Auditor Independence in Malaysia: The Perceptions of Loan Officers and Professional Investors By Maslina Binti Ahmad A Thesis Submitted in Fulfilment of the Requirements for the Degree of Doctor of Philosophy of Cardiff University Accounting and Finance Section Cardiff Business School, Cardiff University October 2012 DECLARATION This work has not previously been accepted in substance for any degree and is not concurrently submitted in candidature for any degree. Signed …MASLINA AHMAD……………………………………………………. (candidate) Date ……30 SEPTEMBER 2012…………………… STATEMENT 1 This thesis is being submitted in partial fulfillment of the requirements for the degree of …………………………(insert MCh, Md, MPhil, PhD etc, as appropriate) Signed …… MASLINA AHMAD ……………. (candidate) Date ……30 SEPTEMBER 2012…………………… STATEMENT 2 This thesis is the result of my own independent work/investigation, except where otherwise stated. Other sources are acknowledged by footnotes giving explicit references. Signed ……… MASLINA AHMAD ………… (candidate) Date …30 SEPTEMBER 2012……………………… STATEMENT 3 I hereby give consent for my thesis, if accepted, to be available for photocopying and for inter- library loan, and for the title and summary to be made available to outside organisations. Signed …… MASLINA AHMAD ………. (candidate) Date ……30 SEPTEMBER 2012…………………… ii ABSTRACT The current study examined several issues regarding auditor independence from the perspective of an emerging market such as Malaysia. A spate of ‘mini-Enrons’ in 2007 and 2008 has raised questions of investor confidence in the financial system specifically the national stock market. These scandals involving listed companies have highlighted concerns of regulators and other interested parties relating to threats to auditor independence. Factors affecting the ability of auditors to remain independent include long audit tenure, financial dependence on a single audit client, non-audit services provided to audit clients, ex-auditor employment with an audit client and the existence of audit committees. It is therefore timely to examine the importance of auditor independence in the provision of reliable and credible financial information. The current study uses a questionnaire survey to examine users’ (bank loan officers and professional investors) perceptions of the impact of the various factors on auditor independence. The results of the study revealed that Malaysian users of financial statements have serious concerns about the threats to auditor independence. The results also reveal that audit committees are perceived as the main safeguard for auditor independence. In general, both groups of respondents agreed that the current regulations for auditors, as set down by the Malaysian Institute of Accountants’ By-Laws, were sufficient to safeguard auditor independence. However, there are mechanisms that the financial statement users believed should be implemented that could provide greater protection for their investment. For example, the loan officers in this study seemed to prefer mandatory audit firm rotation to partner rotation. Further investigation indicated that differences existed in perceptions across the examined demographic and background variables. The results of the study also suggest that Malaysian loan officers and professional investors still have faith in the auditing profession and this is reflected in their belief that audited financial statements are important for them to make lending and investing decisions. iii ACKNOWLEDGEMENT This work would not be completed without the blessing of Allah The Almighty, to whom I present my utmost thanks and gratitude. My special thanks and appreciation go to my thesis supervisor, Professor Roy Anthony Chandler, for his tireless support, encouragement, feedback, suggestions, constructive criticism, and crucially, his endless patience towards me. I would also like to thank Professor Mark Clatworthy and Dr. Alpa Dhanani for their constructive comments and feedback on the thesis. My appreciation also goes to Mrs. Elsie Philips and Ms. Lainey Clayton for their administrative help throughout the research project. To the librarians at Aberconway Building, my appreciation is extended for their continuous assistance in obtaining books and relevant articles for my research. I would also like to thank all the faculty members and staff at Cardiff Business School for the help and support, directly or indirectly given to me. To my work colleagues and friends, I say thank you for being there for me. May Allah bless them all. I would also like to thank Professor Dr. Khaliq Ahmad (Dean, Kulliyyah of Economics and Management Sciences, International Islamic University Malaysia), Assoc. Professor Dr. Suhaiza Ismail (Head of Accounting Department, Kulliyyah of Economics and Management Sciences, International Islamic University Malaysia) and all the lecturers and administrative staff at the Kulliyyah for their constant moral support which I cherish. I am also grateful to the International Islamic University Malaysia and the Ministry of Higher Education Malaysia, which provided the financial assistance for me to continue my study. My great and sincere appreciation goes to my family, especially my husband, Azril Hisham bin Besar, for his unconditional love, patience and understanding throughout this process and to my children, Azri Mukhriz and Azreen Mumtazah, for coping with the stressful time of my PhD journey. My appreciation and gratitude also go to my parents, iv parent in-laws, brothers and sisters for their prayers and encouragement for me to complete my thesis. v TABLE OF CONTENTS TITLE ................................................................................................................................................ i DECLARATION .............................................................................................................................. ii ABSTRACT ..................................................................................................................................... iii ACKNOWLEDGEMENT .............................................................................................................. iv TABLE OF CONTENTS ................................................................................................................ vi LIST OF FIGURES ........................................................................................................................ xi LIST OF TABLES ......................................................................................................................... xii LIST OF ABBREVIATIONS........................................................................................................ xv CHAPTER 1 - INTRODUCTION .................................................................................................. 1 1.1 Introduction ........................................................................................................................... 1 1.2 Objectives of the study .......................................................................................................... 3 1.3 Methodology ......................................................................................................................... 4 1.4 Significance of the study ....................................................................................................... 5 1.5 Organisation of the Thesis ..................................................................................................... 8 1.6 Chapter Summary .................................................................................................................. 9 CHAPTER 2 - LITERATURE REVIEW .................................................................................... 11 2.1 Introduction ......................................................................................................................... 11 2.2 Definitions of Auditor Independence .................................................................................. 11 2.3 Agency Theory .................................................................................................................... 14 2.4 Models of Auditor Independence ........................................................................................ 16 2.4.1 Economic Models ........................................................................................................ 16 2.4.2 Behavioural Models ..................................................................................................... 20 2.4.3 Auditor Independence Risk Models ............................................................................ 22 2.5 Moral Development, Ethical Reasoning and Auditor Independence .................................. 24 2.6 Long Audit Tenure .............................................................................................................. 25 2.6.1 Studies using the Behavioural Approach ..................................................................... 28 2.6.2 Studies using the Archival Approach .......................................................................... 32 2.6.3 Summary ...................................................................................................................... 35 2.7 Financial Dependence on a Single Audit Client ................................................................. 36 2.7.1 Summary ...................................................................................................................... 41