آیا ارتباطات سیاسی، نقش کمیته حسابرسی مستقل و دوگانگی CEO را تحت تاثیر قرار می دهد؟ برخی از شواهد از قیمت گذاری حسابرسی مالزی

This study examines whether political connection to firms affects the association between audit committee independence and demand for higher quality audits. In line with Carcello et al. (2002), our findings show that there is a positive association between audit committee independence and audit fees thus supporting the hypothesis that more independent audit committees demand higher audit quality. However, we find that this relationship is weaker for politically connected (PCON) firms suggesting that the independence of audit committees in Malaysian PCON firms may be compromised. Additionally, we provide evidence that PCON firms that have CEO duality are perceived by audit firms as being of higher risk than CEO duality firms without political connection.

Particularly identified in Asia (Li and Atuahene-Gima, 2001), the link between political connections and firm performance has been investigated in a number of studies. Some studies find political connections positively related to firm performance/value (Nee, 1992, Peng and Luo, 2000 and Fisman, 2001) while others come to a different conclusion (Fan et al., 2007). Of particular interest is the study by Johnson and Mitton (2003) suggesting that the political connections of Malaysian firms may affect transparency in that information concerning expropriation or bribes may be hidden to disguise the poor performance of such politically connected (PCON) firms. Further, PCON firms, besides having the traditional agency costs, also have to bear the costs of catering to the interests of the political party/entity to which they are affiliated (Micco et al., 2007). The risk is that to preserve and serve this political relationship, members of the management who produce financial reports may manage earnings to serve the interests of their political allies at the expense of other stakeholders, such as the shareholders and creditors. This consideration is likely to affect an auditor’s perception of a PCON firm’s business risk. Hence, the suggestion by Gul (2006) that political connections affect audit fees: PCON firms seemed to be associated with higher audit risks and consequently were charged higher audit fees. More recently, Chaney et al. (2009, p. 58) in a cross-country study provide evidence that PCON firms have a significantly lower quality of earnings. It may well be that PCON firms disclose lower quality information due to their having a “lesser need to respond to market pressures to increase the quality of (such) information” (Chaney et al., 2009, p. 58). In this study, we extend this line of research. We investigate how audit pricing is affected by both political connections and the operation of two firm level corporate governance constructs: board committees and CEO duality (where the chief executive officer and the chairperson of the board is the same person). Both these constructs were specially identified in the Malaysian Code on Corporate Governance (MCCG)1 recommendations. Moreover, anecdotal evidence and newspaper reports suggest that these two constructs were particularly problematic for Malaysian firms. More specifically, this study examines whether (1) the independence of the audit committee, and (2) the presence of CEO duality affect audit fees, and whether this association is moderated by political connections. We adopt both a supply-side (Gul and Tsui, 1998) and demand-side (Carcello et al., 2002) perspective to examine the link between these variables and audit fees.2 The well documented existence of PCON firms in Malaysia and data thereon (Gomez and Jomo, 1997, Johnson and Mitton, 2003, Gul, 2006 and Faccio, 2006)3 provides us the opportunity to test these relationships. Independent directors are associated with the demand for higher quality audits. North (1996) and Gul (2006) are among those who argue that as PCON firms are associated with higher agency costs and more rent seeking activities, it is likely that the demand for higher quality audits will be weaker from the independent directors of PCON firms. Our motivation to examine this link may be traced to Carcello et al. (2002, p. 381) who provide evidence that more independent boards demand higher audit quality and are prepared to pay for a more expensive (and expansive) audit. Whilst we expect a positive association between the independence of directors on audit committees and audit fees, we test whether political connections affect this association. In other words, we test whether political connections affect the audit committee’s demand for higher quality auditing (Carcello et al. 2002). CEO duality is associated with higher agency risks which results in auditors having to exert greater audit efforts. This leads us to test whether political connections affect the association between CEO duality firms and audit fees. Evidence on this point is not available in the literature. The sample comprising of the top 500 Malaysian public companies is chosen for a number of reasons. The first is the interesting and somewhat unique feature of the Malaysian corporate landscape – the well documented existence of PCON firms. Second, testing the independence of directors on audit committees in Malaysian PCON firms is consistent with the growing worldwide importance of the role of the audit committee in enhancing corporate governance.4 This is seen in the US by the Sarbanes-Oxley Act (2002) (SOX) that aimed to strengthen the position of the audit committee as a means of improving corporate governance.5 Weaknesses in corporate governance were also touted as a likely cause of the Asian financial crisis to which claim the Malaysian government responded by enacting the MCCG that came into force from the financial year ending 30 June 2001. The MCCG recommended that firms comply with a number of prescriptions aimed at enhancing corporate governance by promoting “best practices”.6 To ensure compliance with the MCCG, the Listing Requirements of the Bursa Malaysia (para. 15.26) required that all listed firms state in their annual reports (1) how they apply the principles, (2) the extent to which they comply with the set out best practices, and (3) reasons for areas of non-compliance that they identified.7 A major requirement in the MCCG is that firms have a predominantly independent audit committee.8 Additionally, the MCCG advocates the avoidance of CEO duality.9 Third, the SOX, by enhancing the degree to which the directors of US firms were legally liable for their actions, also enhanced the likelihood of their being sued. Whilst there is no comparable common law or legislative provision in Malaysia the provisions of MCCG suggest to Malaysian directors and managers that they too would be subjected to a more exacting standard. Fourth, the MCCG has made the Malaysian corporate environment somewhat unique by effectively mandating that the majority of the members of the audit committee (and not all, as in other jurisdictions) must be independent.10 As argued by Gul (2006, p. 932), a study such as this set in a country with such a unique setting addresses the confounding effects often besetting cross-country studies as identified by Miller (2004). The association of audit committee and audit fees has been studied mainly in non-Asian countries, predominantly in the US, Britain and Australia (e.g. see Engel et al., 2010, Goddard and Masters, 2000 and Goodwin-Stewart and Kent, 2006). Fifth, unlike corporations in the US, Malaysian firms appear to be more influenced by the recommendation of the Cadbury Committee (1992) against CEO duality than by the likes of SOX. The fact is that just over 12% of this sample firms from Malaysia have CEO duality. By contrast, up to 80% of the firms in a similar US sample would have CEO duality.11 To the extent that CEO duality may be deemed to be detrimental to good corporate governance, a sample from a corporate regime in which CEO duality is not as pervasive as it is in the US may provide a more appropriate base for comparison. Our findings indicate that more independent audit committees are positively associated with audit fees. This result is in line with the findings of Carcello et al. (2002) that more independent, diligent and expert boards are positively associated with audit fees as the independent directors demand higher quality audits. The major finding in our study is that this positive association between more independent audit committees and audit fees is found to be weaker in PCON firms. This is evidence indicating that the independence of directors on audit committees may be compromised when their firm is politically connected. In other words, the effectiveness of the number of directors on the board as a strong corporate governance mechanism operates only in firms without political connections. Additionally, we provide evidence that risks associated with CEO duality as perceived by the auditor are exacerbated in PCON firms. This is a particularly important result given the pervasiveness of CEO duality in the US, and the possibility that these firms may have political connections. This study contributes to the literature in the following ways. First, it provides evidence that political connections may compromise the independence of audit committees in PCON firms. Second, it provides further empirical evidence for the adoption of good corporate governance practices prescribed by, inter alia, the Cadbury Committee Report (1992) without the results being potentially confounded by a highly litigious environment such as exists in the US. In Malaysia, the common law (Caparo Industries plc v Dickman and others [1990] 2 AC 605) precludes suits against auditors in respect of misstatements in the financial statements generated by the annual statutory audit. Third, whilst numerous studies have investigated board independence and CEO duality ( Beasley, 1996, Dechow et al., 1996, Tsui et al., 2001, Carcello et al., 2002 and Bliss, 2011), no prior study has investigated the impact that political connections may have on the independence of audit committees, or whether political connections exacerbate the auditors’ perceived risks in firms where CEO duality is present. The remainder of this study is organized as follows: The second section provides the background to the study and the hypotheses. The third section discusses the research methodology, followed by a section discussing the results. Finally, limitations are indentified and the main findings (including their implications) are summarized.

This study examines whether the role of independent audit committees and CEO duality are affected by the existence of political connections. Evidence is provided in this study that a higher proportion of independent directors on the audit committee is positively associated with higher audit fee pricing. This result is consistent with that of Carcello et al. (2002) who find that more independent, diligent and expert boards are positively associated with higher audit fees as the independent directors demand higher quality audits. This positive association, however, is found to be weaker in firms with political connections. It appears from this evidence that the independence of directors on audit committees may be compromised when their firm is politically connected. This study also provides evidence that risks associated with CEO duality as perceived by audit firms are exacerbated in PCON firms. This matter is particularly important given the pervasiveness of CEO duality in the US and the possibility that such firms may have political connections. The financial crisis gripping the world markets since the latter quarter of 2008 guarantees that calls for improvements in board oversight will continue into the foreseeable future. Johnson and Mitton (2003) note that in the US, firms with strong political connections have been the beneficiaries of large government bailouts during the financial crisis. The same is true of Malaysia PCON firms which benefitted from government bailouts in one form or another. The beneficiaries included, at different times, “a flock of politically connected banks, the national airline Malaysia Airlines (MAS), the limping national car company Proton… (and) the shipping concern, Konsortium Perkapalan Bhd (KPB)”.23 In both the USA and Malaysia, such government bailouts effectively insulate PCON firms against failure. A point of contrast is that Malaysian PCON firms are comparatively more easily identifiable because the incumbent ruling party remains unchanged in Malaysia, in election after election, from 1957 to the present. In contrast, their US counterparts often support both major political parties with the ruling party tending to change over subsequent elections. Additionally, while the common law legal regime in Malaysia immunizes all auditors (and not only auditors of PCON firms) from actions in negligence by shareholders, creditors or members of the public,24 their US counterparts face the ever-present risk of litigation at the suit of disgruntled shareholders, members of the investing public, and creditors. This study has potential global implications as the world searches for improvements in corporate governance. Given the findings, it may be prudent to reconsider the impact that political connections in firms have on corporate governance