Nonaudit services, audit committee characteristics and accruals quality in Malaysia

Abstract

Purpose

The study examines the relationship between nonaudit services (NAS) and accruals quality in Malaysia. The study also considers several important characteristics of audit committee as the determinant for accruals quality. Next, the study examines whether these characteristics mitigate the relationship between NAS and accruals quality.

Design/methodology/approach

The study employs descriptive analysis, univariate tests and multivariate regression to investigate the potential effect of NAS on acruals quality. Data for audit committee characteristics were hand collected from annual reports downloaded from Bursa Malaysia's website.

Findings

Based on 1,118 firm-year observations for the period 2009–2011, the study finds that NAS negatively impact accruals quality. This empirical result indicates that the economic bond that is created between auditors and clients restricts the auditors from performing their duty objectively. A fully independent audit committee weakens the negative relationship between NAS and auditor independence.

Research limitations/implications

The sample period represents a limitation since it only covers three years of data. This limitation is largely driven by the nature of data collection of NAS fees.

Practical implications

These results contribute to Malaysia's policy deliberation to account for the effects of NAS on auditor independence and the oversight role of an audit committee. This study contributes to theoretical perspectives on accruals quality and corporate governance in Malaysia.

Originality/value

The novelty of this research, coupled with institutional data in Malaysia, claims the originality of this research.

Citation

Nik Abdul Majid, W.Z., Abdul Wahab, E.A., Haron, H., Agustia, D. and Nasih, M. (2022), "Nonaudit services, audit committee characteristics and accruals quality in Malaysia", Asian Journal of Accounting Research, Vol. 7 No. 2, pp. 146-162. https://doi.org/10.1108/AJAR-09-2020-0090

1. Introduction

Does the audit committee play its oversight roles in relation to auditor independence? This question has long been debated, especially when the incumbent auditor provides nonaudit services (NAS). The existence of an audit committee is expected to improve auditing and governance quality. Audit committee members' independence is important because the committees' monitoring affects earnings quality (Inaam and Khamoussi, 2016) and auditor independence (Abbott et al., 2003). Independent audit committees have been associated with a higher disclosure quality (Karamanou and Vafeas, 2005) and a lower cost of debt finance (Anderson et al., 2004).

To protect auditors' independence in fact and in appearance, some countries, such as France, ban the provision of NAS, and current European auditing regulation prohibits the provision of most of the NAS and limits the total for NAS (Meuwissen and Quick, 2019). While in Malaysia, fees paid for NAS are not regulated or restricted under any legislation or act. With no strict enforcement, auditors will accept to jointly provide audit and NAS. This will affect the independence of the auditors (Abdul Wahab et al., 2020).

Auditor independence is associated with the quality of accounting information. The quality of accounting information was affected after the 1997 Asian Financial Crisis, and many collapsed firms were associated with accounting scandals, such as the well-known case of Enron and World Com in the United States (US), HIH insurance in Australia, Parmalat in Italy and Malaysian firms such as Megan Media, Transmile Group Berhad, Technology Resources Industries Berhad, Ocean Capital Berhad, Welli Multi Corporation Berhad and Southern Bank Berhad. It has been claimed that such incidences arose because of governance failure and auditing issues.

The objectives of the study are to examine the association between NAS and accruals quality and to examine the interaction of audit-committee variables on the relationship between NAS and accruals quality.

The study extends current research in several ways. First, this study uses Malaysian data, where the institutional setting may differ from developed countries such as the US, the United Kingdom (UK) and Australia with established rules and regulations. Although Paterson and Valencia (2011) and Abdul Wahab et al. (2014) examined the different types of NAS to auditor independence, these studies use financial restatements as a proxy for auditor independence without the interaction of audit-committee characteristics. Instead of financial restatements, this study uses earnings quality that focuses on accruals quality to proxy for auditor independence. We extend the work by Abdul Wahab et al. (2020) by incorporating the effects of audit committees' oversight roles. This will add to the literature on accruals quality and NAS, with the interaction of audit committees, which are limited in Malaysia.

The study believed that the different institutional settings in Malaysia, where most of the businesses have highly concentrated ownership, are family firms and are subject to government interventions, and political influence (Abdul Wahab et al., 2007, 2013, 2014, 2015) could provide different views in relation to the issue of auditor independence coupled with oversight roles of audit committees.

This study documents the negative relationship between NAS and accruals quality. The findings of the study support regulators' concerns that NAS may affect auditor independence in appearance. These results are consistent with Srinidhi and Gul (2007), which is consistent with the conjecture that economic bonding overrules auditor competence and affects auditor independence. This study supports previous research findings as modeled by De Angelo (1981), which finds that as the economic bond between audit firms and their clients increases, audit dependence also increases. The negative relationship between NAS and auditor independence weakens with a fully independent audit committee.

Section 2 proceeds with the study's institutional background that focuses on institutional setting for financial reporting and auditing in Malaysia. Section 3 presents the rationale for the development of research hypotheses. Section 4 highlights the research methods, whereas section 5 presents the results of the study and section 6 concludes.

2. Financial reporting and auditing in Malaysia

The accounting profession is not the only group that is responsible for instituting proper accounting and auditing systems. The profession is governed by regulatory bodies, such as the Securities Commission, the Central Bank and the Company Commission of Malaysia, the Accountant's General Office, the Auditor's General Office or Department, corporate players and managers of firms. These bodies have a significant role in ensuring that a sound financial reporting system exists to protect public interests.

To strengthen external auditors' independence, Malaysian Institute of Accountants (MIA) established by-laws on professional ethics, conduct and practice. Section 290 indicates that under the Independence – Audits and Review Engagements, the assurance team members and firms should be independent from clients during engagement. The rules also require that all firms listed in Bursa Malaysia (2012) Listing Requirement disclose the amounts of NAS provided by an external auditor.

All public-listed firms are required to disclose the amount of NAS incurred in annual reports under items para 19 of Appendix 9C of the Bursa Malaysia (2012) Listing Requirements. This disclosure clause, made mandatory by Bursa Malaysia in 2001, is aimed at protecting shareholders' interests and increase corporate transparency. Before 2001, Malaysian regulators emphasized only the disclosure of audit fees in firms' annual reports as required by the Company Act 2016.

To ensure the best practice in corporate governance, Malaysia has taken an effort in 1994 by making compulsory the involvement of audit committee to all public listed companies. Another initiative taken from the government, the formation of High Level Finance Committee through the Ministry of Finance that assigned to come out with Malaysia Code of Corporate Governance (MCCG). The code is the voluntary guide which is nonstatutory and self-regulatory.

MCCG has to go through many phases of revision for best practice for all firms listed on Bursa Malaysia [1]. The first issue, in March 2000, marked a significant milestone in corporate-governance reform in Malaysia. The Code was then revised in 2007 (2007 Code) to intensify the board of directors' roles and responsibilities, audit committee and the internal audit function. In relation to the members of an audit committee, the board should establish an audit committee that consists of at least three directors, a majority of whom are independent, whereas the chairman of the audit committee must be an independent nonexecutive director. To increase the audit committee's monitoring role, the new revised MCCG 2007 stressed the need to have audit committees of nonexecutive directors, with all being financially literate and at least one being a member of an accounting association.

3. Research hypotheses

3.1 NAS and accruals quality

Empirical evidence on the relationship between NAS and auditor independence is mixed. In the first view, NAS produce knowledge spillover (Abdul Wahab et al., 2014; Walker and Hay, 2013; Knechel et al., 2012; Krishnan and Yu, 2011), which increases the accruals quality and link with audit quality and auditor independence. They indicate that auditors who provide NAS are not compromising audit quality but are enhancing audit efficiency.

The provision of NAS enhances audit effectiveness because it supports auditors to have a better understanding on clients' operations (Simunic, 1984). Abdul Wahab et al. (2014) extend the study of Paterson and Valencia (2011) and provide evidence that NAS have a positive association with quality financial reporting and support the view of knowledge spillover.

In general, reputational concerns create a motivation for auditors to be independent (Defond and Zhang, 2014; Park, 2015). DeFond et al. (2002) state that the concerns of auditors regarding lawsuits cause NAS to affect audit quality favorably. Therefore, they may decide on their own audit firms as NAS providers because of the quality or cost. They argue the view that NAS may provide knowledge spillover because knowledge that develops during audit work may increase auditors' efficiency.

On the other side of the argument, past studies provide evidence that NAS affects auditor independence negatively (Che Ahmad et al., 2006; Gul et al., 2006; Higgs and Skantz, 2006; Srinidhi and Gul, 2007; Kamarudin et al., 2012a, b; Abdul Wahab et al., 2020). Using 2002 data from Bursa Malaysia of 868 firms, Che Ahmad et al. (2006) provide evidence on the worrying development of NAS to total fees and audit opinion is dependent on NAS fee. Furthermore, Srinidhi and Gul (2007) and Abdul Wahab et al. (2020) support that accrual quality has a significant negative association with the magnitude of NAS and creates a bonding between clients and auditors.

The provision of NAS render an auditor becomes part of a firm's administration and decision-makers, impairing objectivity. Furthermore, the percentage of NAS fees will lead auditors to acquiesce to the management's request to allow for earnings management practice. Srinidhi and Gul (2007) examine specifically NAS and accruals quality and provide evidence of auditor impairment in exercising auditors' judgment. They argue that unregulated NAS allow management to influence auditors by including excessive rents in NAS. Thus, we state the following hypothesis:

H1.

There is a relationship between the level of nonaudit fees and accruals quality.

3.2 Audit committee characteristics

3.2.1 Audit committee size and accruals quality

The Malaysian Code of Corporate Governance 2007 (revised) and the listing requirements of Bursa Malaysia require that the audit committee have at least three directors, the majority of whom are independent. The requirement by this standard reflects the importance of size in audit committees for effective governance. However, a larger audit committee may not necessarily cause more effective monitoring as a larger audit committee may lead to several deficiencies (Lin and Tang, 2008). Abdellatif (2009) finds that a larger audit committee can effectively mitigate asymmetric information during seasoned equity offerings. In addition, Mardjono and Chen (2020) document a significant negative relationship between the size of audit committee and earnings management practice. Thus, a large audit committee should have a positive effect on financial reporting quality.

However, Xie et al. (2003) find no significant relationship between audit committee size and current discretionary accruals as a proxy for earnings management. Mardjono and Chen (2020) link audit committee size with expertise and focus on efficient management and tend to uphold conservative as a corporate mechanism. Therefore, the increase in the size of audit committees is expected to increase oversight roles and enhance auditor independence, and it is posited that:

H2a.

There is a relationship between audit committee size and accruals quality.

3.2.2 Audit committee independence and accruals quality

Bursa Malaysia (2012) Listing Requirement classified audit committee independence as directors who are free from any relationship and are independent from a firm's management or having no shares in the firm and having no relationship with any major shareholders, officers and executive directors. Previous studies have documented evidence on the association between audit committee independence and earnings quality. Hashed and Almaqtari (2020) document evidence that audit committee independence positively affects compliance with International Financial Reporting Standard (IFRS). Xie et al. (2003) mentioned that the more independent the audit committees, it is argued to provide better governance compared to less independent audit committees. Mohd Saleh et al. (2007) provide evidence that a fully independent audit committee is an active mechanism against opportunistic earnings management practice.

Audit committees may demand greater external audit scope to avoid being associated with financial restatement, increasing the likelihood of external auditors detecting the misstatement (Abbott et al., 2003, 2004). In contrast, Sehrawat et al. (2019), Baxter and Cotter (2009) and Lin et al. (2006) fail to find evidence between audit committee independence and earning quality.

With reference to the arguments, it is predicted that audit committee independence can restrain management in earning management practice, thus increasing auditor independence. With that, it is posited:

H2b.

There is a positive relationship between audit committee independence and accruals quality.

3.2.3 Audit committee meeting and accruals quality

The frequency of meetings will help keep up-to-date information and increase monitoring power by audit committees. According to Gebrayel et al. (2018), meeting frequency may indirectly provide information on an audit committee's diligence. Prior studies suggest that an audit committee that meets frequently can reduce the incidence of financial restatement. An audit committee that meets frequently can proactively direct additional external audit resources toward a particular auditing issue in a timely fashion (Abbott et al., 2003).

Prior studies verify that auditor independence is positively associated with audit committee meetings, audit committee report in the annual report, roles to approve and review audit fees, and audit board composition (Muhamad Sori et al., 2008a, b). These results are consistent with the spirit of corporate governance code designed, among others, to improve the quality of financial reporting and, hence, to increase confidence in the information of the reports. However, Abbott et al. (2004) and Thoopsamut and Jaikengkit (2009) fail to prove the relationship between audit committee meetings and quarterly earnings management.

Based on the above arguments, it is predicted that audit committee meetings will enhance auditor independence to restrict earning management. Therefore, it is posited that:

H2c.

There is a positive relationship between audit committee meeting and accruals quality.

3.2.4 Audit committee expertise and accruals quality

MCCG (2007) places a requirement for all audit committees to be financially literate, and, more importantly, at least one must be a member of an accounting association. This requirement reflects the importance of an audit committees' expert in discharging their duties and, thus, is expected to reduce earning management and increase auditor independence. Previous researches verify that audit committee expertise can reduce the incidence of financial restatement. Effective audit committees can influence auditor accountability which leads to better audit quality and higher audit fees (Ali et al., 2018), a better understanding of auditing issues and risks, as well as audit procedures and tendencies that detected material misstatements would be communicated to the audit committee and corrected in a timely fashion (DeZoort and Salterio, 2001).

Experience and knowledge in accounting and auditing-related issues are considered essential attributes for an audit committee. This advantage can help audit committee members to be more conversant with financial and operational reports that effectively execute their oversight duties (Mat Zain, 2005). The oversight role of audit committees will increase the efficiency of the committees' performance. A few studies have documented a negative association between audit committee expertise and earnings management (Xie et al., 2003).

Prior studies provide support for corporate governance regulators' concerns about the monitoring benefits of audit committee independence and the presence of financial expertise on audit committees for auditors' reporting decisions (Wu et al., 2016; Baxter and Cotter, 2009; Abbott et al., 2004). However, Thoopsamut and Jaikengkit (2009) fail to prove the relationship between the proportion of audit committees with accounting or financial expertise and quarterly earnings management.

With reference to the above arguments, expertise is of significant importance to help audit committees discharge their oversight roles and curb any mismanagement and indirectly improve independence in auditing. With that, it is posited:

H2d.

There is a positive relationship between audit committee expertise and accruals quality.

3.2.5 Moderating effect of audit committee variables

The literature investigating the role of audit committees in relation to the purchase of NAS is limited. Since audit committees are involved in NAS purchase decision, their composition would influence the potential impact of auditor-provided NAS to the quality of auditor's report. They face a trade-off between the costs and benefits of auditor-provided NAS, resulting in knowledge spillover (Simunic, 1984) that improves audit processes or possibly a departure from auditor independence if NAS is also being provided by incumbent auditors.

Wu et al. (2016) provided evidence that the association between NAS and auditors' reporting decision is subject to audit committee characteristics. They prove that independent audit committees with expertise are less likely to issue a standard unmodified going concern report prior to failure. From an agency theory perspective, effective audit committees are presumed to vigilantly monitor management and reduce agency costs ensuring the objectivity of external auditors that bring the integrity of financial reporting (Al-Okaily et al., 2019).The involvement of audit committees in management has been proven empirically as an active monitoring body, especially in audit failure (Alderman and Jollineau, 2020).

However, some studies fail to reach a consensus on the negative association between audit committee size and the occurrence of a restatement. Sharma and Sidhu (2011) suggest that the association between client importance and earnings management is conditional on inside ownership, growth, leverage and firm size, moderated by the audit committee. They argue that audit committees can moderate threats to auditor independence and protect the quality of financial reporting. Kamaruddin et al. (2012b) suggest that NAS have a negative effect on earnings response coefficients (ERC), but the negative relationship is moderated by the presence of an effective audit committee. The interaction effect of audit committee variables is expected to mitigate the relationship between NAS and auditor independence. Therefore, it is posited that:

H3.

The relationship between NAS and accruals quality weakens with a strong audit committee.

4. Research method

Data comprised of all Malaysian public-listed firms in the main market of Bursa Malaysia from 2009 to 2011. In line with Puasa et al. (2014), the period chosen is after considering the implementation of MCCG 2007. Using the modification model of Dechow and Dichev (2002) by Francis et al. (2005), this study requires data for the prior and subsequent years, 2008 and 2012, respectively. The prior and subsequent data relates to previous NAS, lag cash flows, future cash flows, changes in current assets, changes in current variables, changes in sales and changes in short-term debts. The rationale for the chosen years of observation where the examination of the cash flows over a period of more than three years may be problematic; firms may change their structures and long-term strategies with a differential effect on accruals (Srinidhi and Gul, 2007).

Table 1 presents the data-selection procedure and indicates that 822 firms are listed on the main market as of 2011. Financial and insurance firms were excluded from the sample because they are subjected to different regulations. Firms with a status of PN 17 and without a complete annual report are also excluded. Final annual reports are provided from 655 firms. The study focuses only on firms that provide NAS. The number of final observations was 1,118, after taking into consideration nonprovider NAS and missing information of 284 and 563 firms, respectively.

Since quality financial reporting is associated directly with auditors' work, accruals quality (one of the construct of quality financial reporting) is used as a proxy to auditor independence. Audit quality is exhibited through the role that auditors engage in lessening estimation error in accruals. Auditors are able to get information and make judgment on accrual estimation error from audit effort and competence. In order to improve accruals quality, a fully independent auditor will require the management to revise their estimates and adapt their accounting methods.

This study focuses on accruals quality using the modified model of Dechow and Dichev (2002) by Francis et al. (2005). The absolute value of the estimation error (ABS) with a negative value is the dependent variable. Fixed effect model is applied in which the model parameters are fixed or nonrandom quantities. This model is chosen because it does not differentiate between errors and irregularities in accruals and does not rest on the assumption that accruals errors only occur because of intentional manipulation. The model used to represent the relationship between NAS fees and auditor independence is as follows:

ABS =β0 +β1NASit+β2AC_FINit+β3AC_INDit+β4AC_MEETit+β5ACSIZEit+β6BIG_4it+β7LEVERAGEit+β8FAMILY_Fit+β9BOD_BUMIit +β10EQUITY+β11LOSSit+β12POLCONit+β13ASSETit+β14INDUSTRIESit+εit

Interaction of audit committee:

ABS=β0+β1NASit+β2AC_FINit+β3AC_INDit+β4AC_MEETit+β5ACSIZEit+β6NASit∗AC_FINit+β7NASit∗AC_INDit +β8NASit∗AC_MEETit+β9NASit∗AC_SIZEit+β10BIG_4it+β11LEVERAGEit+β12FAMILY_Fit +β13BOD_BUMIit+β14EQUITYit+β15LOSSit+β16POLCONit+β17ASSETit+β18INDUSTRIESit+εit

NAS, deflated by a total fee, is the main independent variable in this study. This has been suggested by the Securities and Exchange Commission and also by prior studies (Bloomfield and Shackman, 2008; Knechel et al., 2012; Abdul Wahab et al., 2014, 2020).

Extensive prior research has applied audit committee independent variable to test the effectiveness of audit committees in their oversight role (Abbott et al., 2003, 2004; Xie et al., 2003; Lin et al., 2006; Mohd Saleh et al., 2007; Baxter and Cotter, 2009; Chatterjee, 2011). This variable will be measured by applying the dummy variable of “1” if all audit committees are independent or will be “0” otherwise.

Audit committee meeting is measured by calculating the proportion of audit meetings to the number of audit committees. Audit committee financial expertise is measured by using a dummy variable of “1” if the audit committee is financially literate or “0” if otherwise. The importance of audit committee size has been highlighted in previous studies (Xie et al., 2003; Lin et al., 2006; Lin and Tang, 2008; Abdellatif, 2009; Mardjono and Chen, 2020). Measurements in this study are conducted by calculating the number of executive and nonexecutive directors in the firms.

To provide a more holistic view of Malaysia's capital market, we included three variables that are established in the literature. The first is the proportion of Bumiputra directors on the board (BUMI), the second is an indicator variable that is equal to 1 if the firm is a family firm (FAMILY) and the third is another indicator variable that describes politically connected firms (POLCON). We predict a negative relationship between BUMI and accruals quality because they are viewed as being less transparent and high in secrecy (Haniffa and Cooke, 2002). We predict a positive and negative relationship with earnings quality for FAMILY and POLCON.

We control for firm size, which is the natural logarithmic transformation of total assets (ASSETS), debt to total equity (DEBT), auditor size, which is equal to 1 if the firm is audited by the Big 4 auditors (BIG4) and a dummy variable if the firm recorded a loss in the previous year (LOSS). We also included industry dummies (INDUSTRY) and period dummies (PERIOD) to control for any unobserved effects during the sample period. Table 2 provides information on the variable definitions and sources of data.

5. Results and discussion

Table 3 presents descriptive statistics for fee variables (panel A), independent corporate governance variables (panel B), institutional variables (panel C) and control variables (Panel D). AUDIT_FEE in panel data A presents an average of RM190, 801.800, with a maximum amount charged to the client of RM3,843,000. For the NAS fee that is denoted by NAS_RM, the mean value is RM49,121.660. Compared with Abdul Wahab et al. (2014) in the same setting with different observation years (2007–2009), the mean value is RM68121.255. The result of this study shows a decrease in the value of NAS in Malaysia. Earlier studies by Che Ahmad et al. (2006) included 512 firms from the main market, second board and MESDAQ for a one-year observation in 2002, which shows a mean of NAS of RM127460. The pattern of NAS in 2002 to date in this research shows that NAS keep decreasing. This result indicates that most Malaysian firms are very vigilant in providing NAS probably because of the Enron scandal and the demise of the established audit firm, Arthur Andersen. Another likely cause is the effectiveness of audit committee members in determining the policies and procedures for NAS to be performed by incumbent auditors.

Table 4 presents the correlation between continuous variables using the Pearson (ordinary) and Spearman rank. The correlations between estimation error (ABS) and NAS (NAS) are 0.108 (Pearson) and 0.116 (Spearman-rank). Pearson and Spearman rank correlations show a significant positive relationship at a 1% level, stating a contradiction to the hypothesis that NAS affect auditor independence [2].

Table 5 provides the results for the relationship between NAS and accruals quality. A significant level for coefficient estimates is one-tailed if the estimate is in the predicted direction and two-tailed if otherwise. In line with the hypotheses, it shows that there is a high correlation (0.108-Pearson, 0.116- Spearman-rank) between NAS and ABS. The result shows that NAS affect auditor independence, where there is a positive coefficient between NAS and the absolute value of estimation error (ABS). The higher the error indicated, the lower earnings quality, resulting in a negative relationship between NAS and earnings quality. This result is consistent with prior research that NAS affect auditor independence (Gul et al., 2006; Hay et al., 2006; Srinidhi and Gul, 2007; Kamarudin et al., 2012b; Blay and Geiger, 2013; Meuwissen and Quick, 2019; Abdul Wahab et al., 2020).

Table 6 tabulates the results for the audit committee characteristics. We found no evidence of any relationship between audit committee characteristics and accruals quality. The insignificant result being supported by Abdul Rahman and Mohamed Ali (2006), where there is insufficient evidence to prove the relationship between audit committee independence, audit committee competence and audit committee meeting and earning management that proxy for auditor independence. Ku Ismail and Syed Abd Rahman (2011) also document a weak evidence on the negative association between independence of audit committee and the amendment of quarterly reporting. When we apply the original Dechow and Dichev (2002) model, the result remains the same. The insignificant result might be due to the notion of “one size does not fit all” as audit committee in each firm could work optimally in their own way.

Table 6 presents the moderating effect of corporate governance on the relationship between NAS and accruals quality. Four corporate governance variables are being tested, which include audit committee financial expertise (AC_FIN), audit committee independent (AC_IND), audit committee meeting (AC_MEET) and audit committee size (AC_SIZE). The regression for interaction is run separately for each corporate-governance variable. Regression 1 refers to basic regression on the relationship between NAS and the absolute value of estimation error (ABS). The result provides an impairment in auditor independence where a positive relationship indicates that higher NAS result in a higher estimation error.

Regressions 2 to 5 from Table 6 provide a moderating effect for each corporate governance variable on the mentioned relationship. The results reveal negative relationships; a lower estimation error indicates that the existence of full audit committee independence weakens the negative relationship between NAS and accruals quality. This finding supports the study by Puasa et al. (2014); after the implementation of MCCG 2007, composition of solely nonexecutive directors are linked with timeliness of financial reporting (proxy for auditor independence). This finding is also in line with a study done by Mohamad Sori et al. (2009) using the questionnaire and interview, where 94% agreed that auditor independence would be better safeguarded if audit committees were mostly comprised of independent and nonexecutive directors.

The rest of the audit committee variables provide no evidence on the moderating effect. The chosen control variable might contribute to the insignificance of the relationship and this requires future research.

6. Conclusion

The results of the study provide views that NAS are resulting in an increase in errors. The higher the error indicates lower earnings quality, resulting in a negative relationship between NAS and earnings quality. This result is consistent with prior research that NAS affect auditor independence (Gul et al., 2006; Hay et al., 2006; Srinidhi and Gul, 2007; Kamarudin et al., 2012a; Blay and Geiger, 2013; Abdul Wahab et al., 2020). The interaction of audit committee independence proves to weaken the negative relationship between NAS and accruals quality.

Contribution of this study is practically important to audit committees. Audit committee should establish policies governing the circumstances under which contracts for the provision of NAS can be entered into and procedures that must be followed by external auditors. Moreover, the study found that a fully independent audit committee is successful in solving independence issue for external auditors, which is in line with the MCCG 2007 requisite.

Agency theory states that firms have an incentive to limit NAS because of agency cost that is incurred when an auditor monitoring value is diminished. There is a need to have an independent audit committee to examine auditor independence. This result indicates that the audit committee in a firm needs to be very careful in establishing rules and policies to safeguard the auditor's independence.

Due to the nature of data collection which was hand collected, a more recent data would provide an extension of our research. In addition, it is known that the governance variables are subject to endogeneity and become another avenue for future studies.

Table 1

Sample selection

Companies listed on tde main market as of 2011			822
Minus	Finance companies	37
	PN17	16
	New companies exist on the board in 2010	28
	New companies exist on the board in 2011	14
	Companies with no annual report 2012	37
	Companies with no annual report 2008	8
	Companies with no annual report 2009, 2010 and 2011	27	(167)
	Total companies		655
	Three years of observations (2009–2011)		1965
Minus	Companies with no NAS provider		(284)
	Missing information		(563)
	Total observations		1,118

Table 2

Operational definitions of variables

#	Variables	Definitions	Source(s)
1	ABS (dependent variable)	Modified Dechow and Dichev (Francis 2005 model)	DataStream
Panel A: Fee variable
2	NAS	Nonaudit fees deflated by total fees	Annual report
Panel B: Corporate governance variables
3	AC_FIN	An indicator of “1” if the audit committee is financially literate and also the number of the audit committees that become the member of accounting association or “0” otherwise	Annual report
4	AC_IND	An indicator of “1” if all the audit committee is all independent or “0” otherwise	Annual report
5	AC_MEET	The proportion of audit committee meetings to the numbers of audit committees	Annual report
6	AC_SIZE	The number of executive and nonexecutive directors held in the companies	Annual report
Panel C: Institutional variables
7	BOD_BUMI	Percentage of Bumiputera director on the board	Annual report
8	FAMILY_F	An indicator variable of 1 if the companies are owned by more than one family member or “0” otherwise	Annual report
9	POLCON	An indicator variable of 1 if the firm is politically connected, or “0” otherwise	Johnson and Mitton (2003)
Panel D: Control variables
10	BIG_4	An indicator variable that takes the value of 1 if the auditor is a Big 4 auditor, zero otherwise	Annual report
11	LOSS	An indicator variable that takes the value of 1 if the firm recorded a loss in accounting return	Datastream
12	LEVERAGE	Total debt deflated by total equity	Annual report
13	EQUITY	An indicator variable that takes the value of 1 if the firm recorded negative equity during the sample period, zero otherwise	Datastream
14	ASSETS	Natural log transformation of total assets	Datastream

Note(s): Data from annual reports are hand collected. Annual reports are downloaded from Bursa Malaysia's website

Table 3

Descriptive Analysis (2009–2011, n = 1,118)

	Mean	Median	Maximum	Minimum	Std. Dev
Dependent variable
ABS	0.043	0.029	0.389	0.000	0.046
Panel A: Fee variables
AUDIT_FEE_RM	190801.800	125301.000	3843000.000	12000.000	271183.700
TOTAL_FEE_RM	239923.500	158750.000	5667000.000	21345.000	362793.000
NAS_RM	49121.660	1900.000	2412000.000	105.000	118632.400
NAS	0.179	0.140	0.888	0.001	0.150
Panel B: Corporate governance variables
AC_FIN	0.258	0.000	1.000	0.000	0.438
ABS	0.043	0.029	0.389	0.000	0.046
AC_IND	0.623	1.000	1.000	0.000	0.485
AC_MEET	1.536	1.670	4.330	0.330	0.361
AC_MEET (NUMBER)	4.818	5.000	13.000	1.000	1.034
AC_MEET(LOG)	1.551	1.609	2.565	0.000	0.210
AC_SIZE (NUMBER)	3.184	3.000	6.000	2.000	0.479
AC_SIZE	1.149	1.099	1.792	0.693	0.133
Panel C: Institutional variables
BOD_BUMI	0.315	0.250	1.000	0.000	0.254
FAMILY_F	0.557	1.000	1.000	0.000	0.497
POLCON	0.456	0.000	1.000	0.000	0.498
Panel D: Control variables
BIG_4	0.603	1.000	1.000	0.000	0.490
LEVERAGE	0.223	0.170	0.690	0.000	0.208
EQUITY	0.001	0.000	1.000	0.000	0.030
ABS	0.043	0.029	0.389	0.000	0.046
LOSS	0.153	0.000	1.000	0.000	0.360
ASSET_RM	529,000,000	288,000,000	3580,000,000	39,887,305	626,000,000
ASSETS	19.534	19.478	21.997	17.502	1.049

Note(s): Please refer to Table 2 for operational definitions

Table 4

Correlation matrix year 2009–2011 (N = 1,118)

		1	2	3	4	5	6	7
1	ABS		0.116***	0.024	0.048	0.044	−0.045	−0.068**
2	NAS	0.108***		−0.042	0.021	−0.052*	−0.105***	−0.023
3	AC_MEET	−0.024	0.007		−0.528***	0.001	0.110***	−0.013
4	AC_SIZE	0.063**	0.045	−0.434***		0.199***	−0.095***	0.134***
5	BOD_BUMI	0.047	0.011	0.069**	0.192***		0.141***	0.180***
6	LEVERAGE	−0.075**	−0.067**	0.080***	−0.080***	0.143***		0.161***
7	ASSETS	−0.104***	0.013	0.006	0.154***	0.177***	0.164***

Note(s): Please refer to Table 2 for the operational definition. Italicized figures are Pearson correlations. . *, ** and *** represent 10, 5 and 1% significant levels, respectively

Table 5

Main regression (2009–2011, n: 1,118)

Regression	Expected	Coefficients
	Direction
Intercept	?	0.044 1.307
NAS	−	0.031 3.159***
AC_FIN	−	0.000 −0.053
AC_IND	−	0.000 0.092
AC_MEET	−	0.000 −0.023
AC_SIZE	?	0.018 1.360
BIG_4	−	0.001 0.169
LEVERAGE	+	−0.021 −2.859***
FAMILY_F	−	−0.005 −1.407*
BOD_BUMI	+	−0.002 −0.261
EQUITY	+	−0.081 −1.912*
LOSS	+	0.035 8.925***
POLCON	+	0.000 −0.132
ASSETS	+	−0.002 −0.925
Period Fixed		Yes
Industries Fixed		Yes
Adjusted R2		0.111
F-statistic		7.614***
VIF(Regression)		1.213

Note(s): Please refer to Table 2 for operational definitions. *, ** and *** represent 10, 5 and 1% significant levels, respectively

Table 6

Regressions with interaction terms (2009–2011, n: 1,118)

Regression	Expected direction	1	2 Coeff	3 Coeff	4 Coeff	5 Coeff
Intercept	?	0.044 1.307	0.044 1.302	0.042 1.238	0.038 1.094	0.058 1.567
NAS	−	0.031 3.159***	0.033 2.999***	0.051 3.245***	0.064 2.038**	−0.034 −0.481
AC_FIN	−	0.000 −0.053	0.001 0.272	0.000 −0.080	0.000 −0.079	0.000 −0.026
AC_IND	−	0.000 0.092	0.000 0.087	0.006 1.209	0.000 0.096	0.000 0.061
AC_MEET	−	0.000 −0.023	0.000 −0.038	0.000 −0.039	0.004 0.713	0.000 −0.034
AC_SIZE	−	0.018 1.360	0.018 1.333	0.019 1.415	0.019 1.379	0.007 0.362
BIG_4	−	0.001 0.169	0.001 0.193	0.001 0.246	0.001 0.168	0.001 0.156
LEVERAGE	+	−0.021 −2.859***	−0.021 −2.856***	−0.021 −2.859***	−0.021 −2.862***	−0.021 −2.865***
FAMILY_F	−	−0.005 −1.407*	−0.005 −1.421*	−0.005 −1.483*	−0.004 −1.301*	−0.005 −1.367*
BOD_BUMI	+	−0.002 −0.261	−0.002 −0.275	−0.002 −0.250	−0.001 −0.181	−0.001 −0.192
EQUITY	+	−0.081 −1.912*	−0.080 −1.905**	−0.078 −1.848**	−0.079 −1.869**	−0.079 −1.866**
LOSS	+	0.035 8.925***	0.035 8.933***	0.036 9.021***	0.035 8.945***	0.035 8.938***
POLCON	+	0.000 −0.132	0.000 −0.123	0.000 −0.063	0.000 −0.131	0.000 −0.104
ASSETS	+	−0.002 −0.925	−0.002 −0.915	−0.002 −0.994	−0.002 −0.941	−0.002 −0.929
NAS*AC_FIN	−		−0.009 −0.400
NAS*AC_IND	−			−0.032 −1.624*
NAS*AC_MEET	−				−0.021 −1.127
NAS*AC_SIZE	−					0.056 0.915
Period fixed		Yes	Yes	Yes	Yes	Yes
Industry dummies		Yes	Yes	Yes	Yes	Yes
Adjusted R2		0.111	0.110	0.112	0.111	0.111
F-statistic		7.614***	7.272***	7.422***	7.332***	7.312***
VIF(Regression)		1.213	1.390	1.514	2.315	7.117

Note(s): Please refer to Table 2 for operational definitions. *, ** and *** represent 10, 5 and 1% significant levels, respectively

Notes

1. Currently we have the latest MCCG 2017 that replaced MCCG 2000, 2007 and 2012. Due to data constraint, the discussion is limited up to MCCG 2007.

2. We performed differences in mean and median for dichotomous variables (BIG_4, POLCON and FAMILY) in which we find significant differences for the main fees variables. We find the accruals quality significant differ between family and non-family firms. Results are available upon request.