This paper studies the role of internal corporate governance mechanisms as the deciding factors that determine auditor choice decision in Malaysia. This study is inspired by the growing body of researches that scrutinizes auditor choice decision (Ahmad, Houghton, & Yusof, 2006; Beattie & Fearnley, 1995; Chaney, Jeter, & Shivakumar, 2003; Guedhami, Pittman, & Saffar, 2009; Hope, Kang, Thomas, & Yoo, 2008; Johnson & Lys, 1990; Linda Elizabeth, 1982; Mahdavi, Maharlouie, Ebrahimi, & Sarikhani, 2011; Pittman & Fortin, 2004; Wang, Wong, & Xia, 2008).
Prior study (Fields, Lys and Vincent, 2001), mentions that financial disclosure and reporting are essential in order to address the imperfections and incomplete financial asymmetry within the financial world. Information asymmetries in general are related with the bond between managers and investors in which managers who are better informed tend to disseminate less information to investors. Nurwati & Wan Nordin (2010) stress that to minimize agency problems, what is needed is to reduce the information asymmetry between management and shareholders, which can be gain through transparent financial disclosure. In addition, the aftereffect of corporate scandals such as the Enron shocking incident and other current financial crisis further lead the policy makers and regulators to draw more attention to the needs for a better quality and more transparent financial reporting (Bardos, 2011).
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Independent audits whose plays as an external monitoring role on behalf of the shareholders are one of an essential component of the corporate governance mosaic. As an external watchdog, they also play an important role in ensuring the users of accounting information on the credibility of accounting information provided by management (Ashbaugh and Warfield, 2003). Nevertheless, the efficacy of audit services depends upon the quality of auditing. Previous studies recorded that the increase in agency cost will increase the likelihood of the firms to choose a high-quality auditor in order to improve their corporate governance thus mitigate the potential agency problems that might occur (Fan and Wong, 2005). Moderately speaking, low-quality auditors may not be able to implement an effective monitoring of clients' financial reporting process (Lin and Liu, 2009). Hence, the quality of independent audits will directly affect firms' corporate governance and operations (Cohen et al., 2002).
In the process of selecting and hiring the auditor, there would always being a tradeoff between as either to hire and select a high-quality auditor to improve corporate governance or hiring a low-quality auditor to uphold the opaqueness gains from relatively weak corporate governance mechanism (e.g., benefits through earnings manipulation and "tunneling" behaviors for the controlling owners of the listed firms). Consequently, auditor choice is an issue with momentous theoretical and practical implications (Fan and Wong, 2002).
In that notion, characteristics of a good quality of financial information are that among others, they are understandable, relevant, reliable and comparable. Users of financial information, for examples, owners, managers, employees, prospective investors, creditors as well as government rely on useful financial information to make a sound economic decision. Hence, they have to fully trust the financial information presented in the financial reports that have been audited by professional external auditors. These reports are supposed to present an unbiased and independent opinion on firms' performance and conditions. In other words, auditors play an indispensable role in minimizing information risk, which is the primary economic reason behind the demand for audit assurance services. Independent audit minimizes agency costs by validating the truthfulness and completeness of the financial statements and thus, allowing more precise and efficient decisions to be based on the financial statements (Cohen, Krishnamoorthy and Wright, 2002). Auditors therefore, play a very significant corporate governance role in monitoring a firm's financial reporting process (Ashbaugh and Warfield, 2003).
According to prior studies, in present time boards and managers who construct the corporate dimension of firms undoubtedly work together with auditors and regulators to bring about a financial environment of unparalleled integrity (Imhoff, 2003). This indicates that there is a connection between the corporate governance aspects of a firm which is directly relates to firm's management and financial reporting process which very much connected to auditor choice decision. Although there are extensive antecedent researches on auditor choice globally, not many specifically investigated the link of internal corporate governance aspects to auditor choice within the Malaysian context. Therefore, this study will contribute additional findings on this important issue by using a setting that is unique to Malaysia.
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Malaysia as one of the East Asian country was not spared from being affected from the turbulent financial crisis that started in 1997, which partially originated from the lengthened recession in Japan which occurred in early 1995. Typically, it is believed that a lack of sound corporate governance was considered one of main reason for the occurrence of economic crisis in the East Asia region (Mohammed et al., 2006). On the other hand, the collapse of worldwide corporate giants such as Enron, Parmalat, Megan Media and Lehman Brothers (to name a few) have left profound scar on the corporate world in general and world economics as a whole. It has been documented that most of the collapse of giant company was due to the lack of sound corporate governance. Enron accounting scandal accelerated the understanding of the wide-ranging impact weak corporate governance can have on a country's economy, through the effect on the capital markets. Such incidents have negatively affected public confidence and trust in the trustworthiness and reliability of corporate reporting.
In Malaysia, the financial crises in 1997 to 1998, as well as the financial scandals in US have been considered as a wake-up call to the need for greater corporate governance and transparency of financial reporting among Malaysian companies. Corporate landscape in Malaysia has been tarnished by a few of cases of bad corporate governance such as Perwaja Steel, Renong, Satang Holding Berhad, and Malaysian Airlines System (MAS). Weak corporate governance, poor investor relations, a low level of transparency in disclosing corporate information by companies listed on Bursa Malaysia (BMB) or formerly known as Kuala Lumpur Stock Exchange (KLSE), and the incapability of regulatory bodies in enforcing legislation in punishing offenders and protecting minority shareholders, are all partly blamed as reasons attributing to the downfall of some Malaysian companies (Mohamad, 2002). These situations have drawn interest to the need to sustain corporate governance standards, enhance transparency and increase investor relations, while the market regulatory bodies such as Securities commission (SC) and BMB should push for more efficient enforcement of legislation (Che Haat et. al., 2008).
Generally, Malaysian public listed companies are highly controlled by a small number of shareholders (Samad, 2002). Previous research noted that, the controlling shareholders functions as agents can benefit from the power given to them (Shanthy and Elsa, 2009). The companies with highly concentrated ownership rarely were able to protect the interest of the minority shareholders due to the abuse of power by the controlling shareholders. Controlling shareholders with the power of influencing decision making within the companies typically would make a decision without considering the effects of that decision on the minority shareholders. On the other hand, (Shanthy and Elsa, 2009) also noted that, good corporate governance and fair shareholder wealth maximization will be impaired if ownership is highly concentrated. Moreover, when firms' internal governance is weakening, there will be more opaqueness gain for the controlling shareholders (Lin and Liu, 2009). Therefore, firms with larger controlling shareholders are presuming to be keener to choose a pliable auditor so that they can benefit under a lower level of audit monitoring.
The existence of audit committee as part of the subcommittee to the board is essential to the concept of corporate accountability and good corporate governance practice. The audit committee not only plays an important monitoring role to ensure the quality of financial reporting and corporate accountability, but also to serve as an important governance mechanism. This due to the possible litigation risk and reputation mutilation that would be faced by audit members assure that audit committee members fulfil their roles and responsibilities effectively (Rainsbury et.al., 2009). Thus it is expected that firms with high-quality audit committees are less likely to have internal control weaknesses than firm with low-quality audit committees. Study done on the size of audit committees reveal that, a large audit committee inclines to improve audit committee's status and power within an organization, to receive more resources and to lower the cost of debt financing (Rainsbury et.al., 2009). Thus, it is proposed that, large audit committee is more likely than a small one to improve the quality of internal controls and smaller audit will contribute to weak internal corporate governance. Thus, the more opaqueness gains will there be. Hence, in order to sustain their opaqueness gain, firm with smaller size of audit committee will be inclined to choose lower quality auditors in order to capture their opaqueness gain.
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Another feature of corporate governance that has become a concern these days is the "dominant personality" phenomenon. The issue associated with role duality, when the CEO is also the Chairman of the board. One view on this issue suggests that, the advocates of agency theory argue for a separation of the two roles to provide essential check and balances over management's performance. The other alternative argument based on stewardship theory is that the separation of role is not important, since a lot of companies are well run with combined roles and have strong boards fully capable of providing enough checks. Cohen et.al. (2002) stated that the separation of the role could reduce the chances for self-interest behaviors as more restriction and transparency attached to the board and CEO actions. Thus, one can assume that, firm with the existence of "dominant personality" phenomenon will increase the likelihood of the companies hiring lower-quality auditor in order to capitalize and maintain the opaqueness gain resulted from poor monitoring systems originated from poor internal corporate governance.
The board of directors is one of an important element of internal corporate governance that allows the companies to solve the agency problems inherent in managing any organisations. The board holds a power to either hires, fire and compensate the top-level decision managers and to authorise and monitor important decisions. It is widely known that board of directors is an important mechanism for monitoring and controlling the performance of managers and shielding shareholders' interests (Fama and Jensen, 1983). Malaysian Code on Corporate Governance (MCCG) also acknowledges that good corporate governance rests decisively with the entire board of directors and thus, they should take the lead role in establishing best practice. Previous research recorded that the effectiveness of the BOD's oversight role can be influence by indication of board size. Larger board size would be more efficient in monitoring management due to their ability to delegate the oversight load over greater number of observer (Ebaid, 2011). On the other hand, BOD also serves as an expert in providing advice
As regard to the independence of board of directors, it is alleged by both resource dependence theory and agency theory (Fama and Jensen, 1983) that the larger number of non-executive directors (NEDs) on the board, the more efficient they can execute their role in eyeing, monitoring and controlling the actions of the executive directors (ED), as well as providing visible window to the outside world. The premise of agency theory is that NEDs are needed on the boards to play as a monitoring and controlling role in order to ensure the actions of ED are on track and was not for the purpose of fulfilling their own interest (Jensen and Meckling, 1976). Mangel and Singh (1993) preach that NEDs have more chances for control and face a complex web of motivations, stemming directly from their responsibilities as directors and amplified by their equity position. Thus, NEDs are considered as the check and balance mechanism in improving the boards' effectiveness and efficiency. Moreover, those who have similar view include Fama and Jensen (1983) who argues that directors appointed outside from the company might be considered to be "decision expert", Weisbach (1988) notes that NEDs should independent and should not be intimidated by the CEO, able to reduce managerial consumption of perquisites and they can act as a positive influence over directors' deliberation and decision which is all considered as important attribute influencing the choice of auditor hired by the company.
So, in an attempt to extent the auditor choice literature in Malaysia this study will analyse the relationship between those components of corporate governance on auditor choice decision. The results will be compared to those of Lin & Liu (2009), among others, who study the impact of corporate governance on auditor choice within firms in China. In their study, it was found that the likelihood of choosing high quality auditors is associated with firms that have good corporate governance. While firms with weaker corporate governance represented with the characteristics of larger controlling shareholders, smaller size of audit committee members and duality of roles tend to choose low quality auditors.
Objective of the study
Thus the main focus of this study is to answer the question, to what extent does aspects of corporate governance such as ownership concentration, size of audit committee, size of board of directors, number of independent directors and duality of Chief Operating Officer (CEO) and chairman roles, influence the choice of auditor among Malaysian public listed companies? In answering the research question, this study investigates the determinants of auditor choice with respect to firms' corporate governance mechanisms. It will test the association between proxies of corporate governance mechanism, which in this study; will be ownership concentration, size of audit committee, duality roles of CEO and chairman of BoD, size of the boards of directors and number of independent directors on the board towards firms' auditor choice decisions in Malaysia.
Organisation of chapters
This study is divided into five chapters. Chapter one provides an introductory background of the research. It provides a brief introduction of corporate governance, audit quality and issues involving it. The problem statement and objective of the study are also highlighted in this chapter. Chapter two provides reviews on the literature of agency theory, stewardship theory, studies on corporate governance and audit quality. Chapter three provides the method of data and collection, hypothesis development, sample selection and model specification used in this study. Analyses and findings are presented and discussed in Chapter 4. Lastly, Chapter 5 draws up the conclusion and limitation of the study. Recommendations for future research are also provided in this chapter.
This chapter provides the literature review that serve as a basis of ideas in this study. Section 2.1 discusses on agency theory. Section 2.2 explains about earnings management and its motives. Then, section 2.3 provides discussion on corporate governance in Malaysia followed by the discussion on corporate governance, auditor demand and audit quality in section 2.4. Auditor and audit quality will be discussed in section 2.5 followed by the discussion on corporate governance proxies used in this study in section 2.6. Section 2.7 will then comprise the Table 1 which shows the research framework and the last section, 2.8 will be mainly about the summarization and conclusion of the chapter.
2.1 Theoretical structure of agency theory
Earlier researches on corporate governance and auditor choice have extensively used the principal-agent theory or agency theory to explain the connection between corporate governance and the demand for independent external audit assurance services (Fan & Wong, March 2005; Lin & Liu, 2009; Mahdavi, et al., 2011). In Lin & Liu (2009), it mentions that, the contractual arrangement between the principal and agent is to include the external monitoring performed by independent auditors to ensure that the agent will always act in the best interest of the principal. Fan & Wong (2005) argue that concentrated ownership of East Asian firms will induce conflicts of interest among the controlling owners and minority shareholders. Thus agency theory suggests that to alleviate this agency problem, the controlling owners may obtain ways to retain credible monitoring and bonding mechanisms to reassure that the interests of the minority shareholders would be protected.
However what exactly is the principal-agent theory or also known as the agency theory? The fundamental idea behind the principal-agent theory is that principals as the shareholders are diverse in nature and are physically dispersed thus make it difficult for them to get organized. Hence, by delegating the jobs to the agent, the process of monitoring and managing the companies would be more efficient. However, the fact that they are diverse in nature and are physically dispersed might signifies that the principal might not be able to monitor the works of the agents ideally. Thus it is essential to have an outside monitoring element such as audit assurance services to act as a monitoring device in checking the work of the agents.
Agency theory advocates that the firm can be viewed as a nexus of contracts between resource holders. An agency relationship emerges whenever one or more individuals, called principals, hire one or more other individuals, called agents, to perform some service on their behalf (Jensen & Meckling, 1976). According to Shanthy & Elsa (2009), three commonly recognized agency relationships involve the interaction between firm's owners (principals) and its managers (agents), the interaction between the majority or controlling shareholders (agents) and the minority of non-controlling shareholders (principals) as well as the interaction between the firm (agent) and the other parties (principals) with whom the firm contracts, for example, the debt-holders, the creditors, employees and customers and the public at large. The relationships between these two parties are not necessarily always in tune and are prone to agency conflicts also known as agency problem, which is the conflict between the agents and the principals. These agency problems will affect the firm's corporate governance and business ethics, among other things.
That said, the personal interest of the agents and the principals might not be the same. Instead of acting for the benefit of the principals, the agents might seek to maximize their own wealth (Fama & Jensen, 1983). The power given to the agents enable them to gain an access over the firm's resources management which in turn create an opportunity for the agents to misuse their authority and manipulate the power to fulfil their own interest at the expense of the principals Furthermore, with the imperfect economic market that is bound with the problem of information asymmetry and uncertainty, agents will be open for more opportunities to satisfy their own self-interests at the expense of the principals.
Information asymmetry indicates that market participants denotes by the principal-agent relationship have unequal information sets (Lu, Chen and Liao, 2010). This circumstances point out that, agents, who is better informed might not fully disclose all the information they have to the principals who are the less informed party in this two way principal-agent relationship. Likewise information uncertainty also stems from unbalance information that the two parties have. Such situations have their implication among others on finding out the fundamental condition and value of the firms (Jiang, Lee, & Zhang, 2004; Zhang, 2006). Having less information that matters, principals might not know the true state of the firms, and this is a perfect set up for the agent to manipulate the circumstances to their gain.
Within agency relationship between shareholders and managers, self-interest is the sign for the existence of agency conflict. Commonly in large publicly traded firms, managers are given only a small percentage of the common stock. On that account, maximizing shareholders wealth will just be an array of other managerial goals not the prime goal. As an example, managers may have a prime goal of making the firm bigger. As such, by making the firm grow larger, the managers will be able to strengthen and increase their status. As a result, at the expense of the shareholders, the reigning management may pursue action such as diversification, whereby the shareholders may be better of with individually diversify their own investment portfolio using other investment strategies. On the other hand, to protect their own position, which leads to agency conflict, risk-averse managers will avoid profitable investments opportunities that might be rewarding toward the shareholders' wealth.
Another form of agency relationship involves the relationship between debt-holders or the creditors and the shareholders. Creditors have the foremost claim on part of firms' earnings with regard to payments such as interest, principal payment on debts, not to mention claim on firm's assets in the case of solvency. However, through the firms' management, the shareholders retain managerial and operational decisions' control that shape firms' capital structure and corresponding risks, of which the basis used by creditors to provide capital to the firms. That being so, agency conflict may arise when the management, acting on behalf of the shareholders, undertakes actions that would benefit only the shareholders at the expense of other stakeholders such as creditors, bondholders, employees as well as prospective investors. One example would be when shareholders demand management to undertake projects with greater risk beyond the expectation of the firms' creditors. In consequence, the outstanding value of bond will fall as the bonds' required rate of return will eventually rises in line with the increased corresponding risk. If the high-risk project is successful, the shareholders will secure more benefit than the bondholders, as their returns are predetermined at the original low-risk rate. On the other hand, bondholders may be forced to share in the losses if the project falls through.
When agency problem transpires it will create agency costs. Agency costs are expenses incurred as a means to sustain an effective agency relationship. Jensen and Meckling (1976) note that agency costs include the monitoring expenses incurred by the principal, the bonding expenses by the agent and the residual loss. The establishments of managerial incentives, such as bonuses and employees stock options are a form of monitoring costs borne by the principals to limit the divergence between the managers' interest and their interests. Likewise, audit costs are also a part of monitoring costs that are incurred by the principals. Prior researches indicate that independent auditors act as a monitoring mechanism toward the management in protecting shareholders' interests (Linda Elizabeth, 1981; Wanda A, 2004) and forms part of corporate governance mosaic (Ashbaugh and Warfield, 2003; Cohen, et al., 2002). Another form of agency costs are bonding costs, sustain by the agents. An example of bonding cost include contractual obligation that restrict or limit the agents' behavior and actions, which bond the managers to stay in the firm even in the case of a takeover, and relinquish other potential employment opportunities. Into the bargain there are residual losses, which are the cost incurred as a result of agency problem regardless of the utilization of monitoring and bonding activities.
Theoretical structure of stewardship theory
In contrast with agency theory, stewardship theory assumes that managers are stewards whose behaviors are aligned with the goals and interests of their principals. This theory argues and looks at different type of motivation for managers drawn from organizational theory. Managers are perceived as loyal subjects to the company and their main interest is to achieve high performance to serve the best interest of shareholders. The central motive riding and directing managers to accomplish their job, is their aspiration to perform exceptionally (Abdul Hamid, 2011). Particularly, managers are assumed as being motivated by a need to achieve, to gain inherent satisfaction by successfully performing intrinsic challenging work, exercising responsibility and authority, and in so doing, gain recognition not only from peers but especially from bosses (Abdul Hamid, 2011)
On the other hand, the theory also postulates that an organization needs a structure that allows a balance and harmonization to be attained most efficiently between managers and owners. From the view of firm's leadership, this situation is achieved more readily if the CEO also sits as the chairman of the board. This structure allows the CEO to exercise complete authority over the organization and that his role is explicit and uncontested. It will at the same time, assist the CEO to accomplish superior performance. In this structure, power and authority are more concentrated where a single person holds an absolute power within a corporation. Hence, the anticipation about corporate leadership will be clearer and more consistent for both the subordinate managers and other members of the corporate board. As such, uncertainty as to who has the authority or responsibility over a particular matter will not exist. In other words, the organization will enjoy the benefits of unified direction and of strong command and control.
Davis et al., (1997) reported that, the model of man under stewardship theory is based on "a steward whose behavior is ordered such that pro-organizational, collectivistic behaviors have higher utility than individualistic, self-serving behaviors."Â The stewards values more cooperation than defection which in contrast with agent, who values more defection than cooperation. Stewards believe their interests and benefits are in line with that of corporation and its owner, thus showing that they possess intrinsic motivation. As such, if the managers' motivations match up to the model of man under stewardship theory, empowering governance structures and mechanisms are suitable. Thus, under stewardship theory, focus is more on empowerment than on monitoring and control.
Corporate governance in Malaysia
Prior study such as in Alnasser (2012) notes that corporate government scandals have persuaded scholars to give meaning to corporate governance based on their perspectives on problem solving and corporate affairs. As such, a common definition sets down that internal governance mechanisms take into account elements that relates to the firm's internal organizational structure, such as, board of directors and ownership structure while the external governance mechanisms includes taking over the markets and the legal system. With that, there has been variation of ways of defining corporate governance by researchers. Case in point, in the High Level Finance Committee Report  1999, corporate governance is defined as the process and structure used to direct and manage the business affairs of the firm to further improving the business prosperity and corporate accountability with the fundamental objective to achieve long-term shareholder value and at the same time to consider other stakeholders' interests (MCCG, 2012).
The turning point of corporate governance reformation in Malaysian was after the Asian financial crisis in 1997 (Alnasser, 2012; Kamardin and Haron, 2011; MCCG, 2012). The outbreak of the crisis taught the policy makers valuable lessons and placed their attention, amongst others, on the necessity to raise corporate governance standards. It pointed out the weaknesses in governance practices and made it clear for the need to establish a more responsible, transparent and accountable management in step with international best practices. From that point on, Malaysia has undertaken numerous initiatives in enhancing its corporate governance guidelines and principles to encourage firms to sustain a strong culture of good corporate governance (Kamardin and Haron, 2011; MCCG, 2012).
The agencies that preside over the issues of corporate governance in Malaysia are often limited to those that are directly involved in law enforcement such as the Ministry of Finance, Bursa Malaysia (formerly known as Kuala Lumpur Stock Exchange), Securities Commission (SC) and Registrar of Company (Zainal Abidin and Ahmad, 2007). The jump-start of the development of corporate governance in Malaysia began with the establishment of a high-level Finance Committee on Corporate Governance announced by the Ministry of Finance on 24 March 1998 as the foundation to institute a world-class governance landscape. The committee is led by Secretary General of Treasury of Ministry of Finance and is in a close cooperation with the government and private sectors (Alnasser, 2012).
The members of the committee are a mix of private and public sectors representatives as well as regulatory communities which amongst many, consist of the SC, the Financial Reporting Foundation, the registrar of companies, Bursa Malaysia, the Central Bank of Malaysia, the Federation of Public Listed Companies and the Association of Banks in Malaysia. The committee is responsible to review the corporate governance framework and put forward recommendations to enhance the level of corporate governance within the country. For that reason, the Malaysian Code on Corporate Governance (Code) which outline the corporate governance principles as well as the international best practices were formed in 2000 for the corporate participants (Zainal Abidin and Ahmad, 2007). Accordingly in 2001, after the KLSE Listing Requirements was revamped the Code was set to be effective for public listed firms (Kamardin and Haron, 2011).
In the early development of corporate governance practices in Malaysia, the corporate governance principles, which were being practiced, were particularly similar to those in the United Kingdom (UK) in many respects (Shim, 2006). The Code introduced on March 2000 for instance, was inspired by the Hampel corporate governance approach after the Finance Committee reviewed the distinction between the corporate governance principles and guidelines set out by the Cadbury and Greenbury Reports. The fundamental aims of the Code is to encourage management of a firm to be more transparent apart from providing the investors with necessary and relevant information to allow them to guide the direction of the firm (Zainal Abidin and Ahmad, 2007).
Following that, new rules for public listed companies were gazetted by the Bursa Malaysia and the SC where parts of the listing requirements were for the firms to submit on quarterly basis their financial status, shareholders structure and loan position. Failing to adhere to the rules will subject the firm's manager to penalty or jail sentence (Zainal Abidin and Ahmad, 2007). In order to broaden the scope of governance framework, the Minority Shareholder Watchdog Group (MSWG)  was constructed to protect the minority shareholders' interest through shareholder activism. The MSWG uphold the duty to encourage firms to respect the corporate governance principles while not forgetting the rights and interests of the minority shareholders. Along the line, based on the Finance Committee's report, at the end of 2004, 13 board principles have been manifested in Malaysia as the initiative to improve and modify the initial corporate governance code (Alnasser, 2012).
Another establishment that was mandated to raise awareness on the practice of good corporate governance in Malaysia is the establishment of the Malaysian Institute of Corporate Governance (MICG). The High Level Finance Committee on Corporate Governance established the MICG in March 1998 where the institute fosters ongoing research and analysis as a means to improve the Malaysian corporate governance standards with the emphasis to engender an optimal level of positive relationship between stakeholders and the firm (Kamardin and Haron, 2011).
The corporate governance evolution in Malaysia continues in 2007 as the Code was subsequently revised (2007 Code) with the aim of strengthening the board of directors' roles and responsibilities along with the functions of audit committee and internal audit (MCCG, 2012). Kamardin and Haron, (2011) write that, the amendments placed great emphasis on the importance of the evaluation process of the board's members by the nominating committee. Annual evaluation of BOD and board committee's effectiveness is deemed to be crucial as well as assessing the contribution of each individual director. The amendments also take note the criteria that the nominating committee should consider in the process of directorships candidates' nomination. Among the criteria proposed include skill, expertise, knowledge, experience, integrity, professionalism as well as the candidate's capability to perform such responsibilities.
Coming to the year 2012, the SC has introduced new improvements to the 2007 Code with the intention to strengthen the implementation and function of corporate governance practice in Malaysia. The improved code known as MCCG 2012 is seen to put into action most of the recommendation of the Corporate Governance Blueprint 2011 (Blueprint) launched by the SC in July 2011. The MCCG 2012 maintained some of the best practices from the 2007 Code along with a new structure, which allows for greater clarity, more information to firms and enable for simple reading. The improve code seeks to strengthen key areas such as roles, responsibilities and composition of board.
The MCCG 2012 also highlights the refine principle regarding directors' commitment, remuneration as well as independence in which it points out that the position of chairman and CEO should be held by different persons. Apart from that, it also emphasise the need for the board to establish risk management framework and sound internal control, apart from encouraging good relation between the firm and shareholders. In addition, the audit committee is to ensure the integrity of the financial reporting by ensuring the financial statements are prepared according to established financial reporting standards, and by evaluating the suitability and independence of external auditors.
The MCCG 2012 is particularly targeted at firms listed on Bursa Malaysia. However, all firms are urged to embrace the principles and recommendations of MCCG 2012, and make good corporate governance a fundamental part of their business dealings and culture. The MCCG 2012 favours the adoption of standards that go beyond the minimum prescribed by regulation. Even though the observance of the MCCG 2012 by companies is voluntary, listed firms are obligated to explain in their annual reports how they have complied with the recommendations of MCCG 2012 as well as explain and justify the reasons for neglect of any of the recommendations.
Seeing how corporate governance has become an essential part of the Malaysian business environment, it is therefore important to study the relative influence it has on firms' decisions and performances. One particular matter is its implication on auditor choice decision as many prior studies have delved into the association between these two variables (Guedhami, et al., 2009; Lin and Liu, 2009; Mahdavi, et al., 2011; Wang, et al., 2008).
Corporate governance, auditor demand and auditor choice
Often time, prior research associates the demand for external auditors with the need to monitor the conduct of managers by firms' owners, as explained by the agency theory. In relation, she further relates that, the demand for auditors is stimulated by the separation of firms' owners and managers. With this separation came the probability for managers to behave opportunistically, which in turn, foster the market for independent auditors. In other words, independent auditors are voluntarily hired to monitor the conduct and performance of management, whom have been entrusted with the owners' resources.
(Lin and Liu, 2009) claim that normally firms have to make a trade off in their auditor choice decision. On one hand, firms will hire high-quality auditors if they want to signal effective audit monitoring and good corporate governance. While on the other hand, firms will hire low-quality auditors with less effective audit monitoring with the intent to take advantage and reap private benefits derived from weak corporate governance and less transparent disclosure.. Relatively speaking, the choice of auditor will reflect the governance quality within a firm. A firm practicing good governance will likely choose high-quality auditor while a firm that does not will tend to choose low-quality auditor.
The interrelations between corporate governance and auditor choice have been the issue of many prior discussions and studies. Mahdavi, et al., (2011) look into the influence of corporate governance mechanisms on auditor choice among Iranian listed firms. They explore the impact of ownership structure, concentration of ownership, board composition and duality of the CEO and chairman roles as the proxies of corporate governance mechanisms on firms' auditor choice decisions. The researchers conclude that the corporate governance mechanisms make a difference to the choice of auditor in firms listed on Tehran Stock Exchange, where the possibility of a high-quality audit firm being chosen will increases in line with the percentage of outside directors.
Similarly, Guedhami, et al., (2009) find a link between corporate governance mechanisms with auditor preference in their study on the impact of proportional shareholders ownership on privatized firms' reliance on superior external monitoring by Big Four auditor. Their findings imply that with the present of state ownership, privatized firms become less likely to choose a Big Four auditor. The results also point that privatized firm tends to appoint Big Four auditor with the present of foreign owners. These findings suggest that the diverge interest in accounting transparency among the investors that make up the shareholders and ownership structure within firms will affect the choice of auditor.
In addition, auditor choice has also been reviewed in relation to other perspective. For example, Hope, et al., (2008) analyse the subject of auditor choice and interact it with culture dimension of secrecy hypothesis. The secrecy dimension of national culture relates to reported financial accounting number and the amount of financial disclosure. Preference for more secretive culture in a nation is linked to strong uncertainty avoidance, high power distance and collectivism, which lead to restriction in disclosure of information. The results insinuate that firms in more secretive countries are less likely to engage Big Four auditors.
In relation, auditor choice is also being discussed in connection with specific local factor of a nation. Ahmad, et al., (2006) investigates the extent to which ethnicity and national issues influence firms' auditor choice in Malaysia. The empirical results show choice of auditor is related to ethnic association. That is a firm controlled by Chinese and Bumiputra owners are associated with auditors from the same ethnic background. Correspondingly, national issues such as foreign-owned companies are associated with brand name auditors.
Ahmad, et al., (2006) is an example of a study on auditor choice that considers the specific Malaysian environment, of which not many research papers on the said subject have been published. In reality, there are extensive antecedent researches on auditor choice globally (Ahmad, et al., 2006; Beattie and Fearnley, 1995; Chaney, et al., 2003; Guedhami, et al., 2009; Hope, et al., 2008; Johnson and Lys, 1990; Linda Elizabeth, 1982; Mahdavi, et al., 2011; Pittman and Fortin, 2004; Wang, et al., 2008), however, not many specifically investigated the link of internal corporate governance aspects to auditor choice within the Malaysian context. That being the situation, this study will concentrate on the said subject but only focus on firms in Malaysia, and analyse how the internal corporate governance mechanisms have shaped the audit preference in this specific nation.
Auditor and audit quality
Simon (2006) in his research paper on Malaysian corporate governance mentions that there are three classifications of people that act as "external enforcers" of good governance identified by The Finance Committee, the auditors, corporate advisers and regulators. That is to say, auditors perform a corporate governance role in monitoring a firm's financial reporting process; in other words, they act as "watchdogs" of the firms (Ashbaugh and Warfield, 2003; Simon, 2006). Audit function plays a crucial role not only to monitor managerial actions but also to create a better information environment as well as to provide a secondary source of assurance against corporate failures (Wallace, 2004). As such, auditors are required to give appropriate assurance through their opinions on whether the firms' annual accounts have been properly drawn up and in compliance with the approved standards, and if they portray a true and fair view of the firms' affairs.
In addition, Mahdavi, et al., (2011) note that, agency theory prescribes that as agency conflict increases, the demand for quality external audit assurance on firms' information provided by the managers will also increase. This provides further evidence that audit quality is directly connected to corporate governance and monitoring mechanisms (Lin and Liu, 2009). As such, one can deduce there is a link between audit quality and agency conflict, where better audit quality signify a reduction in agency conflict. In other words, audit quality can be a credible indication of the quality of corporate governance uphold by firms.
Prior research establishes audit quality as the extent to which a given auditor will both discover a breach in the client's accounting system and report the breach (DeAngelo, 1981). With that notion in mind, the extent of audit quality, which reflects auditor's independence, is judge by the likelihood of an auditor to report a discovered breach. High probability of a detected breach or material error being publicly reported indicates high independence (Favere-Marchesi, 2000). As such, factors like auditor's competence and auditor's technology capabilities, the course of audit employed on a given audit, the proportion of sampling and reporting requirement will influence the likelihood of whether a given auditor will detect a breach or otherwise (Favere-Marchesi, 2000).
DeAngelo (1981) further provides evidence that associates quality of audits with difference levels of auditing. Variables such as audit fees (Mohid and Mohd, 1993)(), audit hours, litigation rate, discretionary accruals (Jeong and Rho, 2004) and auditor size (DeAngelo, 1981) are used to proxy audit quality in prior research. For example, Big Six auditors are associated with delivering higher quality audits, are deemed to charge higher audit fees, spend more time on audits and have fewer lawsuits that non-Big Six auditors (DeAngelo, 1981). Favere-Marchesi (2000) finds that the level of audit quality in countries within the Association of Southeast Asian Nations (ASEAN) differs depending on legal environment. Laws and regulations will influence auditors' conduct in terms of the extent of audit content, level of independence and auditors' liability, thus affecting the audit quality.
In Malaysia,Mohid and Mohd (1993) in their study on audit fee of the Big Five (before shrinking to four) find that audit market share for all KLSE listed firms were controlled by Big Five with more than 65 percent controlled of the audit market. This evidence support the notion that industry specialisation of the Big Five audit firm proved that they have high-audit quality as compared to non-big five lead them to secure high audit fee. This evidence support the notion that quality differentiation occurred as a result of industry specialization in terms of audit quality provided by big audit firms lead them to secured higher audit fees. The mergers of audit firms, resulting in the increased size of audit firms, enable auditors to further enhance their audit technology, human resources and reputation, thus increasing the audit quality. As such, it is expected that with greater capital and a higher level of audit expertise, audit firms are able to render more efficient audit assurance services. And to acquire better quality audit services, clients are willing to pay high audit fees to big audit firms..
Audit quality is also being associated with brand name (Mohd Mohid and Takiah Mohd, 1993). Having the advantage in terms of greater capability of capital, clients will perceive that larger audit firms to be able to render higher audit quality as their able to have significant improvement in their work quality and higher quality and more staff and expertise. As such to avoid losing clients and tarnished their reputation, larger audit firms tend to provide better audit quality services. Further, (Stergios and Constantinos, 2005) associate audit quality with audit time in which being linked to audit effort. Larger audit firms tend to have higher audit fees and audit hours as a result of the higher audit quality they provided. Considering the Supervisory Council of the Hellenic Institute of Certified Auditors (SOEL) 
To continues with this current study, based on prior research that asses Big Four audit firms quality within the context of Malaysian audit environment, it is noted that Big Four Malaysian audit firms to be Delloitte, Ernst and Young, Kpmg and PricewaterhouseCooper (PWC)
Ownership concentration and auditor choice
In Malaysian public listed firms, shareholding is highly concentrated in the hands of small number shareholders (La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 2000; Samad, 2002). (Samad, 2002) in his article reports that the average of the first largest shareholding was 30.30 percent and as for the five largest shareholdings was 58.84 percent, which accounted for more than half of the voting shares. Furthermore, (Kamardin and Haron, 2011) mention in their research paper that around 71.4 percent of firms in Main Board and Second Board were controlled by their five largest shareholders, having a shareholding of more than 50 percent and were under majority ownership.
As claimed by the agency theory literature, what comes with a concentrated ownership is a better monitoring of management performance and reducing agency costs arising from the risk of the information asymmetry between managers and owners. Because of that, when the cost-benefit principle is considered, the possibility of choosing a larger audit firm in firms with concentrated ownership structure will be reduced (Mahdavi, et al., 2011). Concentrated ownership structures though at the first place can act as a mechanism to mitigate agency problem could also affect the firm in a negative way. That is to say, with concentrated ownership, the risk of agency conflict will arise among the controlling or majority owners as they act as the monitors of managers and firms' performance.
(Ang, Cole, and Lin, 2000) further explain that, in comparing the effect of ownership and management structure that can be based as point of reference, the absolute agency cost must be measure. In (Jensen and Meckling, 1976), they elucidate that, by definition, the zero agency-cost base case in agency theory relation is that firm owned solely by a single owner-manager. Agency cost should be inversely related to the ownership share of primary owner. For a primary owner the incentive to consume perquisites declines as his ownership share rises. The gain from monitoring in the form of reduced agency costs increase with his ownership stake. Thus agency cost decreases when the ownership becomes more concentrated as shareholders incur agency cost only when management owns less than 100 percent of firm's equity arising from agency cost due to management's shirking and perquisite consumption.
Prior research such as in (Shanthy and Elsa, 2009) note that, the controlling shareholders functions as agents can benefit from the power given to them. In their research publication that tackles the issue of agency conflict in Malaysian small and medium enterprises (SMEs), it is argues that the minority share holders' rights are not properly uphold due the concentrated shareholding. Good corporate governance and fair shareholder wealth maximization will be affect if ownership is highly concentrated. Internal and external controls given to the controlling owners may be exploited to suit their own needs. Internal benefits of control can be defined to comprise all benefits a controlling shareholder can obtain from the company as an agent, which is an insider with access to the company's information, assets and prospects and at value more favorable than at arm's length negotiation.
Meanwhile, external power given to them enables the controlling shareholders to enjoy benefits of power to elect the BOD, change the company's article of association as well as its governance and mergers. The powers that they get permit them to take actions that benefit them more and give little benefits to the minority shareholders (Shanthy and Elsa, 2009). Due to their high and excessive outlay in the company, thus before taking any action controlling shareholder will first look at the possible reward that they will get and neglect the interest of minority shareholders.
The laws protecting minority shareholders in Malaysia primarily focus on director-shareholder conflicts thus are not suited to companies concentrated shareholdings since in the firm with concentrated shareholdings, the director and shareholder is the same person. Thus, the concentration of ownership in Malaysian companies though at certain point help to reduce agency problem it also can results in fewer protection for minority shareholders. Additionally, owing to the intensities of power distance, collectivism and assertiveness in Malaysia, it is less likely the shareholders will litigate (Shanthy and Elsa, 2009).
Further supporting the issues of ownership concentration and agency problem, Claessens, Djankov, Fan and Lang (2002) in their study write that the risk of expropriation of minority shareholders by large controlling shareholders is an important principal-agent problem in most countries. Firm performance improves with higher management ownership or more concentrated ownership, but that, after a point, managers or larger investors become entrenched and pursue private benefits at the expense of outside or minority investors. On one hand, larger investors have strong incentives to oversee managers and maximize firms' value due to larger ownership stake. On the other hand, they also have strong incentives to pursue their own self-interest at the expense of smaller investors.
What more is that, (Ashbaugh and Warfield, 2003) comment that the demand for audits as a monitoring mechanism may be limited in companies with concentrated ownership because concentrated owners generally serve to monitor management. Their research paper that studies the corporate governance role of external audits finds that firms with higher family ownership concentration are less likely to contract with dominant auditors. They also conclude that the higher the shareholder interests of closely held firms, the less likely they will choose dominant auditor. As such this situation indicates that audits play a corporate governance role conditional on companies' relation with alternative stakeholders.
Additionally, in (DeFond, Wong, and Li, 1999) it is notes that initial public offering (IPO) clients that are large and/or have foreign owners tend to choose larger auditors both before and after the adoption of the new standard. Unlike individual investors, government entities are restricted in their ability to trade their shares and their main interest is not to maximize share price. Their controlling ownership interest means the government entity owners are able to directly control and monitor management behavior. Therefore, government owners have strong incentive to pressure management to report favorable earnings, but little demand for independent auditing.
As such it can be deduce that, concentrated ownership in a firm can improve management performance monitoring as controlling or major shareholders will act as the monitoring mechanism in overseeing the managers' action. However this situation can have reverse effect toward the corporate governance quality as controlling or major shareholders misappropriate their dominating powers. As such when firms' internal governance is weakening, there will be more opaqueness gain for the controlling shareholders (Lin and Liu, 2009). Therefore, firms with larger controlling shareholders are presuming to be keener to choose a pliable auditor so that they can benefit under a lower level of audit monitoring.
Size of audit committee and auditor choice
The audit committee is fundamental to the concept of corporate accountability and sound governance. It has become an integral part of the corporate framework to help fulfill board's stewardship accountability to its shareholders and financial stakeholders. An audit committee provides the board with assurance of the quality and reliability of financial information used by the board and of the financial information issued publicly by the firm. Although the board as a whole is responsible for the accuracy and integrity of the firm's financial reporting, it can be difficult for all directors to keep up with the complexities of financial reporting. That where the role of the audit committee emerge as it provides an additional and more specialized oversight of the financial reporting process by facilitating the discharge of the board's responsibility in respect of the timely preparation and issuance of financial statements (MCCG, 2012).
In Malaysia, notes by prior research of (Shamsul Nahar, Nor Zalina Mohamad, and Mohamad Naimi Mohamad, 2010), no empirical evidence has been found to support the dispute of audit committee independence being associated with monitoring effectiveness, as measured by its ability to constraint accrual management and voluntary disclosure. This insignificant finding in Malaysian literature is due to the fact that, prior to the revision of the MCCG in 2007, the CEO or finance director of the firm is still not prohibited to serve on the audit committee. Thus, rendering the audit committees effectiveness in Malaysian firms to still be much influenced by the management. Since the establishment of audit committee is seen as a matter of complying with Bursa Malaysia listing requirements and not for the exclusive responsibility of monitoring the management, an audit committee in Malaysia was perceived as lacks of firmness.
The Blue Ribbon Committee (1999) in its third recommendation propose that audit committees effectiveness could be further enhanced if a minimum of three audit committee directors, each of whom is financially literate and at least one of whom has accounting or related accounting and financial management expertise as proposed by. In Malaysia, beside the condition that a majority of audit committee members are independent directors, Bursa Malaysia also outlines that audit committees of its listed firms composed of at least three members and at least one member must be a member of the Malaysian Institute of Accountants (MIA) (Puan, Pamela, and Peter, 2006).
The Blue Ribbon Committee's (1999) recommendations that attend to the issue of audit committee independence, financial literacy and expertise, as well as audit committee size and authority are reckon to result in a more effective audit committee oversight of the financial reporting process. Additionally, (Puan, et al., 2006) argue that larger audit committees are likely to improve the quality of financial reporting. That being said, larger audit committees are legitimized by a meaningful organizational support from the BOD and are thus more likely to be acknowledge as an authoritative body by the external as well as internal audit function of firms. Consequently the situation will lead to better internal control monitoring that enhances governance and disclosure quality.
(Johnstone and Bedard, 2004) further comment that BOD and audit committee has a duty to provide oversight on the reliability of financial reporting. As part of their financial reporting oversight role, BOD and audit committee should support external audits as they work to address financial reporting risks. An understanding of auditing issues and risks, and the audit procedures proposed to address and detect the issues and risks will be better if audit committee member posses accounting and financial expertise. As such, to assist the responsibility of external auditors, members of audit committees should possess accounting and financial expertise.
Delving into the issues of corporate governance, audit committee and financial disclosure quality, (Nurwati and Wan Nordin, 2010) clarify that the quality of financial disclosure practices are influence by the corporate governance structure as expressed by corporate boards and audit committees. They research study concludes that effective audit committees are the one with a larger membership and a higher fraction of non-executive directors (NEDs) as they were associated with greater forecast accuracy prepared by the management of the initial public offering (IPO) firms. The result suggests that an effective audit committee will enable high quality of information to reach the investors from the management, in the same breath, it also indicate that a more efficient and effective governance practices are being uphold. They also highlighted that audit committees and external auditors influence the quality of financial disclosure. This study provided further evidence of the role and responsibilities of the BOD and audit committee as financial monitors to the managers and firm performance as explained by agency theory.
In association, prior research such as in (Rainsbury, Bradbury, and Cahan, 2009) suggest that audit committees quality can improve financial quality by reducing the incident of fraudulent reporting, accounting irregularities and earning management. Characteristics of effective audit committees are being associated with audit committees that are active, independence, consist of accounting and industry expertise as well as more members (Rainsbury, et al., 2009). Additionally, (Lin and Liu, 2009) find that there is a positive association between the size of the supervisory board and the level of corporate governance in the Chinese firm. In other word, more members in a supervisory board will enhance its monitoring role.
Duality of roles of BOD chairman and CEO and auditor choice
The Companies Act, 1965 (CA) states that the business and affairs of a firm must be managed by, or under the direction of, the board of directors. Boards are obligated to play an active role in directing management. While this does not mean they should be involved in operational matters, it certainly implies that board cannot passively endorse decisions of the management. As such the board's role is to provide entrepreneurial leadership of the company within a framework of prudent and effective controls, which enable risk to be assed and managed.
The MCCG 2012 Code further stipulates that position description should be develop for the board and CEO, of which to include a definition of the limits to management's responsibilities. Moreover, there should be a clearly accepted division of responsibilities at the head of the company, which will ensure a balance of power and authority so that no one individual has unfettered power decision. In the event the roles of BOD chairman and CEO are combined which also refers as CEO duality, it is recommends that there should be a strong independent element on the board to strive for independent decision-making. A decision to combine the roles of chairman and CEO should be publicly explained in the annual report.
It is claims in a research publication by (Fama and Jensen, 1983) that when the decisions of top management cannot be controlled; it indicates that the board of directors is ineffective. This situation may arise when the CEO duality exists. When a considerable influence over the monitoring and evaluating the firm's performance is place on a single individual, the risk of lack of independence will emerge. As such, when the decision-making and monitoring functions cannot be clearly separated due to CEO duality, the board will be deemed ineffective.
Prior researches such as in (Mark, Balachandran, and Abdul, 2007; Shamsul Nahar, 2004) further identify that board leadership refers to the segregation of powers between the board chairman and the CEO. They argue that if board chairman and CEO structure are well place and conform to best practice of corporate governance, the long-term shareholders' values and interests will be enhanced and well protected. That being said, firm's internal corporate governance systems will be weaken if these two roles are combined as there is a conflict of interest between the monitor (i.e. the board chairman) and the implementer of the board's decisions (i.e. the CEO). Firms with positions of BOD chairman combined are likely to be associated with ineffective monitoring control systems and high inherent audit risk (Mark, et al., 2007). As such, when these two roles are set apart, it will avoid resting excessive powers in the hand of the chairman-cum-CEO rendering the board as a whole ineffective. This is because combining these two roles provides an opportunity to the CEO to pursue his interest rather than the shareholders' interests.
It was further notes that, an ideal corporate governance structure is one in which the board is composed of a majority of outside directors, a chairman who is an outside director and the weakest corporate governance is where the board is dominated by insider directors and the CEO holds the chairmanship of the board. It is argues that, for the board to be effective, it is important to separate the CEO and chairman positions. The separation should provide greater incentives to the non-executive chairman to act in the interest of the shareholders rather than to protect the interest of the CEO. If the CEO is also the board chairman, he or she would control and determine the agenda of board meetings and might not disclose important information adequately to enable the board to assess the p