Governance structures, ethnicity,

and audit fees of Malaysian

listed rms
Puan Yatim
School of Business Management, Universiti Kebangsaan Malaysia, Bangi,
Bangi, Malaysia
Pamela Kent
Faculty of Business, Bond University, Robina, Australia, and
Peter Clarkson
UQ Business School, The University of Queensland, St Lucia, Australia
Abstract
Purpose The purpose of this study is to examine the association between external audit fees, and
board and audit committee characteristics of 736 Malaysian listed rms. It is hypothesised that good
corporate governance practices reduce auditors risk assessments, resulting in lower audit fees.
Drawing on the existence of a clearly identiable ethnic domination of board membership and
ownership of Malaysian listed rms, the study also posits that Bumiputera-controlled rms pay higher
audit fees because of their weaker governance practices.
Design/methodology/approach This study employs a cross-sectional analysis of 736 rms listed
on the Bursa Malaysia for the nancial year ending in 2003. Multiple regression analysis is used to
estimate the relationships proposed in the hypotheses.
Findings Overall, the results of this study reveal that external audit fees are positively and
signicantly related to board independence, audit committee expertise, and the frequency of audit
committee meetings. The study also nds a strong negative association between external audit fees
and Bumiputera-owned rms. An additional analysis into the internal governance structures of rms
in the sample show that Bumiputera rms practice more favourable corporate governance practices
compared to their non-Bumiputera counterparts.
Originality/value This study is a unique contribution in that it provides data on corporate
governance practices in Malaysia for a large sample in the period after the corporate governance reforms
taken by Malaysian capital market regulators and participants. Previous studies have shown that
Bumiputera-controlled rms pay higher audit fees than non-Bumiputera-controlled rms. These studies
have not testedtheoretical explanations for this fee differential. Atheoretical explanationprovidedin the
current study is that Bumiputera-controlled rms pay higher audit fees than non-Bumiputera-controlled
rms partially because of differences in corporate governance practices. The study nds conicting
results with previous research suggesting that corporate governance practices have changed in
Malaysia since the amendments of Bursa Malaysia Listing Requirements, 2001.
Keywords Corporate governance, Boards of directors, Audit committees, Auditors fees, Malaysia
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0268-6902.htm
The authors are grateful for useful comments of Allen Craswell, Marion Hutchinson, Jim Psaros,
Carolyn Windsor, participants at seminars at Grifth University, UQ Business School 2005
Research Students Colloquium, Emerging Scholars Colloquium of the Fourth Asia Pacic
Interdisciplinary Research in Accounting (APIRA) Conference, Singapore, 2004, and at the 2nd
AACF International Accounting Conference, Turkey, 2005. Funding from UQ Business School,
the University of Queensland is also gratefully acknowledged.
Governance
structures,
ethnicity
757
Managerial Auditing Journal
Vol. 21 No. 7, 2006
pp. 757-782
qEmerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900610680530
Introduction
Prior studies predominantly using data from the USA, the UK, and Australia have
investigated the association between governance mechanisms and the nancial
reporting process. For instance, using US-based data, Beasley (1996), Dechow
et al.(1996) and Jiambalvo (1996) document a negative relationship between effective
governance mechanisms and nancial reporting decisions that are in violation of
generally accepted accounting principles (GAAP). Recently, Carcello et al.(2002) and
Abbott et al.(2003) show that rms with stronger internal governance structures
demand higher audit quality and thus pay higher audit fees. Using the UK data,
Peasnell et al.(2000) conrm the ndings previously reported by Dechow et al.(1996)
that earnings management is negatively related to the independence of the board of
directors. Similar to ndings reported by Peasnell et al.(2000), Davidson et al. (2005)
also nd that greater board independence lowers the likelihood of earnings
management in Australian rms.
Our study extends this line of research and examines the relation between external
audit fees and internal corporate governance structures in emerging markets such as
Malaysia. The examination of the association between internal governance structures
and audit fees in Malaysia is motivated by two factors. First, Malaysia is an appealing
case to study because it is likely that corporate governance practices used by
Malaysian listed rms are different from those practiced in developed markets. While
the empirical results provide evidence from a strong and sophisticated capital market
environment (Carcello et al., 2002 (US); Goodwin-Stewart and Kent, n.d. (Australia)),
very little research has been conducted in countries where capital markets are less
developed and where corporate governance mechanisms are still evolving.
Further, institutional differences exist between developing capital markets such
as Malaysia and other developed markets. These institutional differences include a
weak market for corporate control (Zhuang, 1999; Lins, 2003; Gibson, 2003), more
concentrated stock ownership (Shleifer and Vishny, 1997; Claessens et al., 2000), and
signicant government ownership in listed rms (Shleifer and Vishny, 1997;
Claessens et al., 2000; Lemmon and Lins, 2001; Mak and Li, 2001). At the corporate
level, these institutional differences may inuence how the managers and the board
of directors govern their rms. Although the audit fee literature is quite developed,
no prior studies have examined the link between internal governance structures and
external audit fees in emerging markets such as Malaysia. Therefore, this study
addresses the scarcity of research in this environment and its inuence on external
audit fees in Malaysia.
Second, the Malaysian corporate environment offers clearly identiable capital
segments divided along ethnic lines. This division can clearly be observed in the listed
rms whose board membership and share ownership are predominantly controlled by
two main ethnic groups, namely the Bumiputera Malays and the Chinese[1]. Although
there are other ethnic groups such as Indians, the distinction between the two main
ethnic groups (i.e. Chinese and Bumiputeras) dominates much of the socio-economic
activities and political policy making decisions. Given this unique corporate
environment, this study extends the audit pricing and governance literature by
examining proxies such as political and ethnic favouritisms (Gomez and Jomo, 1997) in
the audit fee models and how this dimension of inherent risk inuences external audit
fees in Malaysia.
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Further, Eichenseher (1995) and CheAhmad and Houghton (2001) also document a
signicant relation between ethnicity and audit fees in the Malaysian market.
Together, these two studies show that Bumiputera-controlled rms pay higher audit
fees compared to non-Bumiputera-controlled rms. They, however, do not provide
theoretical explanations for the variations in audit fees. This current study is
conducted after the incorporation of the Malaysian Code on Corporate Governance into
the Listing Requirements of Bursa Malaysia 2001. Since, then, the listed companies
including Bumiputera-controlled companies have improved their corporate governance
environment (KLSE-PricewaterhouseCoopers, 2002). This study, therefore, offers
alternative explanations for the fee variations from a corporate governance perspective
given that there is a documented empirical association between ethnicity and external
audit fees in previous studies. The study tests whether Bumiputera-controlled rms
have weaker corporate governance practices than non-Bumiputera-controlled rms.
The remainder of this paper is structured as follows. The next section briey
explores corporate governance in Malaysia. This is followed by a discussion on the
background of the study and development of our hypotheses. The third section
describes the research design. The results of our study are reported in the fourth
section while in the nal section conclusions are drawn and the implications of the
study are discussed.
Malaysian corporate governance environment
The revised Listing Requirements of Bursa Malaysia in 2001 provides greater obligation
for public listed companies to enhance Malaysias corporate governance regime[2].
Specically, the amended Listing Requirements of 2001 outline the requirements for
nancial reporting disclosure on corporate governance matters and continuing listing
obligations. Other than the audit committee, which has been mandatory since 1993, the
Malaysian Code on Corporate Governance also recommends that the board of directors
appoint remuneration and nomination committees. The establishment of other
committees such as a risk management committee and a corporate governance
committee are also recommended but are less frequently set up by listed rms.
The Malaysian Code on Corporate Governance strongly recommends the separation
of responsibilities between the board chair and the CEO even though the Bursa
Malaysia Listing Requirements (2001) does not require the segregation of these
positions. The Malaysian Code on Corporate Governance also states as principle that
the board of directors should maintain a sound system of internal control. This led to
the issuance by the exchange of A Guide on Statement of Internal Control in May 2000.
This guideline explains the key areas that directors must pay attention before they
present A Statement of Internal Control in their companies annual reports. A listed
rm is required to address in their annual reports the Principle and Best Practices in
the Malaysian Code on Corporate Governance relating to internal control such as
identifying principal risks and ensuring implementation of appropriate systems to
manage risks.
In addition, directors appointed to the board of directors of a public listed company
are required under the Listing Requirements to attend a directors training program
known as the mandatory accreditation program. The scope of this program covers
topics such as Companies Act 1965, the listing requirements, risk management and
internal control and relevant securities laws. Self-regulatory initiatives also continue to
Governance
structures,
ethnicity
759
be developed by various industry and professional bodies aiming at promoting
knowledge and awareness of corporate governance best practices in Malaysia.
Although the Malaysian Code on Corporate Governance and the Bursa Malaysia
Listing Requirements (2001) provide the recommendations and rules to restore
investor condence and to improve standards of corporate accountability, the
efcacy of the recommended and mandatory governance practices in inuencing
external audit fees has not been empirically tested. Therefore, our study explores
whether the various best practices and recommendations have inuenced external
audit fees in Malaysia.
Theoretical background and hypotheses
The economic framework underlying this study is that audit fees reect the economic
costs of efcient auditors (Simunic and Stein, 1996). These costs vary considerably
with variables such as the size, complexity, riskiness, and specic characteristics of the
audited client including various aspects of its internal governance structures (Simunic
and Stein, 1996; Carcello et al., 2002; Cohen et al., 2002; Goodwin-Stewart and Kent,
n.d.). This study posits that good corporate governance practices are likely to reduce
both inherent and control risks, leading to lower external audit fees. Specically, from
the auditors perspective, a stronger control and governance environment is likely to
reduce the auditors assessment of control risk and the extent of audit procedures, thus
reducing audit fees. Following this line of reasoning, the study tests hypotheses related
to several governance variables.
The study characterises internal corporate governance structures as strong when a
rm adopts best governance practices as prescribed by the existing empirical literature
and various recommendations and rules for governance reforms (Fama and Jensen,
1983a,b; The Cadbury Committee, 1992; Malaysian Code on Corporate Governance,
2001; New York Stock Exchange, 2002; NASDAQ Corporate Governance Proposals,
2003). The strong governance practices considered in this study include greater board
independence (measured by both a higher representation of independent non-executive
directors on boards and the separation of the board chair and the CEO positions),
smaller boards, diligent boards, and boards with a risk management committee.
In addition, the study also addresses audit committee characteristics identied by the
Blue Ribbon Committee (BRC) on improving the effectiveness of Corporate Audit
Committee (Blue Ribbon Committee, 1999). These characteristics include audit committee
independence, audit committee expertise, audit committee size, and audit committee
diligence. The Blue Ribbon Committee (1999) contends that a more independent, diligent,
expert, and larger audit committee is better able to objectively evaluate managements
accounting and reporting practices. These attributes of an audit committee are likely to
contribute to an improved governance environment within a rm. Focusing on a
risk-based approach of audit services, these audit committee characteristics are likely to
reduce a rms inherent and control risks associated with the rms nancial statements
and disclosures (Beasley, 1996; Dechow et al., 1996; Anderson et al., 2004). Finally, the
study also considers elements of ethnicity that have been found to inuence audit fees in
institutional settings such as Malaysia (Eichenseher, 1995; CheAhmad and Houghton,
2001). This current study offers explanations for fee variations from a corporate
governance perspective in which it argues that governance practices in ethnic favoured
rms are likely to result in differential external audit fees.
MAJ
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In the following section, the study develops two main testable hypotheses on the
relation between external audit fees and both board and audit committee
characteristics. The third hypothesis tests the association between external audit
fees and governance practices associated with ethnic domination of board membership
and share ownership.
Board characteristics, the nancial reporting process, and external audit fees
The board of directors has a primary responsibility of overseeing the rms nancial
reporting process. They also must assess the quality of corporate governance within
the organisation and ensure that the organisation has, for example, effective
accounting practices, internal control and risk management, and audit functions.
Therefore, Boards of Directors are potentially viewed, in particular their structures, as
important elements in delivering credible and relevant nancial statements.
Board independence. Agency literature suggests that board independence from
management provides, among other things, the most effective monitoring and
controlling of rm activities in reducing opportunistic managerial behaviours and
expropriation of rm resources (Fama and Jensen, 1983a,b; Brickley et al., 1994). Board
independence is also likely to provide superior oversight of the nancial reporting
process, hence greater reliability and validity in accounting reports is expected
(Beasley, 1996; Dechow et al., 1996). As a result, this reduces the auditors risk
assessments and less audit efforts are required, leading to lower audit fees charged.
The literature and governance guidelines also show that a boards ability to perform
its governance role is likely to weaken when the CEO is also the board chair (Fama and
Jensen, 1983a, b; Dechow et al., 1996; The Cadbury Committee, 1992; the Malaysian
Code on Corporate Governance, 2001). For instance, Dechow et al.(1996) show that
rms identied as earnings manipulators are more likely to have a CEO who also
serves as a board chair. This suggests that the combination of these roles is likely to
compromise the board effectiveness in monitoring management and the nancial
accounting process. As a result, the auditor needs to devote more audit efforts, hence
charging the rm higher fees.
Board size. Board size may play an important role in directors ability to monitor
and control managers (Jensen, 1993; Lipton and Lorsch, 1992; The Business
Roundtables, 1997). Lipton and Lorsch (1992) and Jensen (1993) argue that because of
difculties in organising and coordinating large groups of directors, board size is
negatively related to the boards ability to advise and engage in long-term strategic
plans. Beasley (1996) also nds that the size of the board of directors signicantly
affects the likelihood of nancial statement frauds. His results indicate that as board
size increases, the likelihood of nancial statement fraud also increases. As such, board
size is likely to affect the nancial reporting process, hence audit process. If larger
boards are less effective monitors of the nancial reporting process (Beasley, 1996),
then the rms external auditor assesses the control environment as weak, hence more
audit hours are required, resulting in higher external audit fees.
Board diligence. The intensity of board activities is likely to contribute to the
effectiveness of its oversight functions particularly in matters concerning the nancial
reporting process. Lipton and Lorsch (1992) and Byrne (1996) argue that boards that
meet frequently are more likely to perform their duties diligently and are benecial to
shareholders. Similarly, Conger et al.(1998) and Vafeas (1999) argue that board meeting
Governance
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761
time can improve the effectiveness of a board. Therefore, a board that demonstrates a
greater diligence in discharging its oversight responsibilities is likely to enhance level of
oversight of the nancial reporting process. It is, therefore, expected that more diligent
boards (measured by the number of board meetings held during the nancial year) are
likely to be negatively associated with external audit fees.
The existence of a risk management mechanism. Consistent with a risk-based
approach, a rm that establishes a risk management committee as one of the board
committees demonstrates a greater awareness of the importance of risk management
and control (The Committee of Sponsoring Organisations of the Treadway
Commission, 1992, 2004; Hermanson, 2003; Selim and McNamee, 1999). As
monitoring by the boards of directors is heightened through a stringent risk
management procedure, one can argue that the nancial reporting quality of the rm is
greatly enhanced. Hence, in the context of good corporate governance attributes, this
study examines association between external audit fees and the existence of a risk
management committee. The study posits that rms with better internal control, in
terms of risk management, are likely to reduce external monitoring from auditors,
thereby lower audit fees are expected.
In sum, the preceding discussion argues that more independent and diligent boards,
smaller boards, and boards with a risk management committee are likely to enhance
internal governance and the control environment and reduce auditors risk
assessments associated with the nancial reporting process. As a result, the extent
of audit procedures is also likely to be reduced, leading to lower external audit fees.
The following hypothesis is, therefore, tested:
H1. Lower external audit fees are associated with boards of directors that are
more independent, have a smaller number of members, establish a risk
management committee, and meet more frequently.
Audit committee characteristics, the nancial reporting process, and external audit fees
The Blue Ribbon Committees (1999) recommendations that address audit committee
independence, nancial literacy and expertise, as well as audit committee size and
authority are expected to result in a more effective audit committee oversight of the
nancial reporting process. Therefore, in addition to board characteristics, this study
also examines whether rms having audit committee structures consistent with the
Blue Ribbon Committees (1999) recommendations are likely to be associated with
higher quality of nancial reporting, resulting in lower auditors assessment of control
risks, hence lower external audit fees are expected.
Audit committee independence. Consistent with the risk-based approach, an
independent audit committee is likely to result in a more effective audit committee
oversight of the nancial reporting process, thus reducing the incidence of nancial
reporting problems (Blue Ribbon Committee, 1999; Abbott et al., 2004; Dechow et al.,
1996; McMullen, 1996)[3]. An independent audit committee (relative to
insider-dominated audit committees) is better able to protect the reliability of the
accounting process and promote objectivity on the part of the audit committee. This
helps strengthen internal controls and should lead to a reduction in the levels of both
inherent and control risk. As a result, the rm requires less substantive testing, and
hence lower external audit fees are expected.
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Audit committee expertise and size. The effectiveness of an audit committee is further
enhanced if members of audit committees possess accounting and nancial expertise. In
its third recommendation, Blue Ribbon Committee (1999) recommends a minimum of
three audit committee directors, each of whom is nancially literate and at least one of
whom has accounting or related accounting and nancial management expertise.
Further, in addition to a requirement that a majority of audit committee members are
independent directors, Bursa Malaysia also mandates that audit committees of its listed
rms be composed of at least three members and at least one audit committee member
must be a member of the Malaysian Institute of Accountants (MIA).
Empirical ndings also support the assertion that an audit committee should at
least consist of one member with accounting and nancial expertise. Audit committee
expertise allows for a better understanding of auditing issues and risks, and the audit
procedures proposed to address and detect these issues and risks (DeZoort and
Salterio, 2001). Knapp (1987) and Cohen et al.(2002) also nd that auditors are less
likely to refer a complex auditing issue to an audit committee that is perceived as not
being knowledgeable about the technical auditing and nancial reporting matters
involved. Collectively, empirical evidence and governance best practices suggest that
audit committee expertise reduces auditors risk assessments associated with the
nancial reporting process, resulting in lower external audit fees.
The audit committee size recommendation is consistent with the desire to increase
the organisational status of the audit committee (Braiotta, 2000). Similarly, Kalbers and
Fogarty (1993) suggest that larger audit committees are legitimised by a meaningful
organisational support from the board of directors and are thus more likely to be
acknowledged as an authoritative body by the external auditors as well as by internal
audit functions of rms. Therefore, consistent with the recommendation by the Blue
Ribbon Committee (1999) with respect to audit committee size, this study argues that
larger audit committees are likely to enhance the quality of nancial reporting,
resulting in lower external audit fees.
Audit committee diligence. A number of studies and governance best practices also
call for audit committees to be diligent in carrying out their duties (Abbott et al., 2004;
Blue Ribbon Committee, 1999; Kalbers and Fogarty, 1993). Generally, studies in this
area use the most common proxy for audit committee diligence, which is the number of
audit committee meetings held annually. Prior research also suggests that an audit
committee that meets frequently can reduce the incidence of nancial reporting
problems. By meeting and communicating frequently, for instance, with the external
auditor, the audit committee can alert the auditor on a particular auditing issue
requiring greater attention from the auditor (Raghunandan et al., 1998). Consistent with
the risk-based approach, it is therefore expected that a more diligent audit committee is
likely to reduce nancial reporting problems, leading to lower external audit fees.
Overall, audit committee structures that are consistent with the Blue Ribbon
Committees (1999) recommendations help strengthen audit committee effectiveness in
their oversight functions. This is likely to result in less substantive testing, leading to
lower external audit fees. The following hypothesis is, therefore, tested:
H2. Lower external audit fees are associated with audit committees that are more
independent, have more members, have greater accounting and nance
expertise, and meet more frequently.
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Ethnicity and audit fees
The effects of cultural differences and various aspects of culture (i.e. ethnicity and
demography) have been shown to inuence business practices, organisations,
and accounting disclosure practices and audit services (Hofstede, 1980, 1991; Haniffa
and Cooke, 2002; Eichenseher, 1995; CheAhmad and Houghton, 2001). However, prior
research fails to explore the effect of ethnicity on monitoring differences (i.e.
monitoring by internal governance mechanisms) despite recognition of its importance.
Malaysian capital market exhibits a unique corporate environment where its
economy offers clearly identiable capital segments divided along ethnic lines
(Jesudason, 1989). Early economic development exhibited a clear distinction between
foreign (mostly British) and local Chinese capital formation. After independence in
1957 from the British, the government initiated the new economy policy, which
gradually adds another distinct component of ethnic groups, namely the Bumiputera or
Malay shareholders, to the Malaysian capital market.
The presence of clearly identiable ethnic domination of board membership and
ownership of Malaysian listed companies is likely to provide evidence of monitoring
differences that may exist in these rms. These differences are also likely to inuence
auditors risk assessments, which in turn may affect variations in audit fees. Johnson
and Mitton (2003) and Gomez and Jomo (1997) argue that Bumiputera-controlled rms
(i.e. ethnically-favoured rms) and politically connected rms are perceived to have
poor corporate governance practices and greater agency problems. In addition, Gul
(2003) also documents evidence of a positive association between audit fees and agency
costs of political afliations using a sample of Malaysian listed rms. He argues that
auditors perceive politically afliated rms as having greater audit risks, thus
charging them higher fees. Both Eichenseher (1995) and CheAhmad and Houghton
(2001) suggest that Chinese business practices may inuence differences in levels of
agency conicts and risks associated with Chinese-controlled companies (i.e.
non-Bumiputera companies), leading to lower external audit fees charged to these
rms. Collectively, these studies indicate that an element of ethnicity or ethnic
favouritism can be considered as another dimension of inherent risk.
Our study extends the work of Eichenseher (1995) and CheAhmad and Houghton
(2001) by seeking an explanation for audit fee variations from a corporate governance
perspective. Gomez and Jomo (1997) and Johnson and Mitton (2003) suggest that
Bumiputera-controlled companies are likely to have a poor governance environment
and are given preferential treatments by the ruling government. This study provides
recent evidence on whether Bumiputera-controlled rms pay higher audit fees than
non-Bumiputera-controlled rms. Further analyses are also sought for an association
between Bumiputera-controlled rms and these internal governance structures.
If Bumiputera-controlled rms (by virtue of government ownership, and board
membership and share ownership controlled by Bumiputeras) are associated with poor
governance practices, then they are likely to have higher levels of inherent and control
risks[4]. The poor governance environment is likely to adversely affect the nancial
reporting process, hence reducing the quality and reliability of nancial reporting. As
monitoring from internal governance mechanisms is weak and ineffective, auditors are
expected to do more substantive testing, hence higher audit fees are charged for these
rms. The following hypothesis is, therefore, tested:
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H3. Bumiputera-controlled rms pay higher external audit fees associated with
poorer corporate governance practices.
Research design
Data collection and sample selection
The sample comprises the Bursa Malaysia non-nancial public listed companies
whose annual reports are available in 2003. Finance-related rms are excluded due to
their unique characteristics and different compliance and regulatory environment. The
rms in the sample are either listed on the Main Board or the Second Board of the
Bursa Malaysia[5]. Both the nancial and corporate data of these rms are obtained
from their annual reports. These annual reports are available and downloadable from
the web site of the exchange (http://announcements.bursamalaysia.com). Listed rms
are required to disclose both non-audit fees and audit fees (statutory audit fees) in their
annual reports.
The number of rms listed on the Bursa Malaysia at the end of 2003 is 874 rms
(excluding rms listed on Malaysia Exchange of Securities Dealing and Automated
Quotations Berhad (MESDAQ)). About 32 rms do not have their annual reports
available, while 61 rms are involved in nance-related activities. The study also
excludes 45 rms that are newly listed[6]. The nal sample consists of 736 rms. A
total of 496 rms are listed on the Main Board of the Bursa Malaysia and the remaining
rms are listed on the Second Board. Just over three quarters of the sample represent
three major sectors classied by the Bursa Malaysia namely industrial products (237
rms), consumer products (119 rms), and trade and services (163 rms). The
remaining rms in the sample are in sectors including property (86 rms),
constructions (57 rms), technology (19 rms), plantations (40 rms), infrastructure
companies (6 rms), hotel (6 rms), and mining (3 rms).
Variable measurements and model specication
Consistent with existing literature on determinants of audit fees, this study employs
the traditional audit fee model introduced by Simunic (1980) and modied by Craswell
et al.(1995). In addition to using variables that are proxies for internal corporate
governance structures (i.e. board and audit committee characteristics), the study also
includes control variables identied by prior research that explain the cross-sectional
variations in audit fees (Simunic and Stein, 1987; Francis and Simon, 1987; Craswell
et al., 1995). These variables include client size, number of subsidiaries, audit quality,
leverage, protability, receivable and inventory intensity, and industry types. The
following regression equation is used as the primary model to test the hypotheses
previously discussed. It is also important to note that this is not the only model used in
the study. There are several other alternative models employed to test the validity of
the primary model.
LAF b
0
b
1
SIZE b
2
SUBS b
3
LEV b
4
REC b
5
INV b
6
ROA b
7
BIG4
b
8
INDUSTRYDUMMIES b
9
BoardIndependence b
10
Dual b
11
BoardSize
b
12
RMC b
13
BoardMeet b
14
ACIndependence b
15
ACSize
16
ACExpertise
b
17
ACMeet b
18
BumiOwned e
Governance
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765
Where LAF, natural log of audit fees; SIZE, natural log of total assets; LEV, total book
value of debt to total assets; SUBS, square root of the number of direct subsidiaries; REC,
the ratio of receivables to total assets; INV, the ratio of inventories to total assets; ROA,
returns on assets (the ratio of earnings before interests and taxes to total assets); BIG4, a
dummy variable of 1 if nancial statements audited by Big 4 audit rms, 0 otherwise;
INDUSTRYDUMMIES, a dummy variable of 1 if a rmis in industrial product sector, or
in consumer product sector, or in construction sector, or in technology sector, or in trade
and services sector, or in property sector, or in plantations sector, or in hotel sector, or in
infrastructure companies sector, or in mining sector, 0 if otherwise; BoardIndependence,
the proportion of independent non-executive directors on boards; Dual , a dummy
variable of 1 if the role of the Board Chair and the CEO is separated, 0 if otherwise;
BoardSize, total number of directors on boards; RMC, a dummy variable of 1 if a rm
establishes a risk management committee, 0 if otherwise; BoardMeet, the number of
board meetings held during the nancial year; ACIndependence, the proportion of
non-executive directors on audit committees; ACSize, total number of directors on audit
committees; ACExpertise, the proportion of audit committee members with accounting
and nance qualications; ACMeet, the number of audit committee meetings held
during the nancial year; BumiOwned, a dummy variable of 1 if a rms shares
outstanding are substantially held by Bumiputera shareholders[7].
Dependent variable. The Companies Act 1965 of Malaysia requires companies to
disclose their non-audit and audit fees in their notes to accounts. The gure was,
therefore, collected from company annual reports. The fees are then transformed into
natural logarithm and are used as the dependent variable. The natural log is used to
control for the skewed nature of audit fees.
Hypothesised variables. Recall that experimental variables tested in the hypotheses
are board and audit committee characteristics, and board ethnicity. Consistent with
prior studies, this study tests the assertion that boards of directors that are more
independent, have a smaller number of members, establish a risk management
committee, and meet more frequently pay lower external audit fees (H1). Two
measures of board independence are used in this study namely the proportion of
independent non-executive directors on boards and whether different individuals hold
the positions of the board chair and the CEO. An independent non-executive director is
a director who is not employed to run the rms day-to-day business activities, and
whose role is to provide an outsiders contribution and oversight to the board of
directors (Hanrahan et al., 2001).
The study also posits in H2 that rms with more independent, diligent, expert, and
larger audit committees are likely to pay lower external audit fees. Audit committee
independence and expertise are measured by the proportion of non-executive directors
on the committee and the proportion of audit committee members with accounting and
nance qualications,, respectively, (Goodwin-Stewart and Kent, n.d.). The proxies
used to measure audit committee diligence and size are the frequency of audit
committee meetings held during the nancial year and the number of directors on the
audit committee, respectively. Finally, the study also predicts that
Bumiputera-controlled rms pay higher levels of external audit fees associated with
their poor internal governance structures (H3). The ethnicity variable is measured
using a dichotomous variable set as 1 if a rms outstanding shares are substantially
held by Bumiputera shareholders, 0 if otherwise[8].
MAJ
21,7
766
Control variables. We expect audit fees to be positively related to the natural log of
total assets, leverage, receivable and inventory intensity, and square root of the
number of subsidiaries. The effects of these variables are controlled in our analysis.
For instance, protability is controlled by including return on assets (ROA) and it is
expected to be negatively associated with audit fees. The study also includes a dummy
variable for Big Four accounting rms to control for differences in audit quality.
Further, there are likely to be variations in audit fees across companies in different
industries (Low et al., 1990). Therefore, in order to control for industry variations, ten
industry dummy variables according to sectors classied by the Bursa Malaysia are
included in the equation. The sectors are industrial products, consumer products,
technology, construction, trade and services, properties, plantations, hotel, mining, and
infrastructure companies.
Results
Descriptive statistics
Tables I and II provide descriptive statistics for the variables employed in the model.
Panel A reports those for continuous variables and panel B presents those for
dichotomous variables. In general, the distributions are similar to previous studies
undertaken in the Malaysian market (Eichenseher, 1995; CheAhmad and Houghton,
2001). For instance, the average audit fees of RM191,975 in this sample is slightly
higher than those documented by Eichenseher (1995) and CheAhmad and Houghton
(2001) where the average audit fees in their samples are RM113,000 and RM137,780,
respectively. The mean asset size of RM1,167,849,518 is lower than that reported by
CheAhmad and Houghton (2001) but higher than that found by Eichenseher (1995)
which are RM1,290,316,000 and RM615,000,000, respectively. There are 506 rms
(68.8 percent) that use Big Four external auditors.
Of particular interest to the study are the corporate governance variables. The
Listing Requirements of Bursa Malaysia 2001 require all public listed rms to have
audit committees comprising at least three members, the majority of whom must be
independent. The size of audit committees ranges from two to seven, with a mean of
3.49[9]. On average, the rms in the sample have their audit committees comprised of
at least three non-executive members (about 79 percent of audit committee members
are non-executive directors). Further, some 252 (one-third) rms in the sample have
formally established a risk management committee. The majority of rms in the
sample also separate the positions of the board chair and the CEO (about 84 percent of
the rms practice dual leadership).
The average number of non-executive directors on Malaysian boards is 4.74,
ranging from a minimum of 1 to a maximum of 12 non-executive board members
(63 percent of overall board members are non-executives). The number of directors on
Malaysian boards is between 3 and 16 with an average board size of 7.51. There are 205
rms whose boards of directors are predominantly Bumiputeras. Finally, there are
some 135 rms whose outstanding shares are substantially held by Bumiputera
shareholders.
Table III reports the correlations between the variables used in the regressions. The
correlation matrix reveals that few variables are highly inter-correlated (above 0.5).
Variables with high signicant correlations include natural log of total assets and
natural log of audit fees (0.741), the ratio of current assets to total assets and the ratio of
Governance
structures,
ethnicity
767
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Table I.
Descriptive statistics
(N 736) (Panel A:
continuous variables)
MAJ
21,7
768
Variable Yes Percent No Percent
Big four auditors (BIG4) 506 68.8 230 31.3
Bumiputera-dominated boards using big four
auditors 141 68.8 64 31.2
Non-Bumiputera dominated boards using big four
auditors 365 68.7 166 31.3
Dual leadership 616 83.7 120 16.3
Risk management committee (RMC) 252 34.2 484 65.8
Bumiputera-dominated boards (BUMI_BRD) 205 27.9 531 72.1
Firms with substantial bumiputera shareholdings
(BUMI_OWN) 135 18.3 601 81.7
Table II.
Descriptive statistics
(N 736) (panel B:
dichotomous variables)
AFee TAsset Leverage CA/TA Rec./TA Inv./TA ROA
Percent
NED Bumi_brd
AFee 1.000 0.741
* *
0.321
* *
20.145
* *
20.118
* *
20.061 0.040 0.053 0.118
* *
TAsset 1.000 0.400
* *
20.271
* *
20.292
* *
20.203
* *
0.139
* *
0.153
* *
0.172
* *
Leverage 1.000 20.360
* *
20.228
* *
20.152
* *
0.025 0.059 0.155
* *
CA/TA 1.000 0.574
* *
0.318
* *
0.063 20.093
*
20.064
Rec./TA 1.000 0.176
* *
0.002 20.163
* *
20.053
Inv./TA 1.000 0.049 20.177
* *
20.205
* *
ROA 1.000 0.034 20.072
percentNED 1.000 0.351
* *
Bumi_brd 1.000
BSIZE
percentNED_AC
ACSIZE
percentBUMI
AC meet
Board Meet
#Subs
percentNon_Bumi
BSIZE
Percent
NED_AC ACSIZE
Percent
BUMI ACMeet BoardMeet #Subs
Percent
non-Bumi
AFee 0.269
*
0.118
* *
0.148
* *
0.148
* *
0.251
* *
0.186
* *
0.698
* *
20.148
* *
TAsset 0.357
* *
0.208
* *
0.176
* *
0.188
* *
0.232
* *
0.186
* *
0.532
* *
20.188
* *
Leverage 0.108
* *
0.072
*
0.053 0.168
* *
0.172
* *
0.095
*
0.244
* *
20.168
* *
CA/TA 20.018 20.107
* *
20.018 20.075
*
20.089
*
20.070 20.153
* *
0.075
*
Rec./TA 20.047 20.177
* *
20.051 20.060 20.069 20.074
*
20.120
* *
0.060
Inv./TA 0.059 20.130
* *
20.001 20.218
* *
20.073
*
20.086
*
20.142
* *
0.218
* *
ROA 0.108
* *
0.114
* *
0.047 20.068 0.023 20.045 20.015 0.068
percentNED 0.043 0.569
* *
0.110
* *
0.380
*
0.116
* *
0.184
* *
0.009 20.380
* *
Bumi_brd 0.018 0.217
* *
0.076
*
0.857
* *
0.180
* *
0.206
* * *
0.105
* *
20.857
* *
BSIZE 1.000 0.117
* *
0.448
* *
0.011 0.146
* *
0.047 0.164
* *
20.011
percentNED_AC 1.000 0.063 0.247
* *
0.092
*
0.150
* *
0.035 20.247
* *
ACSIZE 1.000 0.102
* *
0.077
*
0.040 0.112
* *
20.102
* *
percentBUMI 1.000 0.160
* *
0.201
* *
0.106
* *
21.000
* *
AC meet 1.000 0.503
* *
0.204
* *
20.160
* *
Board Meet 1.000 0.154
* *
20.201
* *
#Subs 1.000 20.106
* *
percentNon_Bumi 1.000
Notes:
* * *
Correlation is signicant at the 0.05, 0.01 level (two-tailed), respectively
Table III.
Pearson correlation
matrix of variables used
in the study (N 736)
Governance
structures,
ethnicity
769
receivables to total assets (0.574), and the proportion of non-executive directors on
boards and the proportion of non-executive directors on audit committees (0.569).
While a few governance variables are signicantly correlated with each other, their
correlations do not indicate that multicollinearity is a serious problem. As shown in
Table III, the correlations range from 0.448 (between board size and audit committee
size) to 0.503 (between the frequency of board meetings and audit committee
meetings)[10].
Multivariate analysis
Regression results of the association between external audit fees and control variables
(traditional audit fee model). Table IV presents the ordinary least square regression
results for testing the hypotheses. In testing the validity of models used in the study,
the traditional audit fee model introduced by Simunic (1980) is employed whereby the
natural log of audit fees is regressed on the control variables only[11]. Results in model
1 show the association between external audit fees and control variables derived from
the extant literature (Francis and Simon, 1987; Simon and Francis, 1988; Francis and
Stokes, 1986) as independent variables[12]. The model is signicant ( p , 0.01), with an
adjusted R
2
of 69.6 percent.
Following prior research (Simunic, 1980; Francis and Simon, 1987; Simon and
Francis, 1988; Craswell et al., 1995), it is expected that audit fees are positively
associated with size, receivables and inventory intensity, leverage[13], the number of
subsidiaries, and whether a rm uses Big Four audit rms. The coefcients for these
control variables are in the predicted direction and signicant ( p , 0.01) except for the
use of Big Four audit rms. The strong negative association between audit fees and
ROA is also consistent with ndings previously documented (Simunic, 1980; Craswell
et al., 1995; Gul and Tsui, 1998). The industry controls are also included (the regression
estimates for industry variables are not reported in Table IV) in all regressions
presented in Table IV. Overall results show that audit fees are not signicantly related
to all industry variables[14].
Regression results of the association between external audit fees and internal
governance structures. Model 2, which regresses external audit fees on control
variables and the test variables of interest, is signicant ( p , 0.01) with an adjusted
R
2
of 69.8 percent. The results reported in model 2 show that external audit fees are
positively and signicantly associated with the proportion of independent
non-executive directors on boards ( p , 0.05), audit committee expertise ( p , 0.05),
and audit committee meeting frequency ( p , 0.10). There is also a negative association
between external audit fees and Bumiputera-controlled rms ( p , 0.10).
A number of board characteristics and audit committee characteristics are highly
correlated (i.e. board size and audit committee size, the proportion of independent
directors on boards and the proportion of independent directors on audit committees,
and the frequency of board and audit committee meetings), and potentially lead to
multicollinearity between variables. Therefore, two regressions are run separately to
test the association between external audit fees and the board and audit committee
characteristics. In addition, consistent with Beasley (1996) and Carcello et al.(2002),
model 3 in Table IV focuses on the full board of directors characteristics, which also
include the existence of a risk management committee [15]. Model 3, which regresses
external audit fees on the control variables and on the ve variables of interest, is
MAJ
21,7
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Table IV.
Regression results for
audit fees on control,
governance and ethnicity
variables (N 736)
Governance
structures,
ethnicity
771
signicant ( p , 0.01) with an adjusted R
2
of 69.6 percent. The results in model 3
indicate that there is a strong positive association between external audit fees and the
percentage of independent non-executive directors on boards ( p , 0.05). The results in
model 3 also showthat external audit fees are not signicantly relatedto dual leadership,
board size, the frequency of board meetings, and the existence of a risk management
committee [16]. Recall that H1 predicts that lower external audit fees are associated with
boards that are more independent, have a smaller number of members, establish a risk
management committee, and meet more frequently. Using a risk-based perspective of
audit services, it appears that the results do not support H1 as there is no negative
signicant association between external audit fees and those governance variables.
Hence, the ndings do not support the view widely held in the nancial reporting
and governance literature (Jensen, 1993; Beasley et al., 2000; Dechow et al., 1996;
Davidson et al., 2005) that greater board independence, smaller board size, and the
existence of an internal control mechanism (as per the existence of a risk management
committee) are likely to reduce risks associated with the nancial reporting process.
With respect to the signicant association between external audit fees and the
proportion of independent non-executive directors on boards, the nding is similar to
those of recent studies by Carcello et al.(2002), Abbott et al.(2003), and
Goodwin-Stewart and Kent (n.d.). These studies report that board independence is
positively associated with audit fees, suggesting independent boards are likely to
demand a higher quality audit from external auditors, resulting in higher audit fees.
Based on the propositions that directors wish to protect their reputational capital
(Fama, 1980; Fama and Jensen, 1983a, b; Gilson, 1990), to avoid legal liabilities (Gilson,
1990), and to protect shareholder wealth, rms with a stronger control environment
may seek differentially higher quality audit services. The auditors are likely to
incorporate the costs of providing these differentiated and higher quality audit services
into the audit fees, resulting in higher audit fees.
Recall that a number of board and audit committee characteristics are highly
correlated and this potentially leads to multicollinearity problems. Model 4 in Table IV
addresses this issue by regressing external audit fees on control variables and on the
four audit committee variables of interest. The model is signicant ( p , 0.01) with an
adjusted R
2
of 69.8 percent [17].
The results reported in model 4 show that external audit fees are signicantly
associated with audit committee expertise ( p , 0.05) and the frequency of audit
committee meetings ( p , 0.05). External audit fees, however, are not signicantly
related to audit committee independence and audit committee size. From a risk-based
perspective of audit services, the results with respect to the association between
external audit fees and audit committee characteristics do not support H2.The results
are consistent with the demand approach of audit services in that more expert and
diligent audit committees are likely to seek higher quality audits from external
auditors, resulting in higher audit fees (Carcello et al., 2002; Abbott et al., 2003). One
interpretation with respect to the positive signicant association between external
audit fees and audit committee expertise is that audit committee members who possess
professional certications (i.e. Certied Public Accountants and Chartered
Accountants) may seek to protect their reputations as experts in accounting and
nancial matters and are likely to demand increased monitoring (Fama and Jensen,
1983a, b; Gilson, 1990).
MAJ
21,7
772
External audit fees and Bumiputera-controlled rms. Recall that the study also posits
that rms whose directors are predominantly Bumiputeras are expected to pay
relatively higher audit fees associated with poorer corporate governance practices (H3).
The results in model 2 in Table IV show that there is a signicant negative association
between external audit fees and the ethnicity variable measured using a dichotomous
variable of whether a rms outstanding shares are substantially held by Bumiputeras
or otherwise ( p , 0.10) [18]. This indicates that Bumiputera-controlled rms pay lower
audit fees than non-Bumiputera-controlled rms, which is the opposite to the prediction
of H3. This result is not consistent with those documented by Eichenseher (1995) and
CheAhmad and Houghton (2001) in which they report that Bumiputera-controlled rms
pay higher external audit fees than their non-Bumiputera-controlled counterparts (i.e.
ethnic Chinese-controlled rms). Two possible explanations for this difference in
ndings are the changes in the regulatory environment during late 1990s and in 2001
and the differences in increased focus on board and audit committee oversight
responsibilities. These are likely to have strengthened the motivation of boards of
directors and audit committees to act in a manner inconsistent with our hypotheses.
Additional testing of H3 is undertaken by an investigation into internal governance
structures of both Bumiputera-controlled and non-Bumiputera-controlled rms. An
examination of internal governance structures is likely to help explain the lower audit
fees paid by the Bumiputera-controlled rms as reported in the previous section.
Additional tests of corporate governance structures of rms. The proportion of
Bumiputera directors on boards is regressed against the set of control variables and
governance variables used in the study. An independent sample t-test is also conducted
to compare means of internal governance structures for Bumiputera-controlled and
non-Bumiputera-controlled rms.
T-tests for internal governance variables for rms grouped as Bumiputera rms
(assignedvalue of 1) andthose non-Bumiputera rms (assignedvalue of 0) are presentedin
Table V. With the exception of audit committee expertise, there is a signicant ( p , 0.05)
difference in internal governance structures for Bumiputera-controlled and
non-Bumiputera-controlled rms. The t-test results are conrmed by non-parametric
Mann-Whitney U tests. x
2
tests are conducted for dichotomous variables (i.e. dual
leadership structure and the existence of a risk management committee) and indicate that
there is a statistically signicant ( p , 0.01) difference between Bumiputera-controlled
and non-Bumiputera-controlled rms in their internal governance structures (dual
leadership structure and the existence of a risk management committee).
Table VI presents the results of a regression model using the proportion of Bumiputera
directors onboards as the dependent variable, and the model is signicant ( p , 0.01) with
an adjusted R
2
of 18.6 percent. The results in Table VI indicate that boards of
Bumiputera-dominated rms are more independent and these rms are more likely to
separate the roles of the board chair and the CEO. This is evidenced by the strong positive
association between the proportion of Bumiputera directors on boards and these two
internal governance variables ( p , 0.01). Bumiputera-controlled rms also appear to
have a better risk management environment as evidenced by the strong positive relation
between the proportion of Bumiputera directors on boards and the existence of risk
management committees ( p , 0.01). Further, Bumiputera-controlled rms are more
diligent as indicated by the strong positive association between the proportion of
Bumiputera directors on boards and the frequency of board meetings ( p , 0.05).
Governance
structures,
ethnicity
773
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Table V.
T tests, x
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test for
independence, and Mann-
Whitney U test for
internal governance
variables between
Bumiputera- controlled
rms and non-
Bumiputera- controlled
rms
a
MAJ
21,7
774
The results also show that audit committees of Bumiputera-controlled rms are more
independent as indicated by a strong positive association between the proportion of
Bumiputera directors on boards and audit committee independence ( p , 0.01). The
proportion of Bumiputera directors on boards are not signicantly related to audit
committee expertise, audit committee-meeting frequency, and audit committee size.
Overall, these results do not support the view that Bumiputera-dominated rms have
weaker governance environments relative to non-Bumiputera-controlled rms as
previously suggested by Gomez and Jomo (1997) and Johnson and Mitton (2003).
With respect to the association between non-Bumiputera-controlled rms and their
internal governance structures, these results appear to be consistent with the view that
Chinese-controlled rms tend to have more inside directors on their boards of directors
and are likely to have a unitary leadership structure (Weindebaum, 1996; Redding,
1995). Chinese businesses do adopt some of the practices of western rms like
recruitment of professional managers and some degree of public ownership. But
essentially, the ownership stakes and control are still in the hands of family holding
companies and family members. Therefore, it is likely that the selection of personnel
for key positions such as board chair, CEO, and managing director, and board of
directors is another way through which control of the company is maintained [19].
The study also explores the internal governance practices of Bumiputera-dominated
boards using logistic regression analysis with the dependent variable set at 1 for rms
whose board members are predominantly Bumiputeras and 0 if otherwise. Unreported
results obtained using the logistic regression method conrm those obtained using the
ordinary least square method indicating that rms whose boards are predominantly
Bumiputeras practice improved internal corporate governance practices relative to
their non-Bumiputera counterparts.
The results obtained in this additional analysis are likely to help explain the
negative signicant association between external audit fees and Bumiputera-controlled
rms. It appears that Bumiputera-controlled rms practice favourable corporate
governance practices relative to non-Bumiputera rms and thus are likely to contribute
to lower auditors risk assessments, resulting in lower external audit fees.
Conclusion
The unique institutional environment in Malaysia coupled with the presence of a clearly
identiable ethnic domination of corporate boards and ownerships of Malaysian listed
rms potentially provides evidence of monitoring differences that exist in these rms.
The study examines the link between external audit fees and internal governance
structures and the element of ethnicity. Overall, we nd that external audit fees are
positively and signicantly associated with board independence, audit committee
expertise, and the frequency of audit committee meetings. In contrast to the ndings
documented byEichenseher (1995) andCheAhmad and Houghton (2001), we document a
signicant negative relation between external audit fees and Bumiputera-owned rms.
An additional analysis also reveals that Bumiputera-controlled rms practice
improved internal corporate governance practices compared to their non-Bumiputera
counterparts. This nding supports the result obtained earlier wherein
Bumiputera-controlled rms pay lower external audit fees because their internal
governance structures are stronger relative to their non-Bumiputera counterparts. With
respect to the association between external audit fees and governance variables, the
Governance
structures,
ethnicity
775
results do not support the risk-based perspective of audit services (i.e. good corporate
governance practices reduce external audit fees). The results, however, are consistent with
the demand approach of audit services, wherein rms with good corporate governance
attributes demand higher audit quality, resulting in higher external audit fees.
While our studymakes an important contribution to the governance debate, there are a
number of limitations that are inherent in this current study. One of the limitations is that
the results of this study cannot be generalised and should be interpreted in the context of
the Malaysian corporate environment, particularly where ethnicity is concerned. Further,
the nancial and corporate data employed in this study and the ndings thereafter may
not completely explain the link between governance variables and external audit fees as
other variables such as detailed ownership structures are likely to better explain the
relationship. Inadditionto archival data, data gathered using survey methods for instance
are also likely to provide better insights to ndings of this study.
Notes
1. Bumiputera means in Malaysons of the soil. It refers to Malays and other indigenous
people as distinct from Chinese, Indians, and other non-indigenous residents.
2. The Kuala Lumpur Stock Exchange (KLSE) became de-mutualised exchange and was
renamed Bursa Malaysia in April 2004.
3. It is also important to note that recent studies have documented the link between audit
committee member independence and audit fees from a demand approach of audit services.
For instance, Abbott et al.(2003) nd that audit committee independence and other audit
committee characteristics (i.e. expertise and diligence) are positively related to audit fees.
They suggest that an independent, expert, and diligent audit committee demands increased
audit coverage or purchases a higher-quality audit, hence higher audit fees. Independent
audit committee directors are likely to view their service on an audit committee as a means of
Variables Exp. sign Coefcients t-statistics ( p-value)
a
Intercept ? 20.625 23.302
* *
(0.001)
Size ? 0.023 2.283
*
(0.023)
Leverage ? 0.0001 0.037 (0.970)
Receivables/total assets ? 0.096 1.420 (0.156)
Inventories/total assets ? 20.425 24.417
* *
(0.000)
Returns on assets (ROA) ? 20.116 22.857
* *
(0.004)
Big four ? 20.047 22.343
*
(0.019)
Number of subsidiaries ? 20.006 21.058 (0.291)
Internal governance variables: board and audit committee characteristics
Percent independent directors ? 0.460 4.792
* *
(0.000)
Dual leadership ? 0.083 3.595
* *
(0.000)
Risk management committee ? 0.055 2.764
* *
(0.006)
Number of board meetings ? 0.011 2.447
*
(0.015)
AC independence ? 0.298 4.489
* *
(0.000)
AC size ? 0.014 1.209 (0.227)
AC expertise ? 0.009 0.187 (0.852)
Number of AC meetings ? 0.008 1.041 (0.298)
Adjusted R
2
0.186
F-statistics ( p-value) 12.196
* *
(0.000)
Notes:
a
All p-values are 2-tailed;
* *
p , 0.01;
*
p , 0.05
Table VI.
Regression results for
relationship between the
proportion of Bumiputera
directors on boards on
control variables and on
board and audit
committee characteristics
(N 736)
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enhancing their reputational capital (Fama and Jensen, 1983a, b). The preservation of
reputational capital serves as one motivation for higher quality reporting.
4. The government-linked companies (GLCs) are included in the Bumiputera ownership category
because the government is staffed mainly by Bumiputeras (Malays) and these companies have
hiring policies that give strong preferences to Bumiputeras. In addition, government-controlled
companies rely heavily on Bumiputera suppliers and vendors. Outstanding shares of these
companies are substantially held by government-linked investment companies (GLICs). These
government-linked investment companies include Khazanah Nasional Berhad (the investment
arm of the Ministry of Finance), Permodalan Nasional Berhad (manages various national unit
trusts), employees provident funds (EPF), pilgrimage board funds (Lembaga Tabung Haji), and
the military pension funds (Lembaga Tabung Angkatan Tentera).
5. The Main Board companies have a minimum paid-up capital of Ringgit Malaysia (RM) 60
millions while the second board companies are those that have a minimum paid-up capital of
RM40 millions.
6. FollowingAbbott et al.(2003), rms in their rst year of public trading are excluded because it is
expected that these rms require an initial period of time post initial public offerings to appoint
an audit committee and effectively transfer functions to the committee and for the committee to
meet. Some companies in the sample did not meet during the year as stipulated by the Listing
Requirements of Bursa Malaysia because they were new listings. The Listing Requirements of
Bursa Malaysia requires audit committees of its listed rms to meet at least four times a year.
7. In compliance with the Companies Act 1965, all listed rms disclose their substantial
shareholders including their 30 largest shareholders in their annual reports. The Bumiputera
shareholding percentage is based on the 30 largest shareholders. Therefore, a
Bumiputera-controlled company (by virtue of their largest shareholdings in a company) is
one in which 50 percent or more of the 30 largest shareholdings is held by government and
semi-government agencies, Bumiputera individuals, Bumiputera-owned companies, and
Bumiputera trust agencies. The same categorisation procedure is used to identify
non-Bumiputera shareholdings.
8. Other measures of ethnicity used in this study include: the proportion of Bumiputera directors
on boards; a dichotomous variable set as 1 if a Board of Directors is predominantly
Bumiputeras, 0 if otherwise; and the proportion of Bumiputera substantial shareholdings. The
ethnicity of the board of directors is determined by examining the names of directors. If the
names are of Chinese origin, for example, having surname of Tan, Chan, or Lee, the criterion is
satised, that is, the director is assumed to be Chinese. A similar approach is also used for
directors who are non-Bumiputeras (i.e. foreign directors or other ethnicities other than
Bumiputeras or Malays). For Bumiputera names or Malay names, the same procedure is used.
The board of directors is categorised as non-Bumiputera directors in the case of uncertainties
between Bumiputera directors and non-Bumiputera directors (Eichenseher, 1995). This
categorization rule is based on the notion that government pressure is exerted to place local
andparticularly Bumiputera (Malay) directors onboards of directors to increase Bumiputeras
participation in listed companies as per New Economy Policy initiatives (Mehmet, 1988).
9. All companies have at least three members on their audit committees except Johan Holdings
Berhad, KPS Consortium Berhad, and UCP Resources Berhad which have two directors on
their audit committees.
10. Two tests are performed to detect multicollinearity. First, variance ination factor (VIF)
scores reveal no problems with multicollinearity (all scores are less than 2). Second, per
Besley et al.(1980), the condition indices are calculated. The condition index is less than 30
indicating weak relations among the independent variables (Besley et al., 1980). Therefore, it
appears that multicollinearity is not a problem.
Governance
structures,
ethnicity
777
11. The study performs a number of diagnostics on the regressions reported in Table IV, and in
those reported in subsequent analyses, including investigation of outliers for both control and
governance variables. The variables with univariate outliers include size, leverage, receivables
and inventory intensity, frequency of both board and audit committee meetings, and board size.
To test whether outliers alter the results, the outlying observations whose standardised z-scores
exceed ^ 3 are excluded and the regressions are re-run. The unreported regression results are
qualitatively similar as those reported in Table IV. Tests are also conducted to detect
heteroscedasticity. The Breusch-Pagan-Godfrey test indicates that a heteroscedascity problem
exists. Whites (1980) heteroscedasticity consistent covariance matrix is performed for all
regressions run in this study to help correct the problem.
12. To address the potential effect of listed board, a dichotomous variable (i.e. whether a rm is
listed on the main board or the second board of the Bursa Malaysia) is included in the
regressions. The unreported results show that external audit fees are positively and
signicantly associated with the BOARD variable (the coefcient 0.108;
t-statistic 2.204; p-value 0.028). The unreported correlation indicates that this
variable is highly correlated with the SIZE variable (0.511; signicant at the 0.01 level;
two-tailed). Because of high correlation between the BOARDand the SIZEvariables, the study
drops the BOARD variable from the regressions. Regression results remain qualitatively and
statistically unchanged when the variable is included (or excluded) from the regressions.
13. As an alternative measure of leverage, the ratio of long-term debt to total assets
(LTDebt/TA) is used in place of the ratio of total debt to total assets (a variable denoted as
Leverage in the regressions throughout the study). The unreported results show that there
exists a positive association between external audit fees and the ratio of long-term debt to
total assets. The positive association, however, is not statistically signicant (the
coefcient 0.252; t-statistic 1.497; p-value 0.135).
14. External audit fees are not signicantly associated with industrial products
( p-value 0.827), Consumer Products ( p-value 0.665), Constructions
( p-value 0.852), Technology ( p-value 0.563), Trade and Services ( p-value 0.495),
andHotel ( p-value 0.638). There also exists a non-signicant negative association between
external audit fees and property (0.909), plantations ( p-value 0.985), and infrastructure
companies ( p-value 0.529) sectors. In order to have parsimonious models and also due to
their non-signicant associations with external audit fees, the industry variables are excluded
and regressions are re-run. The results remain qualitatively and statistically unchanged after
excluding the industry variables from the regressions. It is also important to note that the
adjusted R
2
for the regression with industry variables is 70.6 percent, which is about 0.01
percent higher than that without industry variables (see R
2
in model 1 in Table IV). Other
control variables also remain qualitatively and statistically unchanged.
15. The ethnicity variable is excluded because model 3 seeks to investigate the association between
external audit fees and board characteristics, which are largely found in the existing literature.
16. The study also further examines whether board size is likely to be inuenced by size of
companies measured by total assets. One would argue that larger companies are likely to
have more directors on their boards to reect complexity of their operations and
diversications of the company. Therefore, a greater number of directors with diverse
expertise and greater facilitation of task assignments are required. The study, therefore,
scales board size by total assets. When this transformed variable is included in the
regressions and the regressions are re-run, the results obtained containing this variable is
statistically similar to those of absolute value of board size, indicating that board size is not
inuenced by the size of the company.
17. An explanation for the adjusted R
2
s being almost the same for all models is that control
variables consistently explainmore variationinexternal audit fees thangovernance variables.
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Governance variables provide little incremental explanatorypower. Notwithstandingthat, the
strong association between external audit fees and governance variables appear to support
existing empirical evidence from the demand approach of audit services.
18. There are some mixed results with respect to other measures of ethnicity. For instance, when
measured using the proportion of Bumiputera directors on boards, the proportion of
Bumiputera substantial shareholdings, and a dichotomous variable of whether a rms
board of directors is predominantly Bumiputeras, the association between external audit fees
and these variables are not statistically signicant.
19. The majority of businesses in Malaysia are owned and operated by Chinese (Horii, 1991).
Chinese businesses generally have some common characteristics. These characteristics
include centralised decision-making with heavy reliance on one dominant chief executive,
family ownership and control, and most if not all top management positions are lled with
family members.
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Corresponding author
Puan Yatim can be contacted at: puan@pkrisc.cc.ukm.my
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