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ARA
20,3
Factors influencing auditor
change: evidence from Malaysia
Sharifah Nazatul Faiza Syed Mustapha Nazri
University Teknologi MARA, Shah Alam, Malaysia, and
222
Malcolm Smith and Zubaidah Ismail
Edith Cowan University, Perth, Australia

Abstract
Purpose – The purpose of this paper is to examine two factors which influence auditor change: audit
and client firms’ characteristics, for Malaysian listed companies. Given the costs involved, it is
important to understand the reasons why companies change their auditor and choose a particular level
of audit assurance.
Design/methodology/approach – This study evaluates the effects of various independent variables
on auditor change behaviour and the sensitivity of results to alternative period measurement by using
logistic regression analysis.
Findings – An examination of 400 companies listed on the Bursa Malaysia (formerly known as Kuala
Lumpur Stock Exchange-KLSE) over a period of 18 years reveals auditor change to be significantly
influenced by client firm’s characteristics, notably changes in management, size of the client firm,
complexity, and client’s firm growth, lending support to the findings of previous survey studies.
Research limitations/implications – In the cause of brevity, a number of potentially important
variables, that might enhance an understanding of auditor change behaviour in Malaysia, were not
incorporated in the regression models, and might be considered in future studies.
Originality/value – The results presented in the paper have important implications for both the
auditing profession and regulators in Malaysia.
Keywords Malaysia, Auditing, Auditors, Operations management, Audit change, Audit quality,
Audit assurance, Client firm complexity
Paper type Research paper

Asian Review of Accounting
Vol. 20 No. 3, 2012
pp. 222-240
r Emerald Group Publishing Limited
1321-7348
DOI 10.1108/13217341211263274
1. Introduction
The “auditor change” phenomenon has been found to have implications for the
credibility of financial reporting and the cost of monitoring management activities
(Huson et al., 2000). Academics, accounting professionals and industry experts have
extensively studied the great number of auditor changes in developed countries since
the early 1970s, but few studies have been conducted in Malaysia to examine the
significant reasons for auditor change.
Auditor change involves resignation and removal of auditors from the client firm
(Turner et al., 2005). In Malaysia, the issue of auditor change or rotation of audit firms
is not explicitly addressed in any statute, neither the Companies Act 1965 nor the
Security Commissions Act 1985. The Malaysian Institute of Accountants does
provide guidelines when auditor change or rotation of audit firm takes place, but
despite the chairman of the Malaysian Accounting Standards Board (The Edge, 2002)
announcing the intention of the board to make rotation of audit firm mandatory, every
five years, nothing has been done to date. Therefore, the possible effects of auditor
change on auditor independence in Malaysia remain unclear.
In Malaysia, auditor change has not been taken seriously as the partners of audit
firms and the client firm perceive auditor change in a negative manner rather than in a
positive one. This is because for the audit partner, a change of auditor means that they
are going to lose clients and income, and for the client it means that they have to incur Factors
more cost. A study conducted by Jaafar and Alias (2002), on the rotation/changes of influencing
audit firm found that there are benefits and problems perceived by partners of audit
firms and CFOs of client firms. auditor change
In Malaysia, few studies have focused on auditor change; the most recent,
undertaken by Ismail et al. (2008) used a dataset covering the period from 1997 to 1999.
Other related studies include those of Abdul Nasser et al. (2006), Huson et al. (2000) and 223
Takiah and Ghazali (1993). As with Ismail et al. (2008); Abdul Nasser et al. (2006);
Huson et al. (2000) and Takiah and Ghazali (1993), but all have relied on relatively old
datasets. Jaafar and Alias (2002) used a questionnaire study to address the issue. Thus,
much remains to be investigated, especially given recent changes in the auditing
environment.
This study provides insights into the association between factors related to audit
and client firm characteristics and auditor change by companies listed on Bursa
Malaysia. In the context of auditor change, Malaysia is untypical because it is defined
as a country with weak legal protection, enforcement and corporate governance, and
where agency conflicts are high (Kallunki et al., 2007). The findings of the study will
strengthen and further streamline auditors’ responsibilities in the audit of financial
statements, and facilitate effective regulation of the auditing profession. Malaysia
currently does not have any statute or professional guideline that requires the
following information: who initiated the auditor change (the client firm or the audit
firm), any involvement by the board of directors or the audit committee to approve
the auditor change and any reportable events or disagreements with the predecessor
audit firm.
The Malaysian audit market differs from that in developed countries and other
Asian nations in a number of respects:
(1) The market is not competitive because the corporate environment is based on
politically favoured corporations, ethnicity, language and religion (Haniffa and
Cooke, 2002; Yatim et al., 2006; Gul, 2006). These circumstances have arisen
subsequent to the Malaysian government’s intervention in 1969 to increase the
participation of local Bumiputera in the Malaysian economy. In the context
of a racially diverse society, politically connected or favoured audit firms have
been created (Gomez and Jomo, 1997; Johnson and Mitton, 2003).
(2) Arthur Andersen ceased to practice in Malaysia in 2002 as a result of the
fall-out from the failure of US energy giant Enron. Ernst & Young acquired
the great majority of the associated audit business.
(3) Disclosure relating to the initiation of, and reasons for, auditor change in
Malaysia are not informative. While this information is documented in written
representations, it is not publicly available. Thus whether auditor change
results from resignation or dismissal by the client, remains outside the public
domain. For auditor changes in general, there is no disclosure requirement in
the annual report (Woo and Koh, 2001).
Interested parties in the company’s financial statements, therefore have very little
information to evaluate why an auditor change was put into effect. However, client
firms are required to report to the registrar of companies about the reasons for the
change, including matters of non-compliance with the provisions of the Act. For public
listed companies the managements of client companies’ are required to submit written
ARA representations from the auditor including reasons for such changes to Bursa Malaysia
20,3 if they are publicly listed. These reasons are not disclosed in the annual report
following the auditor change. It is also incumbent upon the auditor to report in writing
any irregularities in their appointment or any change in their appointment to the board
of directors and to the shareholders who appointed them. However, this document is
not publicly available either, nor are the reasons disclosed in the next annual report
224 following the auditor change. Interested parties are left wondering about the real
reason for the change.
As this study examines the factors leading to auditor change, it will also provide
investors and potential investors with a better understanding of auditor change and
may provide an early signal to them of potential problems in the company’s
management and financial health. Companies often attempt to hide the real reason
behind the process of auditor change, as they fear that the disclosure of such changes
may provide the first glimpse of potential problems in a company’s financial
statements and the company’s state of affairs. The insights provided on the factors
leading to auditor change can also guide policy makers in regulating the industry and
ensuring rules exist to protect auditor independence. The results may also provoke
further consideration of what kind of disclosures are appropriate when auditor change
takes place.
This study extends the Malaysian evidence available in two ways: first, by
extending the dataset for the period from 1990 up to 2008; and second, by including
some variables previously not tested in Malaysian studies.

2. Literature review and development of hypotheses

Research on audit demand reveals that auditor change can be explained by agency
theory. An agency relationship arises when one or more principals (e.g. an owner)
engage(s) another person as his/their agent (or steward/nominee) to perform a service
on his/their behalf (Watts and Zimmerman, 1986). Agency theory/contracting theory
can be viewed under two aspects: first, behavioural aspects – it is noted that there is
lack of a general theory to explain auditor choice and change (Schwartz and Menon,
1985; Knapp and Elaikai, 1988). The theory of auditor change and choice is based
heavily on economic theory (e.g. agency theory) (Beattie and Fearnley, 1998a). They
argued that economic theory can only provide a partial explanation and is not
sufficient to explain audit change behaviour. These deficiencies are due to failure to
incorporate behavioural factors into theoretical explanations of the auditor choice
process. Among these deficiencies are that economic theory does not address the
specific characteristics of the audit firm chosen; statistical models indicate that the
extant theory is unable to provide a rationale for a significant number of auditor
changes; and there are cases where companies do not change their auditors though
they are predicted to do so; and second, economic aspects – Schwartz and Menon
(1985); Grayson (1999) argue that there is no single theory that explains why companies
change auditor. However, agency theory appears to be a useful economic theory of
accountability, which helps to explain auditor change. Decisions for auditor change by
client firms are due to the principal-agent problem of separation of ownership and
control of a firm ( Jensen and Meckling, 1976) and the separation of risk bearing,
decision making and control functions in firms (Fama and Jensen, 1983). The conflict
of interest in the presence of information asymmetry appears to arise in the growth of
modern companies today due to absentee owners that has led to the use of professional
managers to manage the daily business operations of firms. The manager who is
running a firm, generally, has more information about the “true” financial position and Factors
results of operations of the firm rather than the shareholders. The reporting of this influencing
financial information to the owner (shareholder), generally, follows general accepted
accounting principles. auditor change
2.1 Audit opinion
A highly sensitive issue in relation to auditor change is the qualification of the audit 225
opinion, especially where one of management’s goals in an audit is to receive an
unqualified audit opinion from the auditors (Hendrickson and Espahbodi, 1991). As
unfavourable audit opinion may cause falls in executive remuneration and may result
in management changes; management has an incentive to avoid such opinions through
the strategic use of auditor dismissals (Lennox, 2002).
According to Williams (1988), managers might seek a new auditor when they
perceive that their reputation is being tarnished. The receipt of a qualified audit
opinion is widely recognised as being one of the factors that might damage a manager’s
reputation. As a result shareholders might lose confidence in the existing management
and seek to attempt to change the management team. Management, as the party
responsible for preparing the financial statements, will have an incentive to change
auditor if the financial statements had been qualified previously, in the hope of
obtaining a clean audit opinion. On the other hand, management may seek to replace
their auditors in an attempt to renew the principals’ (i.e. shareholders’) faith in the
financial reporting system, as well as to install a better monitoring system. Qualified
opinions are also perceived to have a negative effect on companies’ share price (Chow
and Rice, 1982), and can affect a company’s ability to source new financing (e.g.
Schwartz and Menon, 1985).
Prior research on the relationship between audit reports and auditor change has
focused on the effect of the auditors’ reports on the decision to switch auditors. Roberts
et al. (1990), Chow and Rice (1982) and Johnson and Lys (1990) report that unfavourable
audit reports may increase the likelihood of an auditor change. Chow and Rice’s (1982)
finding, however, indicates that firms that change auditors after receiving a qualified
opinion do not tend to move to auditors that issue relatively fewer qualified opinions.
Krishnan (1994) found that qualified opinions are also triggered by the conservative
and stringent treatment of auditing standards which precipitate auditor change by
companies. A Singapore study conducted by Woo and Koh (2001) found that qualified
opinions may actually trigger auditor change which could be traced to causes where
the qualification arose due to some matter of fundamental importance. A study
conducted by Krishnan et al. (1996) also found evidence that audit opinion influences
auditor change. Their arguments are upheld by Lennox (2000, 2002) who found in two
separate studies that when companies received qualified audit opinions they were
more likely to change auditors. Such changes increased the probability of getting
a better audit opinion. It has also becoming increasingly apparent, that, “companies do
successfully engage in opinion shopping and swapping auditors to suit their narrow
self-interest” (Vinten, 2003). Smith (1986) found evidence of the successful elimination
of “subject to” qualified audit reports by changing auditors; successive audit reports
appear to fail to identify the circumstances that would have effectively led to
qualification by the predecessor auditor in the first place. Smith (1986) contends that, in
certain instances, a genuine difference of opinion could be the pertinent issue.
In Malaysia, Hasnah et al. (1997) suggest that a client firm receiving a qualified
opinion is more likely to change auditors than one receiving a clean (unqualified)
ARA report. Takiah and Ghazali (1993) examined the association between qualified audit
20,3 opinions and their effect on auditor change, but failed to find a significant association
between the two variables, findings which may be attributable to a short study period
coupled with a small sample size. The wider aspect of auditor change was studied
by Huson et al. (2000), who examined the economic rationale for auditor change by
Malaysian listed firms and the effect of auditor change on share prices; this study
226 found the audit report to have no effect on auditor change. More recently, the study
conducted by Ismail et al. (2008) examined 31 Second Board Malaysian Companies,
which changed auditors between 1997 and 1999. Consistent with Huson et al. (2000)
and Takiah and Ghazali (1993), they found no significant relationship between
qualified reports and auditor change.
This study therefore posits the following relationship between a qualified opinion
and auditor change:

H1. The probability of client firm changing auditor is higher after receipt of a
qualified opinion than for client firms with unqualified opinions.

2.2 Changes in management

Changes in management are perceived to have a significant impact on auditor change.
Usually, stakeholders identify management weaknesses as the main cause of the
situation and may insist upon management changes in return for their continued
support. New management may be dissatisfied with the quality (and cost) of the
previous auditor and demand auditor change. New management may also look for new
auditors who agree with new reporting methods which show more favourable
financial results. As a result, new management may change to a new auditor with
whom they had some previous association. Agency theory views the relationship
between auditor and client to be a nexus of contracts and a change in the principal-
agent contract, as a result of the appointment of a new manager (agent), may
precipitate a change in auditor (Williams, 1988). An incumbent auditor may be
dismissed as he or she is viewed as being closely associated with the former
management. The new management could also request an auditor change because they
would like to bring in an auditor with whom they are familiar.
Based on previous studies, changes in management consist of changes in the
management team such as the change of the chairman of board of directors, financial
controller, managing director and the chairman of audit committee. As a result of
change in management, new management could demand the replacement of the
incumbent auditor with a new one with whom it has had favourable dealings in
the past (Hudaib and Cooke, 2005; Williams, 1988). Schwartz and Menon (1985) and
Firth (2002), found evidence that a change in managing director leads to switching
because new management attempts to disassociate itself from previous relationships
and prefers to deal with familiar parties (Burton and Roberts, 1967; Carpenter and
Strawser, 1971; Beattie and Fearnley, 1995). Beattie and Fearnley (1998b) provide
further evidence in relation to management change; they report that 35 per cent of
auditor change companies cited top management changes as a reason for the change.
Carpenter and Strawser (1971) and Beattie and Fearnley (1995, 1998b) also found that
change in management is a significant factor in auditor changes. In addition, Hudaib
and Cooke (2005) found evidence of a positive association between management
change and the propensity to change auditor. In Singapore, Woo and Koh (2001)
indicate that management changes are one of the main reasons for a company to
change auditor, supporting results found in Malaysia by Huson et al. (2000) who found Factors
that auditor switch decisions of listed firms were mainly determined by management influencing
change. Woo and Koh (2001) also found that director change is associated with a higher
probability of auditor change, though, neither Chow and Rice (1982); Schwartz and auditor change
Menon (1985) nor Williams (1988) reported any such association.
The signalling hypothesis argues that the choice of auditor is a means by which
managers may impart to the market additional information about the company, as well 227
as their own behaviour. This suggests that a new manager may signal to stakeholders
that companies’ management is being well monitored by choosing a higher quality
auditor as a replacement. However, there is also the possibility that the new manager
may bring in a lower quality auditor, with whom he is more familiar. Given that this
action might trigger stakeholders to question the auditor’s quality and consequently
the manager’s motive, the new manager may be reluctant to choose this option.
Empirically, Woo and Koh (2001) did not find an association between management
change and higher quality auditor selection. In the light of the discussion, the following
hypothesis is suggested:

H2. Changes in management (such as changes in board of directors, financial

controller or managing director) are positively associated with auditor change.

2.3 Client size and complexity

Large clients are less likely to dismiss their auditors (Francis and Wilson, 1988;
Haskins and Williams, 1990; Krishnan, 1994). This is because financial analysts and
the financial press scrutinise large companies’ auditor dismissals closely and this
factor might prevent larger companies from changing auditor as frequently as smaller
companies (Carcello et al., 2002). However, when the company has increased in size,
this will lead to increased difficulty for owners in monitoring managers’ actions
as the principals and agents now become more remote. Consequently, the level of
agency costs will also increase and the company may require a new (higher quality)
auditor to provide better monitoring. Increased size is also related to a higher
delegation of duties which can be associated with “loss of control” by the owner over
employees’ actions. In this situation, the company may engage a higher quality
auditor as a way to diminish the possible “loss of control”. Therefore, given that
auditor change is inevitable, a larger company is expected to engage a higher
quality auditor. In light of the above arguments, the following hypothesis is
suggested:

H3. The larger the size of the client firm, the more likely auditor change will occur.

Auditee complexity can be related to the presence of “loss-of-control” (Abdel-Khalik,

1993). Woo and Koh (2001) report that the number of subsidiaries and sectors in which
the companies operate, are significantly associated with auditor change. As expected,
their results show that the higher the number of subsidiaries, the higher the probability
of change. Palmrose (1984), however, did not find a similar relationship. Larger
companies are generally more complex than smaller companies, and most research
carried out has found a consistent relationship between client size and “auditor
changes” (Sankaraguruswamy and Whisenant, 2004). Palmrose (1986) and Woo and
Koh (2001) suggested that when a client firm increases its size, the number of agency
relationships will also increase. This will create more difficulties for owners to monitor
ARA managers’ actions or for debt holders to monitor managers’ and owners’ actions, hence
20,3 increasing the need for a more “independent audit”. Johnson and Lys (1990) and
Haskins and Williams (1990) also found that client firm size contributes towards
auditor change. However, Schwartz and Menon’s (1985) study failed to support a
relationship between the size of failing firms and auditor changes. A change in the
number of subsidiaries may also mean a change in the company’s geographical
228 dispersion and the number of industrial sectors in which it operates (Woo and Koh,
2001), consequences which may require auditor change. Thus the following hypothesis
is posited:

H4. The more complex the client firm, the more likely auditor change will occur.

2.4 Growth
According to Williams (1988), rapid growth can be viewed as a change in the client
contracting environment and thus would result in a change in the principal/agent
contract. A new contractual agreement may need to be created since there is a
possibility that the expanding company would bring in new management or the
company may need to hire more employees, which in turn will result in control
becoming more remote. Thus, companies that are constantly acquiring subsidiaries or
expanding into new markets would demand auditors who are more effective in
providing the audit service. Studies by Haskins and Williams (1990) and Johnson and
Lys (1990), report that the growth of a firm is associated with auditor changes.
DeAngelo (1981b) contends that, as companies grow, they are more likely to switch
auditor from a non-Big-8 to Big-8 auditor. Danos and Eichenseher (1986) found support
for the assertion that growing clients switched to a Big-8 auditor. In addition, Woo and
Koh (2001) found evidence that growing companies are less likely to switch from
higher quality to lower quality auditors.
Consistent results were also found in Malaysia by Huson et al. (2000). Their finding
of a positive relationship between firms’ asset growth and changes of auditor suggests
that rapid growth entails substantial increases in transaction volume and accounting
complexity, and decentralisation of financial controlling system thus requiring the
services of larger audit firms presumably having the expertise to provide specialised
services. Using stepwise regression analysis, Ismail et al. (2008) also found that auditor
change in Malaysia during the Asian Financial Crisis in 1997 was determined by client
firm growth.
However, Williams (1988), Krishnan et al. (1996), and Hudaib and Cooke (2005)
did not find any empirical support for an association between changes in client
size and auditor change. Based on the above discussion, this study expects that
high-growth clients are less likely to change auditor than are low-growth clients,
and there is a high probability that a small client with high growth will change from a
non-Big-4 audit firm to a Big-4 audit firm. Based on the above discussion, it is posited
that:

H5. The higher the growth in client firms, the more likely that auditor change will
occur.

To test the hypotheses and provide the data for construction of a regression equation,
data were collected for 400 companies; a treatment group of 300 who had changed their
auditors, and a control group of a further 100 companies who had not.
3. Research method Factors
3.1 Data sources influencing
The sample for this auditor change study comprises all the companies that changed
auditor between the years 1990 and 2008. The names of client companies that changed auditor change
their auditors over the analysis period were sourced from the Bursa Malaysia web site
(www.bursamalaysia.com/ – for the years 2000-2008) and from the companies’ annual
reports (for the years 1990-1999) available at the Bursa Malaysia library. The proxy 229
dates of auditor change were based on the official date of public announcement for the
notice of changes of auditor extracted from the annual reports by listed companies
and from the minutes of annual general meeting (announcement dates for auditor
changes) which are kept by the Companies Commission of Malaysia. It was also the
date used by Huson et al. (2000) in their study of firms listed on the main board.
Financial data were drawn from DataStream and the Bursa Malaysia handbook,
annual reports and web site, while other information were also sourced from the
disclosures made in the annual reports.
After the screening process, 300 client firms that change their auditors were
specified as being eligible to be included in the analysis. A further 100 client firms, that
did not change auditor, were randomly selected as control companies, resulting in a
final sample of 400 companies. No formal attempt was made to match companies
in the control group by size or industry, since that would have precluded these
variables being considered as explanatory factors. Thus there was no necessity for
the control group to comprise another 300 companies. Instead a random selection of
100 further companies was made among those who had never changed auditor; similar
characteristics were sought to those of the treatment group, with sensitivity analysis
performed to ascertain that the group was representative, or whether re-sampling
would be required. To confirm the acceptability of the client firms that change their
auditors and those of control client firms that do not change their auditors, tests
for significant differences were performed on mean, median and standard deviation of
total assets and total sales. Panel A in Table II summarises these results.

3.2 Data analysis

Logistic regression analysis was adopted to assess the relationship since the dependent
variables are dichotomous. The model parameters are estimated using the maximum
likelihood method whereby the coefficients that make the observation results most
“likely” are selected on the basis of an iterative algorithm. The maximum likelihood
method also has the advantage of asymptotic properties (Hudaib and Cooke, 2005). The
model has the dependent variable as “change” and “no change” and facilitates the
testing of the research hypotheses.

3.3 Model specification and framework

Figure 1 presents the research framework. As shown, factors which influence auditor
change can be classified into two major categories: audit and auditor characteristics.
The logit model of auditor changes can be expressed as follows:
CHANGE ¼ b0 þ b1 opinion þ b2 mgtchg þ b3 clientsize þ b4 subs þ b5 growth þ e

CHANGE is a binary variable indicating whether or not the client firms changed their
auditors. The other independent variables are defined in Table I.
ARA In annual reports, the actual date of auditor change is rarely disclosed, unless the
20,3 document (written representation) that was filed with Bursa Malaysia is accessed. This
study observed the discontinuity of auditor in office as a way to identify auditor
change. Whenever the auditor that signed the audit report was different from the
previous year, the company was classified as having changed its auditor, as it is clear
that the company has changed its auditor somewhere between the two fiscal year ends.
230 The period of measurement for auditor change is identified in Figure 2.

4. Empirical results
4.1 Descriptive statistics
As seen in panel A of Table II, a four-year period surrounding auditor change was
included to identify any significant differences across time. Client firms that change

Audit characteristics
Audit opinion

Management Decision to
Changes in management change
auditor
Client firm
characteristics Organisation
Figure 1. Firm size
Research framework Complexity
Growth

b0 Intercept
CHANGE Change auditors (1) or no change (0)
opinion The severity of opinion classified as unqualified (0), qualified “except for” (1), adverse
(2) or disclaimer (3) during the year preceding auditor change
mgtchg Equals (1) if the company changed BOD/MD/CEO during the year preceding auditor
change or (0) otherwise
clientsize Natural logarithm of changes in total assets two years before change – (xt1xt2/xt2)
subs (0) if number of subsidiaries is less than five, (1) if number of industries is more than
five
Table I. growth Change in sales two years before change – (xt1xt2/xt2)
Variables in the logistic b1, y b6 Coefficient of the predictor variables
regression model Error term

Predecessor auditor Successor auditor

(identified in the annual report) (identified in the annual report)

t bc2 t bc1 t dc0 t ac1

Figure 2.
Period of measurement Before auditor change Auditor change After auditor change
of auditor change
(bc) (ac)
 Auditor change companies Control companies Test for significant differences
t-test Wilcoxon signed-ranks test
Variables Mean SD Mean SD t-statistics p-value z-statistics p-value

Panel A: Sample description (auditor change companies and control companies)

Asset (tbct1) 872,166 2,258,304 892,890 1,993,276 0.12 0.73 0.71 0.48
Asset (tdct0) 897,491 2,729,946 943,981 2,201,832 0.16 0.69 0.93 0.35
Asset (tact1) 1,009,104 3,059,512 108,0590 3,139,217 0.39 0.53 1.28 0.20
Sales (tbct1) 497,705 1,217,474 606,041 1,223,967 0.62 0.43 1.46 0.14
Sales (tdct0) 436,179 1,288,234 615,336 1,225,196 3.27 0.07* 0.78 0.44
Sales (tact1) 565,606 1,627,102 685,907 1,376,545 0.79 0.38 0.57 0.57
Panel B: Continuous independent variables
clientsize 0.09 0.13 0.05 0.17 2.90 0.00** 1.39 0.17
growth 0.64 0.63 0.36 0.54 4.25 0.00** 2.55 0.01**
Panel C: Dichotomous independent variables
Coding 1 0 1 0
291 99
opinion (97%) 9 (99%) 1 1.11 0.27 1.11 0.27
158 67
mgtchg (53%) 142 (67%) 33 2.52 0.01** 2.50 0.01**
140 39
subs (47%) 160 (39%) 61 1.33 0.00** 1.33 0.00**
Notes: **,*Significant at 5 and 10 per cent levels, respectively (two-tailed)
influencing

Descriptive statistics
auditor change

231

Table II.
Factors
ARA their auditors were found to be smaller than those of control client firms that do not
20,3 change their auditors. For the audit change year, mean total assets of the client firms
that change their auditors was 5 per cent smaller than those of control client firms that
do not change their auditors while median total assets for client firms that change their
auditors was 17 per cent larger than those of control client firms that do not change
their auditors. Conversely, for the audit change year, mean (median) total sales for
232 client firms that change their auditors were 41 per cent (12 per cent) smaller than those
of control client firms that do not change their auditors. The sample of client firms that
change their auditors and control client firms that do not change their auditors consists
of relatively small companies. However, overall there is no significant difference
statistically in terms of total assets and sales between the two groups in any of the four
years. None of the p-values (two tailed) of the t-test or the Wilcoxon signed-rank test
was found to be significant, even at the 10 per cent level. Thus, it can be said that in
terms of size, the samples are comparable.
Panel B in Table II provides the descriptive statistics for variables measured as
continuous metrics and panel C in Table II for dichotomous variables. In the table,
summary statistics for the client firms that change their auditors and control client
firms that do not change their auditors are shown in separate columns. For continuous
measures, mean and standard deviation are shown. Statistical tests (parametric
and non-parametric) were performed to identify significant differences across groups.
The p-value for both tests is expected to be nearly identical. The results suggest that
companies that change auditor and the control companies group are distinctly different
from one another in a number of dimensions.
The sample of auditor change and control companies comprises relatively small
companies. During the auditor change year, the mean and median assets of auditor
change companies were RM897 million and RM290 million, respectively. For the
control companies, the mean assets ranged between RM715 million and RM1,080
million over the 1990-2008 period: median assets ranged between RM170 million and
RM255 million. Abdul Nasser et al. (2006) in his Malaysian study also reported a mean
size of clients of RM1.5 million. In comparison, the mean for clientsize was RM617
million and RM558 million for auditor change companies and control companies,
respectively, in Huson et al. (2000). The descriptive statistics also reveal that
client firm’s (clientsize), was found to be significant in the year of auditor change with
a t-value of 1.61 and 2.56 for auditor change companies and control companies,
respectively. During the auditor change the mean (standard deviation) value of
clientsize of auditor change companies was 3 per cent (20 per cent) in contrast to a mean
(standard deviation) of 0 per cent (13 per cent) for control companies. For comparison,
the mean value for clientsize was 42 and 35 per cent for auditor change companies
and control companies, respectively, in Ismail et al. (2008). Notwithstanding the
imperfect size matching, there are no significant differences in clientsize between
the auditor change and control groups.
In the present study, auditor change companies were found to experience a higher
growth rate than control companies in the year preceding auditor change and remains
higher mean growth rate immediately after changing auditor (64 and 63 per cent,
respectively). Conversely, Huson et al. (2000), in his Malaysian study, found that growth
over the five years surrounding the auditor change period for the two groups was
recorded at 170 and 70 per cent, respectively. However, Ismail et al. (2008) reported a
lower mean value of 32.66 and 20.11 per cent for auditor change companies and control
companies, respectively. In comparison, Woo and Koh (2001) reported a growth rate of
20 per cent in the year preceding auditor change for a sample of Singapore companies Factors
while DeFond (1992) reported a higher growth rate of 26 per cent in his US study. influencing
The difference may be due to a difference in sample size collected and a difference in the
period of time. auditor change
Panel C in Table II reports the descriptive statistics for the dichotomous variables.
A z-test was performed to test for differences in proportions between auditor change
companies and control companies. Results show that only a small proportion of sample 233
companies (2.5 per cent) had been issued with a qualified audit report during the period
under study. Neither disclaimer type of audit report nor adverse type of audit report
was found in this study. However, Takiah and Ghazali (1993) found that 11.8 and
8 per cent of disclaimer audit reports had been issued in 1988 and 1986, respectively.
Consistent with their finding (Takiah and Ghazali, 1993), there were no cases of adverse
type of audit report. Although the difference was not significant, the proportion for
auditor change companies was higher than for control companies with p-value at 1.11
and 1.11, respectively.
Changes in management (mgtchg) among auditor change companies were greater
than in control companies and the difference was statistically significant. Results
show that 225 companies changed their management during the period 1990-2008,
158 auditor change companies (53 per cent) and 67 non-auditor change companies
(67 per cent). This suggests that whether there is a case of auditor change or not,
companies tend to change their management. Similar results were also found in Huson
et al. (2000). In Singapore, Woo and Koh (2001) reported 57.4 per cent companies
changing management during the year preceding auditor change. The test statistics
suggest that the percentage difference in management change between auditor change
companies and control companies was significant at the 5 per cent level, but that both
groups of companies frequently changed their management.
The table reports significant differences with regard to complexity (subs). Results
show that 140 companies, respectively, have more than five subsidiaries (subs) as
compared to 160 companies that have fewer than five subsidiaries (subs).

4.2 Logistic regression analysis results

A logistic regression analysis was conducted to identify which factors influence
auditor change using audit characteristics and client firm characteristics as predictors.
Table III documents the regression results for the auditor change model. The model
w2-test provides the significance test for a logistic model; it is the probability of
obtaining this w2 statistic if there is in fact no effect of the independent variables, taken
together, on the dependent variable. It measures the improvement in fit that the
explanatory variables make in comparison to the model with only one term (null
model). In particular, the model w2 is a likelihood ratio test which reflects the differences
between the error not knowing the independents and the error when the independents
are included in the model. In general, a well-fitting model is significant at the 5 per cent
level or better; the significant w2 statistics, suggest a good fit. This indicates the
rejection of a hypothesis that knowing the independents makes no difference in
predicting the dependent in logistic regression. In this study, w2 is 43.56, po0.000 with
degrees of freedom equal to 6.
According to Tabachnick and Fidell (1996, p. 606) one method of assessing the
success of a logistic model is by evaluating its ability to predict correctly the outcome
category for cases for which the outcome is known. The classification table is a 2  2
table which tallies correct and incorrect estimates. It cross-classifies the actual binary
ARA Statistical test
20,3
w2 43.56
Degrees of freedom (df) 6
Significant 0.00
Correctly classified (%) 78.0
234 Change (%) 98.3
No change (%) 17.0
Coefficient (b) w2 Significance
Intercept 0.89 0.63 0.43
Audit characteristics
opinion 0.82 0.55 0.46
Client firm characteristics
mgtchg 0.61 5.71 0.02**
clientsize 3.44 8.99 0.00**
subs 0.52 4.12 0.04**
growth (tbc1) 1.23 17.85 0.00**
Notes: N, 400 companies; CHANGE, change auditors (1) or no change (0); opinion, the severity of
opinion classified as unqualified (0), qualified “except for” (1), adverse (2) or disclaimer (3) during the
year preceding auditor change; mgtchg, equals (1) if the company changed BOD/MD/CEO during the
year preceding auditor change or (0) otherwise; ethbod_0, equals (1) if the number of Malaysia BOD is
more than the number of Chinese BOD during the year preceding auditor change or (0) if otherwise;
clientsize, natural logarithm of changes in total assets two years before change – (xt1xt2/xt2); subs, (0)
if number of subsidiaries is less than five, (1) if number of industries is more than five; and growth,
Table III. change in sales two years before change – (xt1xt2/xt2). **,*Significant at 5 and 10 per cent level (two-
Summary regression tailed); growth and clientsize are found to be the determinant of auditor change at 0.00, followed by
results mgtch (0.02), and subs (0.04)

response with a prediction, where, in a perfect model, the overall per cent correct will be
100 per cent. The table, however, should not be used as goodness-of-fit measure
because it ignores actual predicted probabilities and instead, uses dichotomised
predictions based on a cut-off. The result can vary markedly by sample for the same
logistic model and hence, the classification table is not recommended for use in
comparing the results across samples.
The auditor change model in the present study, the percentage correctly predicted
was 78 per cent of the outcomes, a better holdout accuracy rate is than in prior studies,
e.g. Williams (1988) reports an accuracy rate of 66.1 per cent and Woo and Koh (2001)
67.6 per cent.
Audit opinion. The receipt of a qualified audit opinion (opinion), in this study does
not appear to be a determinant of auditor change in Malaysia. The variable is
insignificant, a result likely due to the small number of companies receiving a qualified
opinion, compared to those in the findings reported by Krishnan et al. (1996), Chow and
Rice (1982) and Craswell (1988). Furthermore, opinion shopping is not normal practised
in Malaysia. This study fails to support H1 (the probability of a client firm changing
auditor is higher after receipt of a qualified opinion than for client firms with
unqualified opinions). In this study, the results also reveal that there is no reporting of
adverse and disclaimer audit reports in Malaysia throughout the 18 years of data
collection from 1990 to 2008. Most of the audit reports reported either unqualified
or qualified audit reports. Similarly, Takiah and Ghazali (1993) also reported only
unqualified and qualified audit report using data from 1985 to 1989. Huson et al. (2000) Factors
similarly failed to find qualified audit report as the determinant of auditor switch influencing
among main board companies in Malaysia. Takiah and Ghazali (1993), using a w2-test
confirmed that there is no relationship between qualified audit opinion and auditor auditor change
switching in Malaysia.
However, Ismail et al. (2008) found that audit opinion is a significant variable
at 5 per cent level with positive b coefficient. The result indicates that client firms that 235
received a qualified report tend to switch their incumbent auditor for new ones.
However, this study was confined to second board companies in Malaysia. Hasnah
et al. (1997) confirmed that client firms switch auditors because of receiving a qualified
audit report and also because of the seriousness of audit qualification. In the UK,
audit opinion was a significant factor in auditor change in both Lennox (2000) and
Hudaib and Cooke (2005). In Hudaib and Cooke (2005), audit opinion was significant
when interacted with management change and financial distress variables, but certain
types of qualification were also important separately. Surprisingly, Woo and Koh
(2001) reported a significant but negative association.
Changes in management. The results reveal that management change (mgtchg)
is positively significant at 5 per cent confirming the hypothesis that changes
in management (such as changes in board of directors, financial controller or
managing director) are positively associated with auditor change. w2 at 5.71 indicates
a strong relationship between management change and propensity to change
auditor. This study supports H2 (changes in management (such as changes in board
of directors, financial controller or managing director) are positively associated to
auditor change). This finding was supported by Huson et al. (2000); in their study,
the auditor switch decision of listed firms in Malaysia is determined by
management change and positively significant at 1 per cent level. Hudaib
and Cooke (2005) and Woo and Koh (2001) report positively significant
management change variables in their studies in UK market and Singapore
market, respectively. Conversely, Chow and Rice (1982) did not find any significant
association. Meanwhile, in Malaysia, the study by Ismail et al. (2008) again reported
inconsistent findings, with found management change not found to be one of the
reasons for auditor change.
Client size and complexity. The results indicate a p-value at 0 per cent level
confirming the hypothesis that the larger the size of the client firm, the more likely that
auditor change will occur. A w2 of 8.99 indicates a strong relationship between client
size and propensity to change auditor. This study supports H3 (the larger the size of
the client firm the more likely auditor change will occur, when client firm size is
measured by natural log of total assets). This finding is supported by Abdul Nasser
et al. (2006), who found that client size is significantly associated with audit
switching at 5 per cent level and that client size was the most important factor in
explaining switching. Huson et al. (2000) who established a significant
relationship between client size and auditor change at 5 per cent level. Hudaib and
Cooke (2005) also reported the same significant results. However, there is some
conflicting earlier evidence with respect to client size from survey-based studies.
Jaafar and Alias (2002) confirmed the insignificant results on the relationship between
client size and auditor change using a survey with two different categories of
respondents, i.e. Bursa Malaysia public listed companies’ financial controllers and
partners of audit firms. Takiah and Ghazali (1993) also reported that there is no
significant relationship between company size and auditor change at the 5 per cent
ARA significance level for the period 1988-1989. In the USA, Chow and Rice (1982) reported
20,3 insignificant results in their study.
The other significant variable relating to complexity of client firm is the dummy
variable indicating a “1” change in the number of subsidiaries (subs). This suggests
that a company experiencing a major change in complexity is more likely to change
auditor in the following year. The positive coefficient indicates that the larger the
236 number of subsidiaries a client firm has (i.e. the higher the level of client firm
complexity) the higher the probability of auditor change. The strong p-value confirmed
the results on the relationship between complexity and auditor change. This study
therefore supports H4 (the more complex the client firm, the more likely auditor change
will occur). Woo and Koh (2001) also report complexity as an important variable, but
their result is based on a levels measure for the number of subsidiaries.
Growth. In the present study, client growth (growth) was found to be significant.
In this model, the variable, suggesting that companies tend to change their auditor in
anticipation of future growth. Client growth is significant at 5 per cent with w2 of 17.85
and indicates a strong relationship between client growth and propensity to change
auditor. The findings suggest that growth is a determinant factor in auditor change.
This study supports H5 (the higher the growth in clients firms, the more likely that
auditor change will occur). Ismail et al. (2008), using stepwise regression analysis,
also found that audit change in Malaysia is determined by sales growth at 5 per cent
level of significance. A positive significant relationship between companies’ growth
and the propensity to change auditor, was also reported by Huson et al. (2000) in their
Malaysian sample. A similar result was also reported for client growth in a Singapore
study (Woo and Koh, 2001). In contrast, client growth was found not to be significant
by Abdul Nasser et al. (2006).
These differences between the present and prior studies may result from
environmental differences (different time periods, different forms of measurement
and, in addition, different regulatory conditions for development countries compared to
those for UK, USA and Singapore studies). However, it is also possible that model
misspecification due to the omission of important auditor change determinants in prior
studies may be a factor.

5. Conclusions
The objective of this study is to identify the factors that influence auditor changes
notably audit and client firm characteristics. It extends to the Malaysian context the
existing work on auditor changes. Overall, the findings of this study are consistent
with those of prior studies. In particular, logistic regression analysis results indicate,
changes in management (mgtchg), client firm size (clientsize), complexity (subs) and
client firm growth (growth) are shown to be factors that influence auditor change,
lending support to the findings of previous survey studies. Several conclusions can be
drawn from this study: first, client firms that have changes in management
composition are more likely to change auditors; second, client firms that are more
complex change auditor more often than those that are not. As the number of
industries increases, the incumbent audit firm may be incapable of handling the
complex and huge volume of activities. These client firms may thus change to audit
firms who can offer their services competently and competitively; and finally, growing
firms are more inclined to change auditors. Rapid firm growth alters the economies of
scale previously available to the incumbent auditors, who may now not be able to
accommodate the expansion at acceptable costs.
 The incidence of auditor change and opinion shopping has implications for client Factors
risk management. As the company’s health deteriorates more disagreements may arise influencing
between client and auditor regarding issues associated with internal control
weaknesses and the reliability of financial reporting. Auditor switching might be auditor change
seen as an alternative to an auditor qualification, with internal weaknesses
remaining unsolved; switching that may increase the litigation risks for both client and
auditor. 237
It is also noted that the study expects a qualified opinion to be associated with
higher probability of auditor change. However, the receipt of a qualified audit opinion
(opinion) is not a determinant of auditor change in Malaysia (H1). This result is
supported by Huson et al. (2000) and Takiah and Ghazali (1993). However, this finding
is not consistent with the results conducted in developed countries such as in the USA,
UK and Australia (e.g. Lennox, 2000; Hudaib and Cooke, 2005). Perhaps the severity
and nature of the opinion may affect whether a switch is made. This study only uses a
dichotomous measure for qualified and unqualified opinion. In addition, this study also
found that there were no cases of adverse and disclaimer type of audit report. It can be
concluded that in developing countries like Malaysia, where the market for audit
services is not competitive, audit opinion is not a major reason for auditor change. This
contrasts with research done in other countries where the audit market is well
developed and competitive.
Some potential limitations should be considered when interpreting the results of the
study. This study does not make a distinction between auditor resignation and
dismissal since it is difficult to identify a case of resignation or dismissal in Malaysia.
However, it is acknowledged that there are some differences in terms of the
determinants of the two types of auditor change. While auditor resignations are
likely to constitute a small number of cases, there is a possibility that the results
obtained from more refined information would provide stronger or different results.
Disclosure regarding auditor change can be found in the written representation,
but, such written representations are not publicly available. Such disclosures may
provide investors with a useful glimpse into a company’s financial reporting system.
Investors should pay close attention to these disclosures, where available, as the
impact on a particular company’s stock price is unique and specific. There are some
data limitations: companies may have changed name, merge or been taken over, for
example, following the Asian Economic crisis of 1997. There is consequently a
possibility that some auditor change companies may have been excluded from the
study.
Following the limitations highlighted above, future research might be expected to
examine the issue of auditor changes in a different context. Further, replication of the
study and including other potential auditor change determinants in the model such
as audit tenure, non-audit service, income manipulation, new financing, other
corporate governance variables such as audit committee, board independence, duality
of CEO and the auditor-client relationship may provide further valuable insights,
especially since Malaysia has undergone significant corporate governance reforms
since 2002 for all listed companies. These inclusions will provide a more
comprehensive auditor change model. This study used several proxies for financial
risk and audit specialisation and was unable to distinguish between resignation and
removal of auditor. Subject to data availability, this distinction could be further
explored. This might also provide an important avenue to help regulators in decision
making as to the mandatory disclosure required when firms change auditor.
ARA This study unashamedly focuses on the market and economic aspects of auditor
20,3 change; to provide a more complete picture of the drivers of change studies, a
behavioural perspective might be contemplated.

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Corresponding author
Malcolm Smith can be contacted at: Malcolm.smith@ecu.edu.au

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