The increasing importance of corporate financial disclosure

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Introduction

The quality of corporate financial disclosure has become an important policy issue following the Enron and WorldCom scandals. Enhancing disclosure quality increases transparency which facilitates public investors to better monitor firms. Fan and Wong (2002) argue that low transparency is associated with high agency costs and low level of corporate governance. Audits conducted by independent professionals, however, can serve a very important role in improving financial disclosure and information credibility (Balsam et al. 2003; Ferguson et al. 2004). Nevertheless, the quality of auditors will also affect the utility of financial audits.

Auditor choice, or client-auditor alignment, can be viewed as the minimum cost match between client needs (the demand side) and auditor services (the supply side) in a certain auditing environment. Studies on auditor choice and auditor switch to date have been conducted predominantly in the US (Hudaib and Cooke 2005; Lee et al. 2004; Pittman and Fortin 2004; Copley and Douthett 2002; Geiger et al. 1998; Copley et al. 1995; Krishnan 1994; Johnson and Lys 1990; DeAngelo 1982; Chow and Rice 1982), with occasional studies in countries such as Australia (Craswell 1988), New Zealand (Firth 1999; Firth and Smith 1992) and the UK (Beattie and Fearnley 1995), where the auditing environments are fairly similar. However, there are few empirical studies that examine auditor choice and auditor switch in the emerging economies. Emerging economies have less developed equity markets and very different auditing environment than the developed ones (Woodward 1997).

Shortly after the founding of the People's Republic of China in 1949, the auditing profession in China diminished completely. Independent audits were virtually nonexistent under the planned economy before the 1980s, when the State both owned and ran enterprises. The re-emergence of independent auditing was the result of mushrooming Sino-foreign joint ventures, conveyed by China's open-door policy that was adopted in the early 1980s. Due to non-state-owned interests in the joint ventures, demand emerged for the verification of capital contributions and audits of annual financial statements and income tax returns by registered non-government-employed Chinese certified public accountants (Xiao et al 2000). The progress of full-scale economic reforms, with the separation of ownership and management of enterprises, leads to agency problems in business firms. Independent audits are thus called for to alleviate the agency problems in China.

The Chinese Institute of Certified Public Accountants (CICPA) was established in the early 1980s. At the turn of 1990s, the rapid development of shareholding companies (stock companies) in China led to a sharp increase in the demand for external audits. The China Securities Regulatory Commission (CSRC) requires that all listed firms have their annual reports audited by certified public accountants (CPAs). The monitoring of both public and private enterprises by independent auditors has been employed by the government as an important mechanism in transforming the Chinese economy from the one directed by the "visible hand" of centralized set up and schedule towards the one directed by the "invisible hand" of market forces.

Composition of Audit Committees: Independence

Independent auditors, by performing their audits in accordance with the Generally Accepted Auditing Standards (GAAS), would attest the fairness of management's financial reports to the stakeholders, and would discover any deviations from the Generally Accepted Accounting Principles (GAAP). Firms can thus employ reputable auditors to assure the shareholders and the potential investors of the credibility of accounting information and hence mitigate the agency problems underlying the contractual relations between firm management and the owners/shareholders. In attesting the credibility of accounting information, independent auditors thus serve an external monitoring role on behalf of the owners/shareholders (e.g., Fan and Wong 2005; Ashbaugh & Warfield 2003). Audits can reduce agency costs by assuring the quality of financial statements, thereby allowing more precise and efficient contracts between the principals and the agents to be based on the financial statements (Watts and Zimmerman 1986; Bedard and Johnstone 2004).

Prior audit research uses the agency costs to explain heterogeneous demand for external audit services (DeAngelo 1981; Dye 1993; Chaney et al. 2004). Audit quality has been defined in different ways. These definitions embrace, to varied extent, the dimensions of competence and independence of auditors. A high-quality auditing firm should have independence (relationship based), enough expertise (technique based), and good integrity (honesty and forthrightness). In a broad sense, auditors' independence includes expertise and integrity (Pittman and Fortin 2004; Schauer 2002).

Most empirical research defines the audit quality in relation to the audit risk that an auditor may fail to modify the opinion on the financial statements that are materially misstated. To modify his/her opinion on the financial statements, an auditor needs to have the expertise to find out the misstatement and be willing to report it. DeAngelo (1981) has defined auditor independence as the joint probability that auditors will find out and report misstatements in the financial statements. Using ERCs from returns-earnings regression as a proxy for investors' perceptions of earnings quality, Ghosh and Moon (2005) found that investors and information intermediaries perceived auditor tenure as an indicator of audit quality. This finding may suggest that longer tenure leads auditors to better understand their clients' businesses and to have more expertise to find out misstatements. Lennox (2005) found that firms with top management affiliated with their auditors are significantly more likely than unaffiliated firms to receive clean audit opinions. This may imply that affiliation with clients makes auditors less willing to report misstatements. Although diverse to certain extent, most existing definitions of audit quality reflect some aspects of the DeAngelo's definition.

DeAngelo (1981) argues that audit firm quality is positively associated with firm size or the firm's market share. She argues that audit firms are faced with countervailing incentives regarding independence behaviors. On the one hand, an audit firm will be motivated to behave non-independently for fear of losing the future stream of quasi-rents specific to a certain client3. On the other hand, the danger of being caught of behaving non-independently and thereby losing the stream of future quasi-rents specific to all other clients will serve to promote the independent behaviors. Mayhew and Pike (2004) and Monem (2003) reports that, when facing the countervailing incentives, larger firms are, in general, more independent and provide better monitoring.

Composition of Audit Committees: Expertise

Firms with high agency costs are more inclined to choose a high-quality auditor to improve their corporate governance (Fan and Wong 2005; Hay and Davis 2004). One major benefit from improved corporate governance is firms can raise capital at lower costs (Bloomfield 2004). The listed firms in China are featured with high ownership concentration and therefore lower level of transparency (i.e., opaqueness), which leads to information asymmetry between the controlling shareholders and the other shareholders.

Theoretically, the level of opaqueness is associated with the effectiveness of corporate governance mechanism, both internal and external. The more effective (stronger) corporate governance mechanism a firm has, the less opaque it is; vice versa. In this regard, with their monopolist status, the controlling shareholders are able to derive certain opaqueness gains --- private benefits expropriated from other shareholders because of information opaqueness. Therefore, there are incentives for firms with high ownership concentration to opt for or against high-quality audits. On the one hand, firms hiring high-quality auditors could signal good corporate governance to outside investors, so they can raise capital through the equity or debt market at lower costs. On the other hand, the controlling owners may lose their opaqueness gains if firms are monitored by a high-quality auditor, e.g., it will be more difficult for the controlling shareholders to benefit from earnings management and tunneling behaviors (the transfer of resources out of a firm to its controlling shareholder).

Composition of Audit Committees: Operations

According to OECD's definition, "corporate governance is the system by which business corporations are directed and controlled. The corporate governance composition indicates the allocation of rights and responsibilities among different members in the corporation, which includes the board, managers, shareholders and other stakeholders, and makes the rules and procedures clear in the purpose of making decisions on company affairs. In so doing, it also provides the composition through which the corporate objectives are set, and the ways of accomplishing those objectives and monitor performance."

Examples of internal corporate governance controls are of monitoring by and for the BoD, balancing the right or interest of the controlling and minority shareholders, and reviewing performance-based remuneration for managers. The effectiveness of internal corporate governance controls is thus determined by the organizational arrangement for the internal monitoring mechanisms, including ownership concentration, supervision over the BoD and management, duality of positions for business executives and monitoring authority, and so on. External corporate governance controls encompass the controls exercised by external stakeholders over the organization. Examples consist of debt covenants, external audits, government regulation, media pressure, takeovers, competition, and managerial labor market. Auditors provide an independent check on the work of the management and on the quality of the financial information provided by the management, and therefore serve a fundamental role in promoting confidence and reinforcing trust in corporate financial reporting. By performing the attestation function, auditing is a significant part of a firm's monitoring system.

Information Quality, Information Credibility and Audit Quality

Information quality refers to how well the financial statements reflect the true economic conditions of the company. Francis and Krishnan (1999) argue that the management is less (more) able to manipulate earnings to meet the forecasted earnings when they hire auditors with high (low) quality. Prior studies provide support for an inverse association between the auditor brand name and the propensity for earnings management. Becker et al (1998) found that discretionary accruals were higher for firms with non-brand name auditors than for firms with brand name auditors because firms employing higher-quality auditors would have less opportunity to use accruals to manage earnings.

Krishnan (2003) defines information quality in terms of its ability to predict future profitability. His findings suggest that the discretionary accruals of firms with brand name auditors are a better predictor of future earnings and future cash flows than the discretionary accruals reported by firms with non-brand name auditors. His study supports prior theoretical suppositions that brand name audit firms offer higher-quality audits, both from an auditor reputation and a monitoring strength perspective, than do non-brand name auditors.

The credibility of an information is totally dependent on the capability and capacity of an auditor to persuade the users and manipulate their confidence in the financial statements, most especially the information that is provided in it. Auditors provide investors with independent assurance that the firm's financial statements conform to GAAP. The fact that stock prices react to earnings announcements suggests that, overall, investors perceive earnings information as credible (Krishnan 2003). Many studies confirm that capital providers require firms to hire an independent auditor as a condition of financing, even when it is not required by the regulations (Ashbaugh and Warfield 2003; Datar et al. 1991). For example, banks normally require firms to present the audited financial information, even for private firms, in making loan and other financial decisions. This implies that capital providers believe auditors can enhance the credibility of financial information provided by firms (Dye 1993; Easton and Pae 2004; Felix et al. 2005).

External auditors are thought to provide value by adding to the credibility of financial reporting (Porter, Simon and Hatherly 2003). Dopuch et al. (1986) suggest that since brand name auditors have more observable characteristics associated with audit quality (e.g., specialized training and rigorous peer reviews), it is expected that stakeholders perceive them as providing greater assurance to the credibility of the financial statements. On the other side, since the credibility of financial statements is judged by users (Dopuch and Siminic 1982), prior research has sought to represent the perceived audit quality through some proxies for the credibility of financial reporting. The common belief shared by bankers and underwriters is that brand name auditors add more credibility to the financial statements (Feltham et al. 1991; Hay and Davis 2004).

Earnings Response Coefficients

The ultimate test of earnings quality is the market's responses to earnings. It is therefore a measure of the extent to which new earnings information is capitalized in the stock price (Kim and Kross 2005; Ryan and Zarowin 2003). Holthausen and Verrecchia (1988) documented a positive association between the magnitude of the stock price responses and the precision of the accounting information.

Teoh & Wong (1993) and Balsam et al. (2003) suggested that investors' responses to an earnings surprise depend on the perceived quality and credibility of the earnings reported. Specifically, Teoh and Wong (1993) hypothesized that to the extent that investors perceived Big 8 auditors as providing higher-quality audits. Examples of this includes the reaction of stock price towards unanticipated income report of Big 8 clients which is expected to be higher compared to others. Thus, by linking financial reporting results to the ERCs, they provide evidence that the financial statements audited by Big 8 are of higher quality and utility.

Earnings Management in the US and in China

Earnings management entails the selection of accounting procedures and estimates that may induce a bias to achieve certain objectives. Earnings management has the potential to decrease the perceived quality of earnings (Schrand and Wong 2003; Watkins et al. 2004). Due to the fact that income management is pricey to detect, the agency theory forecasts that income management will arise when the benefit of manipulating earnings exceeds the relevant costs (Watts and Zimmerman 1986). A large number of studies have documented that business managers have great motivations to handle earnings. These incentives come up out of the explicit and implicit contracts that link the management's interest to accounting numbers (Anderson et al. 2004; Bartov and Mohanram 2004).

The literature on earnings management makes three general predictions about the use of discretion relevant to a particular benchmark (Healy 1985; Abarbanell and Lehavy 2003). First, if pre-managed earnings are high above a relevant benchmark, firms will make income-decreasing choices. Next, if pre-managed earnings are below a benchmark but reserves are available to meet the benchmark, firms will draw from accounting reserves to just beat the benchmark. Finally, if pre-managed earnings and available reserves are insufficient to meet any benchmark, firms will engage in extreme, income-decreasing behavior that will pay back in the future. Healy (1985), Das and Zhang (2003), and Dechow et al. (2003) all reported the evidence from the US market that firms might undertake extreme, income-decreasing earnings management to maximize accounting reserves for future use.

Prior research also documents other incentives for earnings management. Watts and Zimmerman (1990) contended that larger firms would make income-decreasing accounting choices in an attempt to minimize political costs. Other empirical studies (Cahan 1992; Han and Wang 1998; Jones 1991; Cahan et al. 1997; Monem 2003) also document that business managers use income-reducing discretionary accruals to minimize the political costs. Litigation concerns discourage firms to manage earnings upward because of the asymmetric loss function on firms who exaggerate their earnings. Perry and Williams (1994) reported the evidence of downward earnings management in the year prior to the management buyouts in the US.

A large body of recent literature indicates that the management has strong incentives to report earnings growth (e.g., Kothari 2001). Studies by Hayn (1995), Burgstahler and Dichev (1997), and Degeorge et al. (1999) documented unusual patterns in the distribution of earnings levels, earnings changes, and earnings surprises. For instance, Burgstahler and Dichev (1997) reported that an unusually large number of firms report small profits and an unusually small number of firms report small losses. These patterns are widely interpreted as the evidence of earnings management. These findings have spawned many studies to investigate various aspects of the management's incentives to meet or beat earnings benchmarks, including Healy and Wahlen (1999), Dechow and Skinner (2000), Fields et al. (2001), Bartov et al. (2002) and Kasznik and McNichols (2002).

The survey evidence in Graham et al. (2005) indicates that reporting increases in quarterly EPS is an important goal for the management, and may even be more important than either beating analyst forecasts or reporting profits. While Degeorge et al. (1999) provided evidence that the management's first objective was to report positive earnings, then to increase quarterly earnings, and then to beat analyst forecasts. Myers et al. (2005) demonstrated many more firms reported long strings of consecutive increases in EPS than would be expected by chance. They interpreted this phenomenon as an evidence of earnings management and provided the evidence that business managers had incentives to maintain their firms' earnings trends.

Hence, in the US and also in other Western countries, as the management is generally motivated to manipulate earnings upward, there are also bunch of incentives for them to manipulate earnings downward. However, the incentives and behaviors of earnings management are different in China, because the structure of ownership and motivation scheme of the Chinese listed firms are quite different from their counterparts in the Western world (Haw et al. 2005).

Abarbanell and Lehavy (2003) suggest that firms with poor performance may not take an 'earnings bath' if they want to maintain good investor relations. The Chinese listed firms usually have a highly concentrated ownership structure, which makes the opaqueness gains possible for the controlling owners of the firms. In order to maintain the opaqueness gains, the controlling shareholders may try hard to package the listed firms so as to avoid the monitoring from outside shareholders. They are very unwilling to take an 'earnings bath', since such an action will badly damage the investor relations and very probably lead to much stricter surveillance by market regulators [1] . The Chinese listed firms are willing to take a big bath only if they are labeled as ST firms [2] by the stock exchanges.

As Chinese listed firms are usually controlled by the government or parent state-owned enterprises (SOEs), they face much fewer political costs compared with their US counterparts. The threat of litigation is less likely to deter Chinese business managers from reporting optimistically when it is difficult to successfully sue them for doing so. In China, the legal system is not highly independent, often influenced by the government; and the law enforcement is weak. In addition, class legal action is not allowed in China at present. As the controlling shareholders are usually the government agencies or parent SOEs, it is very difficult for Chinese investors to effectively sue business managers (usually appointed by the controlling shareholders) and the controlling shareholders. Management buyout is nearly impossible as business managers of the Chinese listed firms are usually appointed by the government and they hold none or an insignificant amount of the firm's shares. Kim et al. (2003) found that, in the US, the share-decreasing firms have the intentions to manage earnings downward; however, share-decreasing action is generally disallowed in China.

Considering the facts and the arguments above, the Chinese listed firms have few incentives to manage earnings downward. However, they do have strong incentives to manipulate earnings upward. In order to maintain the opaqueness gains from weak corporate governance mechanism, the controlling owners (through the management) are motivated to manipulate earnings upward to avoid stringent market surveillance and the monitoring from the public investors. For example, the controlling owners have been involved actively in a lot of related-party transactions to boost profit or decorate the below-the-line items as operating income. The listed firms need to manipulate earnings upward to avoid being de-listed or being capped with ST status. As business managers are usually appointed by the government or the controlling SOEs, there are incentives for them to overstate earnings to please their superiors to maximize their own benefits. Business managers are also motivated to manipulate earnings upward to fulfill certain political agenda to get promotion in their political career. In addition, the bonus system also motivates business managers to overstate earnings.

Hence, in China, the listed firms have a much stronger intention to manage earnings upward than to manage earnings downward. I conjecture that the earnings management in China is dominantly unidirectional. Haw et al. (2005) suggested that Chinese investors would make a distinction to the quality of income and set not as much of value on the income assumed to be of a larger extent of manipulation. Their results imply that the Chinese investors, to some extent, can make rational adjustment for the quality of earnings.

Auditors' Role in Curbing Earnings Management

Information of accruals-based earnings is considered superior to cash flows because it overcomes the timing and mismatching problems inherited in the determination of cash flows (Dechow 1994). Accruals allow the management to communicate their private and inside information and thereby improve the ability of earnings to reflect the underlying economic value (Durtschi and Easton 2005; Ghosh et al. 2005). However, business managers could engage in opportunistic earnings management that would seriously undermine the informativeness of the reported earnings (Hribar et al. 2006; Hunton et al. 2006). This phenomenon is especially serious in China, where business managers have strong incentives to opportunistically manipulate earnings upward for the benefits of the controlling owners and themselves.

Investors rely heavily on the audited financial statements and auditor opinions to make investment decisions. If the audited financial statements and auditor opinions turn out to be misleading, investors may sue the auditors. Auditors are thus encouraged to curb opportunistic management of accruals to make earnings credible and of high quality. The audit quality is one aspect that limits the extent to which business managers can manipulate earnings (Balsam et al. 2003; Imhoff 2003; Kadous 2000). A number of studies have examined whether the audit quality, calculated by auditor brand name, is related with the income value. Becker et al. (1998) and Reynolds and Francis (2000) argue that high-quality auditors are more capable to notice income management because of their advanced awareness and resources. High-quality auditors will control opportunistic income management to care for their status. Francis and Krishnan (1999) and Krishnan (2003) reported that Big 6 auditors were more effective in constraining the opportunistic reporting of the discretionary accruals than non-Big 6 auditors.

The literature on auditor characteristics further suggests that auditors play two valuable roles in capital markets: an information role and an assurance role (Dye 1993). Auditors provide independent verification of the financial statements prepared by management, and can detect and report significant breaches in clients' accounting system (Watts and Zimmerman 1981; DeAngelo 1981). In addition, since investors often use the audited financial statements as the basis for asset allocation decisions, the securities laws normally provide recourse protection for investors against the auditors. In this way, auditors provide investors a means to indemnify potential losses (Kellogg 1984; Chow et al. 1988; Stice 1991; Dye 1993). Lennox (1999) found even stronger support to the 'deep pocket hypothesis' than the 'reputation hypothesis'. Therefore, auditors produce value to the capital market. As the high-quality auditors (e.g., Big 4) are more effective in constraining the opportunistic earnings manipulation and provide 'deeper pockets,' they perform better information and assurance roles. Hence, firms audited by large auditors are valued more by investors and have higher ERCs (Teoh and Wong 1993; Beck and Wu 2006; Felix et al. 2005).

Auditor Switch and its Market Implications

Auditors may issue an unclean opinion on the accounting methods and disclosure policies chosen by the management under one or more of the following reasons: limitations on the scope of the auditor's examination; lack of conformity with GAAP; a departure from an accounting principle set by the authorized body; lack of consistency in accounting treatments; division of responsibility between the principal auditor and other auditors; uncertainties in business operations; and emphasis of special issues (SAS No. 58). However, receiving an unclean auditor opinion would depress the price of a firm's securities. This will cause an impairment to the capacity to increase expected finances and resources. Therefore, firms receiving qualified auditor opinions may initiate a search for a new auditor whose views are more in line with that of the management. Chow and Rice (1982) found a significant positive association between the qualified opinions and the subsequent auditor switch in the US. In a similar study of Australian firms, Craswell (1988) reported the evidence consistent with Chow and Rice (1982). Krishnan (1994) and Schauer (2002) have also documented similar results.

Auditor switch after a qualified opinion may represent bad news, because the client may be perceived to shop for a clean opinion from a new auditor. Chaney and Philipich (2002) found that stock prices declined after firms' auditor switch. They attribute this phenomenon to the notion that a perceived decline in audit quality impairs the credibility of financial reporting. However, other studies that examine the information role of audits (proxied by market reactions to auditor switches) find no evidence that changing auditor affects the stock prices (Nichols and Smith 1983; Johnson and Lys 1990; Klock 1994; Rosner 2003). The inconsistent empirical results may suggest that it is necessary to probe into the types of auditor switch to obtain more convincing results.

Research Theory

A listed firm in China usually has a controlling owner, being usually the government or a parent SOE. The controlling owner can exercise absolute control over the listed firm, including the auditor choice decision. The preceding discussion suggests that whether a firm hires a high-quality auditor to serve a corporate governance function is controversial, depending on the potential costs and benefits to the controlling owner. The state-shares and legal entity-shares are not tradable at present, so there is no motivation for the controlling large shareholders to care about the changes in the values or share prices of the listed firms in the market. In fact, the controlling shareholders of many listed firms, who are mainly government agencies or parent SOEs, are keen only in raising funds from the stock market (Xiang 1998).

For the Chinese listed firms, the main benefit of hiring a high-quality auditor is the firms may be able to raise funds in the capital market at a lower cost or sell shares at a higher price as the market may perceive that high-quality auditors will lead to better quality of information disclosure. And the costs will be the diminution of the opaqueness gains: the controlling owner may be inhibited in its ability to maximize self-interest through 'tunneling' or benefit transfer because of high-standard monitoring of the auditor.

Basically, the controlling shareholders benefit from a lack of transparency: they engage in rent-seeking activities, at the cost of other shareholders (Leuz et al. 2001). In China, the controlling shareholders have frequently intervened in the operations of the listed firms to benefit parent companies, e.g., using the listed firms to guarantee loans for related entities, and exposing the listed firms to unnecessary financial and operating risks. They are frequently engaged in benefit transfer through misappropriation of funds or related-party transactions to expropriate the listed firms and infringe upon the interests of other shareholders, the public investors in particular.

In such a market, the benefits of lowering capital raising costs are of insignificance: the Chinese listed firms have little intention or possibility of offering new equity to the public; IPO firms can sell their shares with no difficulty, but they are unable to offer new equity in the near future after listing. Therefore, the opaqueness gains are supposed to outweigh the benefits of lowering the costs of capital raising. Hence, lower-quality auditors will be preferred by the listed firms, especially by the listed firms with weaker internal corporate governance mechanism, because they have relatively more opaqueness gains to protect (Beasley et al. 2000; Carcello and Neal 2000; Felo et al. 2001).

The internal corporate governance mechanism within a firm consists of various types of organizational arrangements or procedures to balance the power and responsibilities among the firm's shareholders, directors, the management and the employees. Among them, the ownership structure, the board of directors (BoD), the supervisory board (SB) and the duality of the BoD chairman and the CEO are of great importance in determining the effectiveness of internal corporate governance mechanism, especially for the listed firms in China (Liu and Sun 2005).

There are many multifaceted traditions that affects the value of the corporation as well as the corporate governance because of ownership structures. Daniels and Iacobucci (1999) argue that more narrowly held firms may face greater agency costs because the controlling shareholders would have a dominant influence on corporate affairs and it is easier for them to bypass the monitoring of other shareholders.

La Porta et al. (1998, 1999) showed that in the emerging transitional economies, the controlling shareholders may expropriate the minority shareholders through aggressive "tunneling" behaviors. They further argue that "the central agency problem in large corporations around the world is that of restricting expropriation of minority shareholders by controlling shareholders" (La Porta et al. 1999). This is particularly true for the Chinese listed firms where the controlling shareholders, on average, hold a very large portion of the equity.

There are two primary patterns of board structure: the unitary-board system or Anglo-American system, and the two-board system or the German-Japan system. Under the unitary-board system, a company has only one board, comprised of the executive directors and the independent directors. The executive directors are in charge of the company's business operation, while the independent directors act as supervisors of the management. Under the two-board system, a firm has two boards --- the BoD and the supervisory board (SB). The SB functions as the special monitoring organ and may have the same mandates as the BoD or even higher status than the BoD. Pursuant to the Chinese Company Law, the listed firms adopt the typical two-board system, thus each listed firm has both the BoD and the SB.

The Code of Corporate Governance for Listed Companies in China issued by the CSRC and State Economic and Trade Commission (2001) further requires that members of SB should have professional knowledge or work experience in such areas as business law and accounting. The SB shall ensure its capability to independently and effectively conduct its supervision over the activities carried out by the directors and the management as well as to monitor or examine the financial affairs of the firm.

The board of directors (BoD) is expected to perform in ways that gives guarantee to share holders that their interests are protected. The BoD is responsible for the execution of the resolutions passed in the shareholders' meetings; for appointing, removing and remunerating the general managers and other senior managers. On the other hand, there are quite a number of directors who are, at the same time, holds the CEO title or considered as the firms top executives. It is due to this situation, when most of these top executives are less likely to be detached in administering, appraising and assessing the management's performance. For the BoD to effectively perform a monitoring function, the separation of the positions of the CEO and the BoD chairman is essential in respect of an effective internal corporate governance mechanism (La Porta et al. 1999).

Extracting private control benefits, if detected, is likely to invite external intervention by minority shareholders, analysts, stock exchanges, or market regulators (Haw et al. 2004). The desire to maximize self-interest through 'tunneling' or benefit transfer may drive the listed firms to avoid being monitored by Top 10 auditors. In general, the more concentrated the ownership structure, the weaker the internal corporate governance, hence, there will be more opaqueness gains for the controlling shareholders (Chau and Leung 2006). Therefore firms with larger controlling owners are more eager to choose a pliable auditor so that they can easily benefit from tunneling behaviors under a lower level of audit monitoring. In addition, the controlling shareholders have the monopolist position and influence so they can easily control or dominate the nomination and appointment of directors and senior management officers and virtually preclude other shareholders from participation in making operating decisions, including hiring of auditors. Hence, a larger controlling shareholder is more likely to choose a low-quality auditor in order to realize and sustain the opaqueness gains.

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