Audit-firm tenure and financial reporting quality in Malaysia

Abstract

The need to implement the mandatory auditor rotation has become the concern of regulators in Malaysia and throughout the world. The concern stems from the corporate failures of several major corporations such as Enron, WorldCom to name a few. Corporate failures are believed to arise due to the tendency of the auditor, over a period of time, to gradually align with the wishes of management and thus, not act completely independently. This long relationship between the auditor and the client is seen to affect the auditors in forming their opinions. The auditor gets too cozy with the companies and their review of the accounting books is questionable as their independence might be affected. This has led to financial reporting reform as documented in the Sarbanes-Oxley Act 2002 in the U.S. and the revised MIA By-Law on Professional Independence in Malaysia. These two regulations imposed the requirement of mandatory rotation of audit partners within a period of five years. So far, mandatory auditor rotation has not yet been implemented but the issue has been actively debated. It is hoped that certain unresolved issues regarding mandatory auditor rotation in Malaysia may be clarified by conducting this research. The objective of this study is to examine whether audit-firm tenure is associated with the financial reporting quality in the context of Malaysia. The sample consists of 47 randomly selected companies. The financial data were collected from the 2004 annual report. The duration of the auditor with their client companies was identified from the Auditors’ Reports from 1998-2004. The main statistical tests carried out are: descriptive statistics for non-dichotomous variables, frequency analysis on the dichotomous variables, univariate test, multivariate regression and independent sample t-test. The results indicated that most of the companies selected have a long tenure of more than five years with the auditor, and the majorities are audited by the Big 4 auditors. The findings of the study merely provide weak evidence that financial reporting quality of medium tenure is significantly higher than that of short tenure and long tenure. This interesting outcome will have practical implications when the regulators and professional bodies consider the need for mandatory auditor rotation in Malaysia.