Managerial Auditing Journal
Auditor-client relationship: the case of audit tenure and auditor switching in Malaysia
Abu Thahir Abdul Nasser Emelin Abdul Wahid Sharifah Nazatul Faiza Syed Mustapha Nazri Mohammad
Hudaib
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Abu Thahir Abdul Nasser Emelin Abdul Wahid Sharifah Nazatul Faiza Syed Mustapha Nazri Mohammad
Hudaib, (2006),"Auditor-client relationship: the case of audit tenure and auditor switching in Malaysia",
Managerial Auditing Journal, Vol. 21 Iss 7 pp. 724 - 737
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Keywords Auditors, Auditing, Customer relations, Malaysia
Paper type Research paper
1. Introduction
Auditor independence is the cornerstone of the auditing profession. In general, auditor
independence can be of two forms: “independence in fact” and “independence in
appearance”. The former requires auditors to form and express an opinion in the audit
report as a disinterested and expert observer, uninfluenced by personal bias, while the
latter expects auditors to avoid situations that might cause others to conclude that they
are not maintaining an unbiased objective attitude of mind (Porter et al., 2003).
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/0268-6902.htm
The authors acknowledge the research funding from IRDC of University Teknologi Mara,
Malaysia in conducting this research.
MAJ
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Managerial Auditing Journal
Vol. 21 No. 7, 2006
pp. 724-737
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686900610680512
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Flint (1988) argued that independence will be lost if the auditor is involved in a
personal relationship with the client, as this may influence their mental attitude and
opinion. One of such threats is lengthy tenure. He contends that lengthy tenure in office
may cause the auditors to develop “over-cosy relationships” as well as strong loyalty or
emotional relationships with their clients, which could reach a stage where auditor
independence is threatened. Lengthy tenure also results in “over familiarity” and

partners were not explicitly addressed in any of the relevant Malaysian official
documents such as the Companies Act 1965, the Security Commission regulations,
approved auditing standards, etc. Lack of official pronouncements on this issue could
be due to the rejection of such rotation idea by the business community. Jaffar and
Alias (2002) found only 35 per cent of the audit firms’ partners and only 32.4 per cent of
the chief finance officers surveyed favoured audit firm rotation every three years of
engagement. However, in light of the Enron case, the Chairman of the Malaysian
Accounting Standard Board announced the intention of the board to make it
mandatory to rotate the audit firm once every five years (The Edge, 2002). While some
countries are either considering or have already imposed the five-year restriction to
rotate the audit firms, the length of audit tenure and the possible effect of switching on
Auditor-client
relationship
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auditor independence in Malaysia is still unclear. Hence, the results would highlight if
audit tenure and switching should be of concerned before any rotation length is
imposed. This is our main contribution to the literature.
Our analysis involves an examination of 297 Malaysian listed companies between
1990 and 2000 using logistic regression. Results indicate the probability of switching
the audit firm is greatest for distressed large client and that the direction of switch and
length of tenure are dependent on type of audit firm. This implies that auditors in such
environment fear losing their tenure and being switched, hence their independence and
objectivity may be impaired. As such, we assert that rotation policy should be partially
imposed on distressed clients as a first step forward in protecting auditor independence
in the country. The paper proceeds as follows. The next section discusses the literature
review and the development of the hypotheses. Sections 3 and 4 present the research
method and results, respectively. Section 5 presents the summary and conclusions.
2. Literature review and development of hypo theses
It has been suggested in the literature that larger audit firms (Big 4) are usually

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Based on the above arguments, we expect the length of tenure of auditors of large
clients to be longer than that of auditors of smaller clients in Malaysia. In other words,
we expect the propensity to switch auditors to be lower for large clients than their
smaller counterparts. This leads us to the following hypothesis:
H2. The probability of large clients switching audit firms is significantly lower
than the probability of small clients switching audit firms, ceteris paribus.
When businesses continue to grow, the demand for the highly independent and
qualified audit firm to reduce agency costs and to provide non-audit services needed
for the expansion of the firm increases. Therefore, growing businesses are expected to
be more likely to retain their audit firms than their lower growth counterparts. Sinason
et al. (2001) examined 16,976 COMPUSTAT companies in the US over a period of
20 years and found that audit tenure is significantly affected by client’s growth rate.
Since, the literature indicates that audit tenure is affected by the client’s growth rate,
we hypothesised the length of tenure of auditors of high growth clients in Malaysia to
be longer than low growth clients. In other words, high growth clients are less likely
to switch their auditors. As such, our next hypothesis is:
H3. The probability of high growth clients switching audit firms is significantly
lower than the probability of low growth clients switching audit firms, ceteris
paribus.
The financial position of auditees may have important implications on decisions in
retaining the audit firm. Auditees who are insolvent (have high gearing ratios) and are
experiencing an unhealthy financial position are more likely to engage auditors having
high independence to boost the confidence of shareholders and creditors as well as to
reduce the risk of litigation (Francis and Wilson, 1988). In addition, financially stressed
clients are more likely to replace their audit firms compared to their healthier
counterparts (Schwartz and Menon, 1985; Hudaib and Cooke, 2005).

m
1
). Hence,
m
1
–
m
2
–
m
3
–
m
4
.
where,
m
1
, switched from non-Big 4 to non-Big 4;
m
2
, switched from non-Big 4 to Big 4;
m
3
, switched from Big 4 to non-Big 4;
m
4
, switched from Big 4 to Big 4.
3. Research method
3.1 Data sources

3.2 Data analysis
Logistic regression was adopted to assess the relationships since the dependent variables
are dichotomous. The model parameters are estimated using the maximum-likelihood
method whereby the coefficients that make the observed results most “likely” are selected
on the basis of an iterative algorithm. Furthermore, the maximum-likelihood method has
also the advantage of asymptotic normality (Hudaib and Cooke, 2005). Model 1 has the
dependent variable as switching/non-switching (SWITCH
t
) and Model 2, direction of
switching/otherwise (
m
xt
). Model 1 provides answers to the research hypotheses
associated with audit tenure and switching while Model 2 investigates the impact of
independent variables on the directions of auditor switching.
3.3 Model specification
3.3.1 Model 1. We use the following logistic regression model to test for the
relationships between auditor switching (SWITCH
t
) and type of audit firm (AUDIT),
client size (CLI.SIZE), client growth (Ln DS), client financial risk (Ln Z), the interactive
effects of length of tenure of remaining in the office before being switched
(TENU
*
AUDIT
xt
), the change in operating income (Ln DR
t2 2
), change in market value
of equity (Ln DMVE) as well as change in total assets (Ln DTA):

xt
þ
b
7
Ln DR
t22
þ
b
8
Ln DMVE þ
b
9
Ln DTA þ1
SWITCH
t
is a binary variable indicating whether or not the audit firm was switched or
not switched. The other independent variables are as summarised in Table I.
3.3.2 Model 2. To further explain the impact of independent variables on the
switched directions of audit firms (
m
xt
), the following logistic regression model was
adopted to test the association between auditor switching from one type of audit firm
to another and the nine independent variables, viz. type of audit firm (AUDIT), client
size (CLI.SIZE), client growth (Ln DS), financial risk (Ln Z), change in operating income
(Ln DR
t2 2
), change in market value of equity (Ln DMVE), the change in total assets
(Ln DTA), the interactive effects of length of tenure before the first switching
(TENU

4
¼ from Big 4 to Big 4
AUDIT A dummy variable, 1 if the firm is a Big4 audit firm, and 0 otherwise
CLI.SIZE A dummy variable, 1 if the client’s TA is large (ln TA . the mean), and
0 otherwise
Ln DS The natural logarithm of squared changes in sales scaled by ln TA
½lnððDS=ln TAÞ
2
Þ;
Ln Z The natural logarithm of company’s financial risk: cash flow from operations
over long-term debt [ln(Z)
2
]
SQ ln BVE The square root of natural logarithm of BVE ½
ffiffiffi
2
lnðBEÞ
2
p
;
ln TA The natural logarithm of the client’s assets [ln TA]
Ln DTA The natural logarithm of squared changes in of total assets ½lnðDTAÞ
2
;
ln MVE MVE [ln MVE]
Ln DMVE The natural logarithm of squared changes in MVE ½lnðDMVEÞ
2
;
LnDR
t2 2

1 Error term
Table I.
Variables in the logistic
regression models
Auditor-client
relationship
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m
t
¼
a
0
þ
b
1
AUDIT þ
b
2
CLI:SIZE þ
b
3
LnDS þ
b
4
Ln Z þ
b
5
Ln DR
t22

SQ ln BVE 5.22 6.84 6.1446 0.2
MVE 350 17,432,850 404402.64 1614674.7
Ln DMVE 2 9.6318 12.9503 2 0.753392 2.1
Ln DS 2 13.6249 9.5961 2 3.629986 3.3
Ln DR
t2 2
2 18.4207 10.1909 2 1.388829 3.2
Risk (Z) 2 0.0300 1835.8700 24.510732 172.1
Ln Z 2 20.8286 15.0305 2 0.525179 4.2
TENU
*
B1.SWI 1 11 6.10 3.5
TENU
*
AUDIT
B4
0.00 1.00 0.5576 0.46640
TENU
*
AUDIT
nB4
0.00 1.00 0.4424 0.46640
Panel B (Dichotomous)
CLI.SIZE 0 1 129 0.43 0.497
AUDIT 0 1 175 0.59 0.493
SWITCH 0 1 87 0.29 0.457
TOT.TENU 1 11 1,987 6.69 3.619
m
xt
0 4 198 0.67 1.191

– the
interactive effects of years in office by non-Big4 before switching over total tenure period; CLI.SIZE – a
dummy variable, 1 if the client’s TA is large, and 0 otherwise; AUDIT – a dummy variable, 1 if the
firm is a Big4 audit firm, and 0 otherwise; SWITCH – a dummy variable, 1 if the audit firm is
switched, and 0 otherwise; TOT.TENU – total length of tenure (years) for the period;
m
1
– switched
from non-Big4 to non-Big4;
m
2
– switched from non-Big4 to Big4;
m
3
– switched from Big4 to
non-Big4;
m
4
– switched from Big4 to Big4
Table II.
Descriptive statistics
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the mean values indicate poor financial performance during the period of analysis.
Table II (Panel B) reports the descriptive statistics of the dichotomous variables. It can
be seen from the table that the sample consisted of 43 per cent (129) large companies,
60 per cent (175) Big 4 and 29 per cent (87) cases of audit termination (switching). It also
shows that switching from small to large audit firm (i.e. from non-Big 4 to Big 4) is the

were found not to be significant. The results indicate that the main factors for
switching audit firm are the increase in total assets and the financial risk of the
company. The highest log odds of CLI.SIZE [Exp(B) ¼ 1.76] indicates that client size is
the most important factor followed by financial risk in explaining switching and as
such H2 and H4 are accepted. However, the growth of company’s business, the
increase in operating income and increase in market value do not affect the length of
tenure of the audit firm, thus allowing us to reject H3. The fact that the length of tenure
of large audit firms (Big 4) is negatively associated with switching suggests that larger
audit firms experience fewer instances of being replaced compared to their smaller
counterparts who face shorter tenure as they tend to be replaced more often and as
such, H1 is accepted.
4.2.2 Model 2. Table V shows the results of testing Model 2, i.e. the impact of
various independent variables on the four switching directions (
m
xt
). As indicated by
the results, the only factor that significantly impacts switching behaviour is the
interactive effects of length of tenure before the first switch (TENU
*
B1.SWI), followed
by changes in total assets of the client (Ln DTA).
Table VI (Panel A) provides details on the pattern of switching behaviour. As can be
seen, switching for similar sized audit firms, i.e. switching from a small audit firm to
another or from a large audit firm to another, often occurs after lengthy tenure.
However, switching to dissimilar sized audit firms, i.e. switching from a small to a
large audit firm or from a large to a small audit firm, occurs in a relatively shorter
period. This suggests that the propensity to switch to a large audit firm is greater for
clients experiencing an increase in total assets.
Auditor-client
relationship

1 2 0.05 0.05
m
4
1 0.14
*
SQ ln BVE 1
Ln DTA
Ln DMVE
Ln DS
Ln DR
t2 2
Ln Z
AUDIT
TOT.TENU
TENU
*
B1.SWI
TENU
*
AUDIT
B4
Variable Ln
D
TA Ln
D
MVE Ln
D
SLn
D
R

1 2 0.07
Ln Z 1
AUDIT
TOT.TENU
TENU
*
B1.SWI
TENU
*
AUDIT
B4
Variable AUDIT TOT.TENU TENU
*
B1.SWI TENU
*
AUDIT
B4
TENU
*
AUDIT
nB4
SWITCH 0.02 0.31
**
0.05 2 0.09 0.09
m
1
2 0.35
**
0.10 0.16
**

SQ ln BVE 0.05 0.33
**
0.29
**
0.08 2 0.08
Ln DTA 0.03 0.06 0.02 0.03 2 0.03
Ln DMVE 2 0.06 2 0.07 2 0.05 20.06 0.06
Ln DS 0.11 0.05 0.02 0.10 2 0.10
Ln DR
t2 2
0.01 0.08 0.05 0.02 2 0.02
Ln Z 2 0.06 2 0.06 2 0.06 2 0.09 0.09
AUDIT 1 0.08 0.05 0.90
**
2 0.90
**
TOT.TENU 1 0.89
**
0.09 2 0.09
TENU
*
B1.SWI 1 0.14
*
2 0.14
*
TENU
*
AUDIT
B4
1 2 1.0

m
xt
). The
results show that retention of audit firms depends on the size of clients based on total
assets, level of financial risk and type of audit firm but not by changes in operating
income and market value. The likelihood of non-distressed large client audited by large
audit firm to switch is significantly less compared with distressed small client audited
by small audit firm. Results also show that switching directions are mainly influenced
by the interaction between directions of switch and type of audit firm with the length of
tenure. Length of tenure before switching from a small to a large audit firm is
significantly shorter compared to the length of tenure before switching from a small to
another small audit firm. Large audit firms were found to secure longer tenure. Hence,
such differences in the lengths of tenure suggest independence impairment.
Since, financially distressed clients are more likely to switch audit firms, the smaller
auditors would be more reluctant to qualify their reports or show disagreement with
their clients for fear of being dismissed and losing a client. The implication of this
finding is that such audit-client relationship may impair auditor independence and
weaken audit quality. This in turn has important implications for policy makers in
Malaysia since auditor independence may be impaired due to the unhealthy
competition among the audit firms.
This study is subject to several limitations. First, corporate governance
characteristics that would shed more light on this topic were not included in our
analysis. Second, we have not considered the effects of audit and non-audit fees on
audit tenure and the decision to retain auditor. Third, we did not consider types of
Variables B Exp(B)
Dependent variable: switch/not switch
Independent variables
CLI.SIZE 0.566
***
1.761

10 per cent significance
Table IV.
Multivariate logistic
analysis: propensity to
switch (Model 1)
Auditor-client
relationship
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Independent variables B Exp(B)
(A) Dependent variable:
m
1
(n Big 2 n Big) [n ¼ 23]
CLI.SIZE 0.227 1.255
Ln DS 0.096 1.101
Ln Z 0.091
*
1.095
Ln DR
t2 2
0.093 1.098
Ln DMVE 0.255
*
1.290
Ln DTA 0.333
***
1.394
TENU
*

1.173
Ln Z 0.029 1.030
Ln DR
t2 2
2 0.047 0.954
Ln DMVE 2 0.186
*
0.830
Ln DTA 0.049 1.051
TENU
*
B1.SWI 2 0.274
***
0.760
TENU
*
AUDIT
B4
––
TENU
*
AUDIT
nB4
2 0.115 0.892
x
2
180.07 ( p ¼ 0.000)
Number of selected cases: 297
Number of switching from nB5 2 B2: 36
Nagelkerke R

––
x
2
300.78 ( p ¼ 0.000)
Number of selected cases: 297
Number of cases: 9
Nagelkerke R
2
0.912
(D) Dependent variable:
m
4
(Big 2 Big) [n ¼ 19]
CLI.SIZE 0.478 1.613
Ln DS 0.000 1.000
Ln Z 0.004 1.004
Ln DR
t2 2
0.137
*
1.147
Ln DMVE 0.147 1.159
Ln DTA 0.384
***
1.468
TENU
*
B1.SWI 2 0.175
**
0.839

2
217.60 ( p ¼ 0.000)
Number of selected cases: 297
Number of cases: 19
Nagelkerke R
2
0.754
Notes:
***
1 per cent significance,
**
5 per cent significance,
*
10 per cent significance
Table V.
Panel A Panel B
Switched from
Regression results
Dependent variable:
TENU
*
B1.SWI
TENU
*
B1.SWI
m
1
m
2
m

***
8 2 4 3 0 TENU
*
AUDIT
nB4
4.431
***
91202
10 1 2 0 0
11 10 0 0 9
Total 23 36 9 19
x
2
¼ 10.9
x
2
¼ 46.5
***
x
2
¼ 19.4
**
x
2
¼ 14.8 Adj. R
2
0.796
Notes: TENU
*
B1.SWI: interactive effects of length of tenure before the first switch;

Crosstabs between length
of tenure with the four
directions and regression
results
Auditor-client
relationship
735
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Corresponding author
Mohammad Hudaib can be contacted at:
Auditor-client
relationship
737
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