audit committee and corporate governance among … committee and corporate... · audit committee...

AUDIT COMMITTEE AND CORPORATE GOVERNANCE AMONG SARAWAK PUBLIC LISTED

COMPANIES

..

Ngu Leong Hui

HD 2741 N576 Corporate Master in Business Administration 2012 2012

I

I

I:

l j

Pusat Khidmat Maklumat Akademik UNIVERSm MALAYSIA SARAWAK

P,KHIOMAT MAKLUMAT AKAOEMIK

11111 1111 limrll11111 III 1000246921

AUDIT COMMITTEE AND CORPORATE GOVERNANCE AMONG SARA WAK PUBLIC LISTED

COMPANIES

NGU LEONG HUI

A dissertation submitted in partial fulfillment of the requirements for the degree of Corporate Master in Business Administration

.'

Faculty of Economics and Business UNIVERSITI MALAYSIA SARA W AK

2012

APPROVAL PAGE

I certified that I have supervised and read this study and in my opinion it conforms to

acceptable standards of scholarly presentation and is fully adequate in scope and quality

as a research paper for the degree of Corporate Master in Business Administration.

Associate Professor Dr. Venus Khim-Sen Liew Supervisor

This research paper was submitted to the Faculty of Economics and Business, UNIMAS

and is accepted as partial fulfillment of the requirements for the degree of Corporate

Master in Business Administration.

Professor Dr. Shazali bin Abu Mansor Dean, Faculty ofEconomics and Business UNIMAS

11

STATEMENT OF ORIGINALITY

The work described in this Research Paper, entitled

"AUDIT COMMITTEE AND CORPORATE GOVERNANCE AMONG SARA WAK PUBLIC LISTED COMPANIES"

is to the best of the author's knowledge that of the author except

where due reference is made.

Date NGV LEONG HUI 10031731

III

ABSTRACT

AUDIT COMMITTEE AND CORPORATE GOVERNANCE AMONG SARAWAK PUBLIC LISTED COMPANIES

By

Ngu Leong Hui

In Malaysia, Malaysian Securities Commission mandates all companies listed in Bursa

Malaysia to form audit committee. Audit committee is responsible to oversee the

financial reporting process and take note of the financial reporting risk. This study

examines the relationship between finn size and audit committee composition such as

audit committee size, proportion independent director in audit committee, financial

expertise in audit committee, and frequency of meeting by audit committee toward

corporate governance among Sarawak pubJic listed companies. The 28 companies

incorporated in Sarawak listed on Main Market in Bursa Malaysia for year 2006 - 2011

is investigated. The study identifies the corporate governance based on accrual ratio, the

lower the accrual ratio, the higher the corporate governance. The Pearson Correlation [I

Test is used to examine the relationship between dependent and independent variables.

The finding indicates that there are no significant relationships between audit committee ,,'

composition and finn size with corporate governance. This study revealed that the

I

establishment of audit committee in Sarawak listed companies in Malaysia has yet to

achieve success in its monitoring role.

iv

, !

...,.

I

ABSTRAK

JAWATANKUASA AUDIT DAN TADBIR URUS KORPORAT DI KALANGAN SYARIKAT TERSENARAI SARAW AK

Oleh

Ngu Leong Hui

Di Malaysia. Suruhanjaya Sekuriti mewajibkan semua syarikat yang tersenarai di Bursa

Malaysia untuk menubuhkan jawatankuasa audit. Jawatankuasa audit bertanggungjawab

untuk mengawasi proses pelaporan kewangan dan sedar terhadap risiko dalam pelaporan

kewangan. Kajian ini menyelidik hubungan antara saiz firma dan komposisi

jawatankuasa audit seperti saiz jawatankuasa audit, bilangan pengarah yang bebas dalam

jawatankuasa audit, pakar kewangan dalam jawatankuasa audit, kekerapan perjumpaan

oleh jawatankuasa audit terhadap tadbir urns korporat. 28 syarikat yang diperbadankan di

Sarawak yang tersenarai di Pasaran Utama Bursa Malaysia bagi tahun 2006 - 2011

disiasat. Kajian ini menghitung tadbir urns korporat berdasarkan kepada nisbah akrual,

semakin rendah nisbah akrual, semakin tinggi tadbir urus korporat. Ujian Empirik

Pearson digunakan untuk mengkaji hubungan antara pembolehubah bersandar dan

pembolehubah tak bersandar. Penemuan kajian menunjukkan hubungan tak signiflkan

antara komposisi jawatankuasa audit dan saiz firma dengan tadbir urus korporat. lni

mengungkapkan penubuhan jawatankuasa audit dalam syarikat tersenarai Sarawak di

Malaysia masih belum mencapai kejayaan dalam peranan pemantauan.

v

ACKNOWLEDGEMENT

I am so grateful to a number of people and organizations that have helped me

whether directly or indirectly during the preparation of my thesis. First of all, my greatest

sincere gratitude to my supervisor, Associate Professor Dr. Venus Khim-Sen Liew for his

assistance and kindness towards me. Associate Professor Dr. Venus Khim-Sen Liew had

spent much time and indefatigable effort to guide me by evaluating and providing

detailed comments of the thesis.

Thanks to my coursemates and friends, who helped me do the checking on my

thesis. Thanks for their support and encouragement. They have inspired me with lots of

information and idea on how to accomplish my thesis writing .

. Last but not least, I would like to convey my gratitude to my family for their

endurance throughout any my studies. Writing this thesis took such a long time that at

certain moments, it seemed endless. They suffered and sacrificed for my tenacious

commitment to finish it. lbis thesis could not have been performed without whole

hearted support from them. For their love and support, I am deeply appreciated.

VI

Pu~at Khidmat MakJumat Akademik UNIVERSm MALAYSIA SARAWAK

TABLE OF CONTENTS

Content Page

LIST OF TABLES IX

LIST OF FIGURE X

CHAPTER

1 INTRODUCTION

1.1 Overview 1 1.2 Background of the Study 3 1.3 Problem Statement 7 1.4 Objectives of the Study 9 1.5 Scope of the Study 9 1.6 Significance of Study 10 1.7 Outline of the Study 12

2 LITERATURE REVIEW

2.1 Introduction 13 2.2 Audit Committee Financial Reporting and

Corporate Governance 13 2.2.1 Historical Development ofAudit Committee

In Malaysia. 16 2.3 Financial Reporting Criteria 19

2.3.1 Financial Reporting in Malaysia 21 2.3.2 Audit Committee Determinant 23

2.4 Firm Size and Corporate Governance 29 2.5 Chapter Summary 31

3 THEORETICAL FRAMEWORK AND METHODOLOGY

3.1 Th~retical Framework 32 3.1.1 Si~ ofaudit committee 33 3.1.2 ProPortion of independent director

In audit committee 33 3.1.3 Financial expertise ofaudit committee 34 3.1.4 Frequency ofmeeting by audit committee 34 3.1.5 Firm size 35

3.2 Hypothesis 36 3.3 Data and Variables 37

3.3.1 Data Sampling 37

Vll

3.3.2 Data Collection Method 39 3.3.3 Data Analysis 40 3.3.4 Variable Instrumentation 41 3.3.5 Variable Measurement 4

3.4 Chapter Summary 43

4 RESULTS AND DISCUSSION

4.1 Introduction 44 4.2 Descriptive Statistics 44

4.2.1 Discussion 49 4.3 Normality Test 52 4.4 Correlation Analysis 53

4.4.1 Discussion 59

5 CONCLUSIONS AND LIMITATIONS

635.1 Conclusions 645.2 Recommendation

5.3 Limitations and Suggestions for Future Study 66

69REFERENCES

APPENDICES

A Summary of Sample for Sarawak Listed Companies In Bursa Malaysia

viii

LIST OF TABLES

,

Table Page

3.1 Description of Independent Variables and Sources 39

4.1 Descriptive statistics ofall variables for companies in year 2006 45

4.2 Descriptive statistics ofall variables for companies in year 2007 46

4.3 Descriptive statistics of aU variables for companies in year 2008 46

4.4 Descriptive statistics of all variables for companies in year 2009 47 4.5 4.5 Descriptive statistics ofall variables for companies in year 2010 48

4.6 Descriptive statistics of all variables for companies in year 2011 49

4.7 Median score for all variables for Year 2006 to 2011 49

4.8 Tests ofNormality for Accrual Ratio 52

4.9 Table of Pearson Correlation Test for Sarawak Listed Companies Year 2006 53



4.12 Table ofPearso~.correlation Test for Sarawak Listed Companies Year 2009 56

4.1.3 Table of Pearson Correlation Test for Sarawak Listed Companies Year 2010 ' 57


4.15 Summary ofHypotheses 59

IX

J

,....... I

LIST OF FIGURE

Figure Page

3.1 32Theoretical Framework

x

CHAPTER I

INTRODUCTION

1.1 Overview

To perfonn the task of corporate governance, audit committee is a must in a

public listed organization. However, the question is how well and how accurate the audit

committee's function contribution towards fmancial reporting. This study is trying to

understand the roles of audit committee by studying the scope and quality of audit

committee analysis and fmancial reporting by using Malaysia as the research country.

The pnmary rrusslon of Audit Committee Institute (ACI) Malaysia is to

communicate with audit committee mel)1bers to enhance their awareness of,

commitment to, and ability to implement effective audit committee process. Can we

assume corporate governance will penneate the business environment ever since the

introduction ofaudit committee in Malaysia?

As massive corporate accounting scandal happen, the U.S. accounting finns have ",'

formed a new private-sector group, known as the Center for Audit Quality to improve

the audit quality of publicly company audit ~d restore confidence in a profession for

increasing the investor confidence.

1

I

Nowadays, as increased in complexity of accounting issue, audit committee

required to clarity their responsibilities and mandate and perform their task efficiently

and step up the committee's interaction with management, internal audit and external

auditor. Audit committee is responsible to oversee the financial reporting process and be

aware of the fmancial reporting risk as well as communicating with internal and external

auditor. Audit committees possess authority to communicate with external auditor

regarding the appointment, compensation, evaluation and retention to ensure the

independence, accountability and effectiveness of external auditor in financial reporting

process. The competent auditors will increase investor's confidence toward financial

reporting and make a wise investment decision (Rashidah, 2006).

Financial statement provided useful historical information to potential investors,

creditor and other users in making rational decjsion. Hence, the reliability and relevance

of information disclosed is crucial to investors to make the right decision. Financial

reporting standard setting regulatory body in Unites States is Financial Accounting

Standards Board (F ASB) while in Malaysia; the responsibility development of

accounting standard for financial reporting is rested with Malaysian Accounting

Standard Board (MASB).

2

1.2 Background of the study

The economic crisis confronted by Malaysia as well as other East Asian

countries in 1997 became the catalysts for the conscious to improve corporate

governance practices to the public and private sectors. This crisis highlighted the

weaknesses of corporate governance in Malaysia, in which led to the needs to rectify the

corporate governance system in Malaysia. A good corporate governance system is

recognized as a key issue for improving the corporation's competitiveness in market-

oriented economy.

In year 1998, Malaysian government established a High Level Finance

Committee (HLFC) to construct a framework for corporate governance for corporate

sector. The Malaysian Code is brought iQ.to full effect in January 2001 with the

amendments to the Kuala Lumpur Stock Exchange's listing requirement where public

listed companies in Malaysia are required to put the statement of corporate governance

in their annual report, this includes a statement of internal control, composition of the

board of directors, composition of audit committee, quorum of audit committee and any

additional statements by the board of directors. According to the Report on Corporate

.'Governance 2002 by the High Level Finance Committee, Corporate Governance is

defined as;

3

The process and structure used to direct and manage the business and affairs of the

company tawards enhancing business prosperity and corporate accountability with the

ultimate objective ofrealising long term shareholder value, whilst taking into account

the interests ofother stakeholders.

Corporate governance is essential to stakeholder. Weak corporate governance

indicated poor risk management. Good corporate governance enhances the corporation's

performance and encourages better relationship among its stakeholders. The revamped

Listing Requirements is recognized as a major milestone in corporate governance

reform and its release bring into effect the Finance Committee Report on Corporate

Governance and create an environment that demands higher standards of conduct and

higher quality of disclosures from corporate governance participants in Malaysia.

The history of audit committee start since year 1940 when SEC in United State

suggested that formation of audit committee will ensure the accurateness of financial

reporting for publicly traded companies. In year 1970s, New York Stock Exchange

(NYSE) makes compulsory the formation of audit committee for listed companies. In

year 1999, with joint effort ofNYSE, NASDAQ, public companies, and CPA firms, the ,,'

Blue Ribbon Committee (BRC) was established. Thls committee produces reports and

recommendations on how to improve the effectiveness of Corporate Audit Committees

this is to ensure the audit committees perform their jobs effectively at the same time

ensure high-quality of financial reporting. The Blue Ribbon Committee also requires

the membership the audit committee to be independent and financially literate.

4

Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK

In Malaysia, Malaysian Securities Commission requires all companies listed in

Bursa Malaysia to form an audit committee in year 1994. With to aim to enhance the

standard of corporate governance; MICG developed Malaysian Code of Corporate

Governance in March 2000. It required higher quality of disclosure of fInancial

statement for the publicly listed companies. The Code set the qualifIcation and

responsibilities of audit committee. Malaysian Code of Governance (2000) outlined the

composition of board, the use of board, their authorities and activities.

The responsibilities Audit committees have been significantly increased after the

introduction of Sarbanes-Oxley Act of year 2002. According to Listing Requirement of

Bursa Malaysia, audit committees play the role of reviewing internal and external report

and ascertain audit quality of fIrms. Audit committee also responsible to ensure all

procedure and process comply with relevant regulations, laws and rules established by

relevant regulatory bodies. The chairman of audit committee must be an independent

non-executive director and shall comprise at least three member fully of non-executive

director and fmancially literate. At least one member of audit committee is a member of

Malaysian Institute of Accountant (MIA) or have at least three years working

experience and must fulfill requirement approved by Bursa Malaysia or Securities ,,'

Commission if one not a member of MIA.

5

A research by Rashidah (2006) found that most audit committee in firm meet

Bursa Malaysia Listing Requirement which allocated at least one qualified accountant in

audit committee, by the aimed to increase investor creditability of qualified financial

statement.

. The Listing Requirement of Bursa Malaysia had listed out the requirement that

need complying by public listed company with regard to audit committee. The Listing

Requirement also decided the authority and quorum of an audit committee as well as

review of audit committee at least once every three year. All listed companies are

required to prepare the audit committee report at the end of financial year. In year 2007,

the amendment on Listing Requirement required all audit committee member comprise

of non-executive director, improve the disclosure of annual report regarding the internal

audit function, as well as granting the audjt committee meeting with external auditor,

internal auditor or both without presence ofdirector or employee.

In this study, the main emphasize is on the extent of relationship of the

composition of audit committee toward corporate governance in Sarawak companies.

The paper study the effectiveness of audit committee for Sarawak listed companies

.' listed on Bursa Malaysia.

Besides that, the study also investigates the relationship between firm sizes with

the corporate governance in Malaysia as transparent disclosure of financial statement is

the important indicator for investor decision making.

6

1.3 Problem Statement

The importance of corporate governance is became clear as many large

corporation in US such as Enron, Adelphia, WorldCom breakdown due to fraud. Since

the happened of several failures in corporate structure and accounting scandal, the

American Congress enacted the United States federal law on 30 July 2002, with

establishment of the Sarbanes-Oxley Act of 2002 (Sarbox), which also known as Public

Company Accounting Reform and Investor Protection Act of 2002.

Although the audit committee is established with the purpose to ensure the

effectiveness of corporate governance; however, many issues had arisen regarding the

inefficiency of audit committee. The issues arise included the audit committee do not

have sufficient expertise or time to perform Jhe audit function or the audit committee did

not treated as audit client by auditor.

A study by Rashidah (2006) indicates that the audit committees are not

performing their task effectively. Zulkarnain et al. (2001) also show that majority

companies that listed on Bursa Malaysia complies the requirement to disclose audit

.' committee's report without concern about the quality of report.

After Asian fmancial crisis, public are more concern about the effectiveness

corporate governance. Hence, there is a need to study the extent of the audit committee

composition effect the corporate governance.

7

The equity capital and organizational structure reflect the size of the finn. The

large finn tends to have huge equity capital. The larger the organization, the more

resources they have including human capital. Seem there are very few studies on the

effect of organization size on corporate governance; hence there is a need to study the

relationship between the organization sizes and corporate governance.

As more and more fraudulent or misleading fmancial reporting in the most

recent spate of corporate disasters, there are demand for integrity, credibility and

transparency of fmancial reporting process. Malaysia is demanding for more effective

audit committee. Hence, this research is designed to determine the relationship between

organization size, composition of audit committee and corporate governance in

Malaysia, in particular for Sarawak listed companies.

Two questions to be addressed in this study are as followed:

1. Does finn size influence the corporate governance among Sarawak listed

companies?

11. Does composition of audit committee influence the corporate governance?

8

1.4 Objective of study

The general objective of this paper is to identify factors that are related to

corporate governance. The specific objectives are as followed:

• To test if corporate governance is significantly related to audit

committee characteristics

• To examine if corporate governance is significantly related to corporate

sIze

1.5 Scope of the study

The study covers all Sarawak listed companies in Bursa Malaysia. This includes

various industry such as industrial, consumer, construction, trading, and plantation but

exclude banks, insurance and unit trusts companies due to different statutory

requirements. In addition, utilities companies were also excluded from the popUlation of

interest as they possess different incentives and opportunities to manage earnings

(peasnell et al., 2000). ,,'

9

1

1.6 Significance of Study

Corporate governance is recognized as a key issue of the sustainability of a

corporation. The economic crisis 1997 has made clear the need to enhance the standards

of corporate governance in Malaysia for promoting the more transparent and

accountable disclosures in line with international best practices. Researchers have found

evidence on the association between poor governance and poor fmancial reporting

quality including earnings manipulation, fmancial restatements and frauds (Dechow et

01.,2000; Klein, 2002).

In McKinsey (2002) survey, he found that majority of investors agree that

corporate governance remains as their great concern with the strengthening of the

quality of accounting disclosure as the top priorities. The majority institutional investors

are willing to pay a high premium for companies with good corporate governance, i.e.

averaged 12-14% in North America and Western Europe, 20-25% in Asia and Latin

America and over 30% in Eastern Europe and Africa. The survey also provides evidence

that as more as 71% of the respondents' state that accounting disclosure is the most

important factor that impacts their investment decisions and 52% of the respondents

.,' identify that improving fmancial reporting quality is the governance priorities for

policymakers.

10

The audit committee plays an important role in the process of preparing the

annual financial statement and provides supervision of internal and external audit

function (Rittenberg, 2005). First and foremost, the role of audit committee is ensuring

"high quality financial reporting". Additionally, audit committee is responsible to

mitigate the agency problem between. manager and shareholder (Wallace, 2004).

Furthermore, Audit committee served as governance mechanism due to potential

litigation risk and reputation impainnent (Zhang et al., 2007). When a firm had strong

audit committee, then the likelihood ofcompany litigation would reduce.

The appointment of external auditor by audit committee reflects the committee

effectiveness and independence in monitoring the audit functions, encouraging the

external auditor to express their point of view freely and speak out the fraud without fear

(Zulkamain, 2007).

When a company has larger equity capital, it is regard as larger-size firm. The

larger-size firm is tends to has higher reputation and more asset (Arthur, 2002). Investor

is more interest in large-size companies and they demand for high corporate governance

practice.

Hence, it needs a study about the ex~ent of composition of audit committee and

firm size effect on the corporate governance in Malaysia in general and Sarawak in

specific. The fmdings from this study will enable the public to explore and understand

the characteristic of an effective audit committee and benefit several parties such as

11

regulatory bodies, shareholder and management of company in enhancing the

effectiveness of their audit committee. The result of analysis will give investor better

guideline in their decision making process.

1.7 Outline of the Study

The thesis is organized into five chapters. Chapter 1 introduced the meaning and

background of the study. Chapter 2 presented the development of literature on the

subject matter. The literature review included the finding and discussion about prior

study from different researcher for different point of view on the audit committee and

corporate governance in Malaysia. While chapter 3 was discuss about research design,

hypotheses, data and variable, and the methodology used. Chapter 4 will present the

finding and result of the analysis for this $tudy. The conclusion and recommendation

are present in chapter 5.

12

CHAPTER 2

LITERATURE REVIEW

2.1 Introduction

Malaysian Code of Corporate Governance (revised 2007) published by

Securities Commission Malaysia stated that the Board of Director should establish an

audit committee that comprise fully non-executive directors, with at least three members,

a majority of whom are independent. All members in audit committee should be

financially literate, so that they can read and interpret financial statement and perform

their function effectively. In addition, at least one of the members must from the

accounting body or association. According to Malaysian Code of Corporate

Governance (revised 2007), audit committf<e is responsible to review the quarterly and

year-end financial statement.

2.2 Audit committee fmancial reporting and corporate governance

. The evolution of audit committee can divided into four phases, namely,

voluntary establishment of audit committee, mandatory requirement of establishment of

audit committee, effectiveness of audit committee, and strengthening the effectiveness

ofaudit committee.

13

audit committee and corporate governance among … committee and corporate... · audit committee...

Documents