ b 4 Ln Zþ X 2 i¼1 d ixt TENU * AUDIT xt þ b 7 Ln DR t22 þ b 8 Ln DMVE þ b 9 Ln DTA þ1 SWITCH t is a binary variable indicating whether or not the audit firm was switched or not switched. The other independent variables are as summarised in Table I. 3.3.2 Model 2. To further explain the impact of independent variables on the switched directions of audit firms ( m xt ), the following logistic regression model was adopted to test the association between auditor switching from one type of audit firm to another and the nine independent variables, viz. type of audit firm (AUDIT), client size (CLI.SIZE), client growth (Ln DS), financial risk (Ln Z), change in operating income (Ln DR t2 2 ), change in market value of equity (Ln DMVE), the change in total assets (Ln DTA), the interactive effects of length of tenure before the first switching (TENU * B1.SWI) and the interactive effects of length of tenure of a large audit firm (Big 4) remaining in the office before being switched (TENU * AUDIT B4 ): a 0 Intercept SWITCH A dummy variable, 1 if the audit firm is switched at time t , and 0 otherwise m xt Four propositions of switch directions 1. m 1 ¼ from non-Big 4 to non-Big 4 2. m 2 ¼ from non-Big 4 to Big 4 3. m 3 ¼ from Big 4 to non-Big 4 4. m 4 ¼ from Big 4 to Big 4 AUDIT A dummy variable, 1 if the firm is a Big4 audit firm, and 0 otherwise CLI.SIZE A dummy variable, 1 if the client’s TA is large (ln TA . the mean), and 0 otherwise Ln DS The natural logarithm of squared changes in sales scaled by ln TA ½lnððDS=ln TAÞ 2 Þ; Ln Z The natural logarithm of company’s financial risk: cash flow from operations over long-term debt [ln(Z) 2 ] SQ ln BVE The square root of natural logarithm of BVE ½ ffiffiffi 2 lnðBEÞ 2 p ; ln TA The natural logarithm of the client’s assets [ln TA] Ln DTA The natural logarithm of squared changes in of total assets ½lnðDTAÞ 2 ; ln MVE MVE [ln MVE] Ln DMVE The natural logarithm of squared changes in MVE ½lnðDMVEÞ 2 ; LnDR t2 2 The natural logarithm of squared changes in operating income two years (year t2 2 ) before switching in year t2 0 ½lnðDR t22 Þ 2 ; TOT.TENU Total length of tenure (years) for the period TENU * B1.SWI The interactive effects of length of tenure before the first switch, company j is coded 1 up to 11 depending of the length of tenure before the first switch in period tx TENU * AUDIT xt Two propositions of the interactive effects of tenure length before switching 1. TENU.AUDIT B4 ¼ number of years the incumbent Big4 held office before being replaced divided by TOT.TENU 2. TENU.AUDIT nB4 ¼ number of years the incumbent non-Big4 held office before being replaced divided by TOT.TENU 1 Error term Table I. Variables in the logistic regression models Auditor-client relationship 729 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) m t ¼ a 0 þ b 1 AUDIT þ b 2 CLI:SIZE þ b 3 LnDS þ b 4 Ln Z þ b 5 Ln DR t22 þ b 6 Ln DMVE b 7 Ln DTA þ b 8 TENU * B1:SWI þ b 9 TENU * AUDIT B4 þ 1 The model is run four times to cover all switch directions taken by clients to appoint their new audit firms after terminating the services of their incumbent audit firms. 4. Empirical results 4.1 Descriptive statistics Table II (Panel A) presents descriptive statistics for the experimental, control and dependent variables. The mean size of clients is RM 1.5 billion. The negative signs in Minimum Maximum Sum Mean SD Panel A (Continuous) TA 35,251 51,453,100,000 1546788049.45 4855264576.1 Ln DTA 2 15.2018 1.1077 2 5.106514 2.6 BE 2 1,882,020,548 14,518,600,000 449149349.93 1182242201.7 SQ ln BVE 5.22 6.84 6.1446 0.2 MVE 350 17,432,850 404402.64 1614674.7 Ln DMVE 2 9.6318 12.9503 2 0.753392 2.1 Ln DS 2 13.6249 9.5961 2 3.629986 3.3 Ln DR t2 2 2 18.4207 10.1909 2 1.388829 3.2 Risk (Z) 2 0.0300 1835.8700 24.510732 172.1 Ln Z 2 20.8286 15.0305 2 0.525179 4.2 TENU * B1.SWI 1 11 6.10 3.5 TENU * AUDIT B4 0.00 1.00 0.5576 0.46640 TENU * AUDIT nB4 0.00 1.00 0.4424 0.46640 Panel B (Dichotomous) CLI.SIZE 0 1 129 0.43 0.497 AUDIT 0 1 175 0.59 0.493 SWITCH 0 1 87 0.29 0.457 TOT.TENU 1 11 1,987 6.69 3.619 m xt 0 4 198 0.67 1.191 m 1 0 1 23 0.08 0.268 m 2 0 1 36 0.12 0.327 m 3 0 1 9 0.03 0.172 m 4 0 1 19 0.06 0.245 Notes: n – 297; TA – total assets; ln TA – the natural logarithm of total assets; Ln DTA – the natural logarithm of squared changes in total assets; SQ ln BVE – the square root of natural logarithm of BVE; Ln DMVE – the natural logarithm of squared changes in MVE; LnDS – the natural logarithm of squared changes in sales scaled by ln TA; Ln DR t2 2 – the natural logarithm of squared changes in operating income; Ln Z – the natural logarithm of company’s financial risk; TENU * B1.SWI – the interactive effects of length of tenure before the first switching; TENU * AUDIT B4 – the interactive effect of years in office by Big4 before switching over total tenure period; TENU * AUDIT nB4 – the interactive effects of years in office by non-Big4 before switching over total tenure period; CLI.SIZE – a dummy variable, 1 if the client’s TA is large, and 0 otherwise; AUDIT – a dummy variable, 1 if the firm is a Big4 audit firm, and 0 otherwise; SWITCH – a dummy variable, 1 if the audit firm is switched, and 0 otherwise; TOT.TENU – total length of tenure (years) for the period; m 1 – switched from non-Big4 to non-Big4; m 2 – switched from non-Big4 to Big4; m 3 – switched from Big4 to non-Big4; m 4 – switched from Big4 to Big4 Table II. Descriptive statistics MAJ 21,7 730 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) the mean values indicate poor financial performance during the period of analysis. Table II (Panel B) reports the descriptive statistics of the dichotomous variables. It can be seen from the table that the sample consisted of 43 per cent (129) large companies, 60 per cent (175) Big 4 and 29 per cent (87) cases of audit termination (switching). It also shows that switching from small to large audit firm (i.e. from non-Big 4 to Big 4) is the most common type of auditor change (36 cases), followed by switching from small audit firm to small audit firm (23 cases) and switching from large audit firm to large audit firm (19 cases). Not surprising, the least common type of auditor switch is from large audit firm to small audit firm (9 cases). Table III presents the correlation matrix for the dependent and continuous independent variables. It indicates no multicollinearity problem, as the correlations are relatively low except the correlation between two independent variables: type of audit firm (AUDIT) and (TENU * AUDIT xt – the tenure length of Big 4 and non-Big 4). Therefore, AUDIT and TENU * AUDIT nB4 are dropped when we run our regression models. 4.2 Results of the logistic regressions 4.2.1 Model 1. Model 1 tests which independent variables (viz. client size, client growth, client financial risk, the length tenure in the office before being switched, the changes in operating income, market value of equity as well as the changes in total assets) explain the behaviour of ending audit firm tenure in office (i.e. audit switching). The results are shown in Table IV. Client size, client financial risk, the changes in total assets and the interactive effects of the length of tenure in office before switching large audit firm (TENU * AUDIT B4 ), were found to be significantly associated with audit switching while client growth, changes in operating income and market value of equity were found not to be significant. The results indicate that the main factors for switching audit firm are the increase in total assets and the financial risk of the company. The highest log odds of CLI.SIZE [Exp(B) ¼ 1.76] indicates that client size is the most important factor followed by financial risk in explaining switching and as such H2 and H4 are accepted. However, the growth of company’s business, the increase in operating income and increase in market value do not affect the length of tenure of the audit firm, thus allowing us to reject H3. The fact that the length of tenure of large audit firms (Big 4) is negatively associated with switching suggests that larger audit firms experience fewer instances of being replaced compared to their smaller counterparts who face shorter tenure as they tend to be replaced more often and as such, H1 is accepted. 4.2.2 Model 2. Table V shows the results of testing Model 2, i.e. the impact of various independent variables on the four switching directions ( m xt ). As indicated by the results, the only factor that significantly impacts switching behaviour is the interactive effects of length of tenure before the first switch (TENU * B1.SWI), followed by changes in total assets of the client (Ln DTA). Table VI (Panel A) provides details on the pattern of switching behaviour. As can be seen, switching for similar sized audit firms, i.e. switching from a small audit firm to another or from a large audit firm to another, often occurs after lengthy tenure. However, switching to dissimilar sized audit firms, i.e. switching from a small to a large audit firm or from a large to a small audit firm, occurs in a relatively shorter period. This suggests that the propensity to switch to a large audit firm is greater for clients experiencing an increase in total assets. Auditor-client relationship 731 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) Variable m 1 m 2 m 3 m 4 SQ ln BVE SWITCH 0.45 ** 0.58 ** 0.27 ** 0.41 ** 0.14 * m 1 1 2 0.11 2 0.05 2 0.08 0.05 m 2 1 2 0.07 2 0.10 0.02 m 3 1 2 0.05 0.05 m 4 1 0.14 * SQ ln BVE 1 Ln DTA Ln DMVE Ln DS Ln DR t2 2 Ln Z AUDIT TOT.TENU TENU * B1.SWI TENU * AUDIT B4 Variable Ln D TA Ln D MVE Ln D SLn D R t2 2 Ln Z SWITCH 0.06 2 0.03 0.08 0.10 0.08 m 1 2 0.01 0.05 0.00 0.02 0.10 m 2 0.04 2 0.09 0.12 * 2 0.00 0.05 m 3 0.09 2 0.03 0.04 0.15 ** 2 0.02 m 4 0.02 0.02 2 0.04 0.06 20.03 SQ ln BVE 2 0.07 2 0.07 2 0.07 2 0.04 2 0.07 Ln DTA 1 2 0.02 0.21 ** 0.03 0.02 Ln DMVE 1 2 0.04 2 0.07 20.03 Ln DS 1 0.17 ** 0.12 * Ln DR t2 2 1 2 0.07 Ln Z 1 AUDIT TOT.TENU TENU * B1.SWI TENU * AUDIT B4 Variable AUDIT TOT.TENU TENU * B1.SWI TENU * AUDIT B4 TENU * AUDIT nB4 SWITCH 0.02 0.31 ** 0.05 2 0.09 0.09 m 1 2 0.35 ** 0.10 0.16 ** 2 0.35 ** 0.35 ** m 2 0.27 ** 0.19 ** 2 0.15 ** 2 0.03 0.03 m 3 2 0.21 ** 0.13 * 2 0.05 0.00 2 0.00 m 4 0.22 ** 0.11 0.16 ** 0.25 ** 2 0.25 ** SQ ln BVE 0.05 0.33 ** 0.29 ** 0.08 2 0.08 Ln DTA 0.03 0.06 0.02 0.03 2 0.03 Ln DMVE 2 0.06 2 0.07 2 0.05 20.06 0.06 Ln DS 0.11 0.05 0.02 0.10 2 0.10 Ln DR t2 2 0.01 0.08 0.05 0.02 2 0.02 Ln Z 2 0.06 2 0.06 2 0.06 2 0.09 0.09 AUDIT 1 0.08 0.05 0.90 ** 2 0.90 ** TOT.TENU 1 0.89 ** 0.09 2 0.09 TENU * B1.SWI 1 0.14 * 2 0.14 * TENU * AUDIT B4 1 2 1.0 ** Notes: ** Correlation is significant at the 0.01 level two-tailed; * correlation is significant at the 0.05 level two-tailed Table III. Correlation matrix MAJ 21,7 732 Downloaded by Central Michigan University At 05:19 22 December 2014 (PT) [...]... Accountancy, pp 6 9-7 8 Hudaib, M and Cooke, T.E (2005), The impact of managing director changes and financial distress on audit qualification and auditor switching , Journal of Business Finance & Accounting, Vol 32 Nos 9/10, pp 170 3-3 9 ICAEW (2001), Members Handbook 2001, Institute of Charted Accountants in England and Wales, London Jaffar, N and Alias, N (2002), Audit firm rotation in Malaysia: prospects and problems”,... mainly in uenced by the interaction between directions of switch and type of audit firm with the length of tenure Length of tenure before switching from a small to a large audit firm is significantly shorter compared to the length of tenure before switching from a small to another small audit firm Large audit firms were found to secure longer tenure Hence, such differences in the lengths of tenure suggest independence... ‘low-balling’ and disclosure regulation”, Journal of Accounting and Economics, August, pp 11 3-2 7 Dopuch, N (1984), The demand for quality-differentiated audit services in an agency-cost setting: an empirical investigation: discussion”, in Abdel-Khalik, A and Solomon, I (Eds) paper presented at Auditing Research Symposium, University of Illinois, Urbana, IL, pp 25 3-6 3 Dunn, J (1996), Auditing: Theory... that retention of audit firms depends on the size of clients based on total assets, level of financial risk and type of audit firm but not by changes in operating income and market value The likelihood of non-distressed large client audited by large audit firm to switch is significantly less compared with distressed small client audited by small audit firm Results also show that switching directions are mainly... Hatherly, D (2003), Principles of External Auditing, Wiley, Chichester Schwartz, K.B and Menon, K (1985), Auditor switches by failing firms”, The Accounting Review, Vol LX, pp 24 8-6 1 Sinason, D.H., Jones, J.P and Shelton, S.W (2001), “An investigation of auditor and client tenure , Mid-American Journal of Business, Vol 16 No 2, pp 3 1-4 0 Teoh, H and Lim, C (1996), “An empirical study of the effects of. .. Prentice-Hall, Upper Saddle River, NJ Flint, D (1988), Philosophy and Principles of Auditing – An Introduction, Macmillan Education Ltd, London Francis, J and Wilson, E.R (1988), Auditor changes: a joint test of theories relating to agency costs and auditor differentiation”, The Accounting Review, Vol 63, pp 66 3-8 2 Hoyle, J (1978), “Mandatory auditor rotation: the argument and alternative”, Journal of. .. Burns, A.C and Bush, R.F (2003), Marketing Research, Prentice-Hall, Upper Saddle River, NJ Che-Ahmad, A and Derashid, C (1996), The pricing of audit services: evidence from the KLSE listed companies”, Journal Analysis, Vol 4 No 1, pp 3 3-4 5 Chow, C.W and Rice, S.J (1982), “Notes: qualified audit opinions and auditor switching , The Accounting Review, Vol LVII, pp 32 6-3 5 DeAngelo, L (1981), Auditor independence,... problems”, Finance India, Vol XVI No 3, pp 93 3-4 8 Mautz, R.K (1974), “Rotation of auditors”, Financial Executive, July, pp 4 8-5 6 Palmrose, Z (1984), The demand for quality-differentiated audit services in an agency-cost setting: an empirical investigation”, in Abdel-Khalik, A and Solomon, I (Eds) paper presented at Auditing Research Symposium 1984, University of Illinois, Urbana, IL Porter, B., Simon, J and. .. makers in Malaysia since auditor independence may be impaired due to the unhealthy competition among the audit firms This study is subject to several limitations First, corporate governance characteristics that would shed more light on this topic were not included in our analysis Second, we have not considered the effects of audit and non -audit fees on audit tenure and the decision to retain auditor. .. examines audit tenure and switching behaviour in the Malaysian audit environment for the period from 1990 to 2000 It provides evidence on the relationships between switching and five related variables, viz the interactive effects of length tenure of Big 4 before being replaced (TENU*AUDITB4), client size (CLI.SIZE), client growth (Ln DS), client financial risk (Ln Z) and four switching directions (mxt) The . switched, the changes in operating income, market value of equity as well as the changes in total assets) explain the behaviour of ending audit firm tenure in of ce (i.e. audit switching) . The results. Managerial Auditing Journal Auditor- client relationship: the case of audit tenure and auditor switching in Malaysia Abu Thahir Abdul Nasser Emelin Abdul Wahid Sharifah Nazatul. in explaining switching and as such H2 and H4 are accepted. However, the growth of company’s business, the increase in operating income and increase in market value do not affect the length of tenure