Darmadi 2016

Asian Review of Accounting
Ownership concentration, family control, and auditor choice: Evidence from an emerging market
Salim Darmadi
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Salim Darmadi , (2016),"Ownership concentration, family control, and auditor choice: Evidence from an emerging market",
Asian Review of Accounting, Vol. 24 Iss 1 pp. -
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Ownership concentration, family control, and auditor choice:
Evidence from an emerging market
Abstract
Purpose: This empirical study extends the existing, yet limited, literature on the influence of
ownership concentration and family control on the demands for high-quality audits. This
study focuses on an emerging market, namely Indonesia, where ownership concentration and
family control are relatively higher than those in developed markets.
Design/methodology/approach: The sample consists of 787 firm-year observations of
public firms listed on the Indonesia Stock Exchange (IDX). Following prior studies, a firm is
considered using a higher-quality audit when its external auditor is one of the Big 4 audit
firms. Logistic regressions are employed to test research hypotheses.
Findings: Empirical evidence obtained reveals that firms with higher ownership
concentration are more likely to hire a Big 4 auditor. Hence, in such firms, high-quality audits
are employed to mitigate agency issues. However, when the controlling shareholder is a
family, the association between ownership concentration and the demands for high-quality
auditors turns negative, implying that family-controlled firms tend to sustain opaqueness
gains by hiring lower-quality auditors.
Originality/value: Previous empirical studies examining the influence of ownership
concentration and family control on auditor choice are relatively limited in the literature and
are heavily focused on developed economies. In addition, the present study is one of the first
to investigate the association between family control and auditor choice in the context of a
developing economy.
Keywords: Auditor choice, Big 4, corporate governance, external audit, family-controlled

firms, Indonesia
Paper type: Research paper
1
1. Introduction
The poor corporate governance system in East Asian countries is frequently attributed
as one of the key factors behind the declining stock markets and listed firms during the 1997
Asian financial crisis (Johnson et al., 2000; Lemmon and Lins, 2003). Since then, various
reforms to promote better corporate governance have been undertaken by many parties,
including international organizations, governments, market regulators, and stock exchanges.
Corporate governance includes various internal and external mechanisms to alleviate
problems that may arise between shareholders and managers due to the separation between
ownership and control (Jensen and Meckling, 1976). However, such a definition of agency
problems seems to apply in firms with more diffused share ownership. In firms with
concentrated ownership structure, the agency problems may arise between the controlling
shareholder and minority shareholders, where the former may pursue their interests at the
expense of the latter (Shleifer and Vishny, 1997).
Due to the separation between shareholders and management, or the existence of the
controlling shareholder and minority shareholders, information asymmetry exists in the
capital market. This condition leads to demands for independent audits on the firm’s financial
statements to serve as a monitoring mechanism. As suggested by Jensen and Meckling (1976)
and Imhoff (2003), an external audit provides an independent check on financial information
provided by management, which plays an important role in reinforcing confidence in the
financial information. Additionally, the controlling shareholder may employ an independent
auditor as a monitoring mechanism, limiting its opportunity to pursue expropriation behavior
at the expense of minority shareholders (Ang et al., 2000). Therefore, independent audits are
considered one of the external corporate governance mechanisms to mitigate the agency
problems and reduce the information asymmetry. With respect to financial audits conducted
2
by independent auditors, audit quality appears to be an important element to ensure the
credibility of corporate governance and financial reporting process (Wan-Abdullah et al.,
2008). As argued by DeAngelo (1981), audit quality affects the ability of an auditor to detect
material misstatements in the firm’s financial statements, as well as the auditor’s willingness
to report such misstatements. Since audit quality is relatively difficult to observe, there are
several indicators used by researchers to proxy for this variable, one of them is the size or
reputation of audit firms (e.g. DeAngelo, 1981; Palmrose, 1988; Beasley and Petroni, 2001),
where larger audit firms are assumed to provide higher quality of audit services.
The determinants of auditor choice have been addressed in numerous studies, mainly in
developed markets, such as the US (Beasley and Petroni, 2001; Copley and Douthett, 2002;
Hodgdon et al., 2009), the UK (Chaney et al., 2004), Finland (Knechel et al., 2008; Niskanen
et al., 2010, 2011a), and New Zealand (Firth and Smith, 1992; Firth, 1999). Such studies
within the context of developing economies are relatively rare; among the few are Aksu et al.
(2007), Wan-Abdullah et al. (2008), and Lin and Liu (2009), which use the data of Turkey,
Malaysia, and China, respectively. Previous studies considered such aspects as institutional
environments, corporate governance structure, share ownership, and firm-specific
characteristics as the determinants. However, there is still very limited research examining
how ownership concentration and family control influence the firm’s decision in auditor
selection. This is particularly important, since ownership concentration and family control are
the most common features of corporate ownership in capital markets worldwide, as
documented by La Porta et al. (1999), Claessens et al. (2000), and Faccio and Lang (2002).
Hence, this study is intended to fill this gap.
The objective of the present study is to examine whether and how the auditor choice of
Indonesian publicly-listed firms is associated with ownership concentration and family
control. The contribution of this study is twofold. First, this study investigates the influences
3
of both ownership concentration and family control on auditor choice. Some prior studies
examine the influence of ownership concentration, while some others investigate the effect of
family control. Since ownership concentration and family control appear to be two most
common features of corporate ownership in capital markets around the world, it seems to be
interesting to offer some new evidence on the influence of the two features.
Second, the present study focuses on an emerging economy, where ownership

concentration and family control are more prevalent. Indeed, a limited number of studies
have addressed such an issue, but they are generally conducted within the context of
developed economies, which generally have stronger legal environments and investor
protection than do their emerging counterparts. Indonesia provides an interesting setting
because the country is one of the Asian economies heavily affected by the 1997 financial
crisis. As contended by Rosser (2005), the corporate governance improvement in post-crisis
Indonesia is considered lagged behind some other countries affected by the 1997 crisis, such
as Malaysia and South Korea. In addition, Indonesia is the largest economy in Southeast Asia
and the 16th-largest in the world. The country is home to one of Asia’s main emerging capital
market, attracting portfolio investments from various parts of the world. As found in other
emerging markets, the country’s capital market is characterized by weaker legal system and
investor protection, as well as weaker disclosure requirements (La Porta et al., 1999;
Claessens and Fan, 2003). Given its unique institutional setting, the influence of corporate
ownership structure on auditor choice among Indonesian listed firms may differ from that in
developed economies.
The present paper is structured in the following manner. Section 2 provides an
overview of the Indonesian accounting and auditing environments. A review of prior studies
and research hypotheses are presented in Section 3. This is followed by Section 4, which
4
describes the data and methodology used in this study. Empirical results and discussions are
presented in Section 5. Finally, Section 6 concludes.
2. Accounting and auditing environments in Indonesia
The history of accounting regulations in Indonesia can be traced back to the 1970s
when the Indonesian government planned to re-establish the country’s capital market to
attract foreign investments. In 1973, the government’s tentative committees in conjunction
with the Indonesian Institute of Accountants (Ikatan Akuntan Indonesia or IAI) produced the
so-called Indonesian Accounting Principles (Prinsip Akuntansi Indonesia or PAI). The PAI,
which was based on a 1965 research report of the American Institute of Certified Public
Accountants (AICPA), appeared to be Indonesia’s first set of accounting standards, even
though in a simple form (Rosser, 1999). As explained by Ninsuvannakul (1988), the
principles tend to address general accounting issues, instead of detailed guidelines for
accounting practice. A year later, in 1974, the IAI formed the Accounting Standards
Committee, which was assigned to set accounting standards. No major change was made
until 1984, when the PAI was significantly revised by the Committee.
In early 1990s, the World Bank criticized the country’s weak accounting and auditing
system. In the same time, the Indonesian capital market saw an increasing number of firms
listed on the Jakarta Stock Exchange (JSX), as well as financial scandals committed by a
number of firms, leading to greater demands for sound financial reporting requirements
(Rosser, 1999). Finally, in 1994, supported by the government, Arthur Andersen, and the
World Bank, the IAI introduced a new set of the Statements on Financial Accounting
Standards (Pernyataan Standar Akuntansi Keuangan or PSAK). PSAKs provide a
comprehensive set of accounting standards and were based on the International Accounting
5
Standards issued by the International Accounting Standards Committee. PSAKs obtained
legislative backing through the enactment of the 1995 Corporation Act. The Act required all
corporations to prepare their financial statements in accordance with PSAKs. The new 2007
Corporation Act also requires the same. Currently, PSAKs are still in the process of
convergence with International Financial Reporting Standards. The financial year 2011 was
determined as the first period in which corporations are required to prepare their financial
statements based on the revised PSAKs.
The Indonesian auditing profession emerged through the enactment of Auditing Norms
(Norma Pemeriksaan Akuntan) in 1973. In the 1980s, applicable government regulations had
also required listed firms, as well as firms with certain criteria, to have their financial
statements audited by a public accountant. The public accountant section of the IAI was then
set up to promulgate professional standards for public accountants. As stated by Kurniawan
and Indriantoro (2000), since 1994, the IAI has committed to harmonize its accounting and
auditing standards with international standards. Indonesia’s auditing standards are mostly
based on the Statements on Auditing Standards issued by the AICPA. With respect to
auditing practice, even though foreign public accountants are permitted to practice in
Indonesia on an individual basis, international audit firms are still not allowed to establish
their own offices (Rosser, 1999). In other words, to be able to operate in Indonesia,
international audit firms should have a domestic affiliate.
The 1995 Corporation Act also provides legislative backing for the auditing profession.
The Act requires a firm to have its financial statements audited by a public accountant if the
firm manages public funds, issues bonds, or has its shares listed on the stock exchange. As
further determined in the Regulation of the Minister of Finance, corporations are not allowed
to hire a particular audit firm for five consecutive accounting periods. The new 2007
Corporation Act also requires an independent audit if a firm is a state-owned corporation, has
6
a total value of assets of minimum Indonesian Rupiah (IDR) 50 billion, and is obliged by law
to have its financial statements audited.
There are more than 500 audit firms in Indonesia. Like in many other countries, the
concentration of the audit market is also found in the country. Among corporations listed on
the Indonesia Stock Exchange (IDX), based on data compiled by the annual directory IDX
Watch, it is found that the Big 4 firms had a 38-percent market share in 2007, in terms of the
number of audit clients. Based on the market capitalization of audit clients, their market share
was 75 percent.
3. Literature review and hypothesis development
3.1. Ownership concentration, family control, and corporate governance
The conventional concept of agency problems states that there may be conflicts
between managers and shareholders due to lack of alignment and differences in interests
(Jensen and Meckling, 1976), later referred to as Agency Problem I. The separation between
ownership and control of the firm also leads to information asymmetry, where managers
possess information advantage over the other parties, including shareholders (Ross, 1977).
However, this condition probably arises in firms whose share ownership is dispersed among a
large number of shareholders. Based on the finding of La Porta et al. (1999), dispersed
ownership is a common phenomenon in capital markets of a few developed countries, such as
Canada, Ireland, Japan, the UK, and the US.
The above principal-agent conflicts seem not to apply in a firm with concentrated
ownership, where the largest shareholder has effective control of the firm. La Porta et al.
(1999) contend that highly-concentrated shareholdings and a predominance of controlling
ownership appear to be the norm of corporate governance worldwide. This finding is
7
supported by regional cross-country studies conducted later, for example, in the context East
Asia (Claessens et al., 2000) and Western Europe (Faccio and Lang, 2002). In such firms, the
agency problem may arise between the controlling shareholder and minority shareholders,
where the former have greater opportunities to expropriate the firm’s wealth at the expense of
the latter (Shleifer and Vishny, 1997), later referred to as Agency Problem II. As Barclay and
Holderness (1989) contend, the controlling shareholder enjoys significant private benefits
from control, leading to potential misalignments of interests between the controlling
shareholder and minority shareholders. The private benefits from corporate control tend to be
higher in firms with a higher level of ownership concentration, as well as in less-developed
markets with weaker minority shareholder protection (Nenova, 2003; Dyck and Zingales,
2004).
With regard to the type of the controlling shareholder, prior studies indicate that family
control is a global phenomenon (La Porta et al., 1999; Classens et al., 2000; Faccio and Lang,
2002; Burkart et al., 2003). There are, however, various definitions of family firms existing in
the literature. For example, Morck and Yeung (2004) contend that family firms have two
criteria, namely (1) the largest shareholder of a firm is a specific family; and (2) the
ownership proportion of that family is greater than either 10 percent or 20 percent of the
voting shares. Westhead and Cowling (1998) and Chrisman et al. (2004) suggest the
following dimensions: share ownership, the participation of family members in the
management team or boardroom, and transgenerational management succession or ownership
transition within the family. Considering limitations in the identification of family ties among
board members, Faccio and Lang (2002) and Maury (2006) determine a corporation to be
family-controlled when its controlling shareholder is an individual or a non-listed, privately-
held company.
8
The existing literature suggests that family control of the firm may either mitigate or
exacerbate agency problems. Substantial control in the hand of a family may lead to stronger
monitoring on management and, hence, aligned interests between shareholders and
management (Demsetz and Lehn, 1985). Family firms usually focus on the firm’s long-term
survival and good reputation (Anderson and Reeb, 2003), preventing the controlling family
from behaving opportunistically and influencing financial reporting process (Wang, 2006).
On the other hand, as formulated in Agency Problem II, corporate control in the hand of a
family may provide incentives to expropriate wealth from other shareholders. Additionally,
since family members usually sit in both the management team and board of directors
(Westhead and Cowling, 1998), inferior corporate governance may persist due to ineffective
monitoring by the board. As suggested by Gomez-Mejia et al. (2001), family ownership and
control can also lead to greater managerial entrenchment.
Differences of interests between shareholders and management, or between controlling
and minority shareholders, stresses the importance of corporate governance mechanisms to
reduce the agency costs. Studies in the literature have addressed how ownership
concentration and family control influence various corporate governance mechanisms. With
regard to information asymmetry, a number of studies examine the association between
family ownership or ownership concentration and the extent of corporate disclosure, such as
Chen and Jaggi (2000), Karamanou and Vafeas (2005), Ali et al. (2007), Chen et al. (2008),
and Chau and Gray (2010). Other studies also examine the influence of ownership
concentration or family control on executive compensation (e.g. Gomez-Mejia et al., 2003;
Cheng and Firth, 2006), earnings management (e.g. Wang, 2006; Jaggi et al., 2009), cash
holdings (e.g. Ozkan and Ozkan, 2004), dividends policy (e.g. Chen et al., 2005), capital
structure (e.g. Wiwattanakantang, 1999; Anderson et al., 2003), and board structure (Setia-
Atmaja et al., 2009). In terms of the external mechanisms of corporate governance, an
9
increasing number of empirical studies investigate how ownership concentration and family
control are associated with various aspects of external audits, such as audit fees, audit quality,
and auditor choice; including El-Ghoul et al. (2007), Francis et al. (2009), Niskanen et al.
(2011a), and Dey et al. (2011). These studies are generally conducted within the context of
developed markets. Among a few studies from developing economies, Lin and Liu (2009)
investigate the relationship between corporate governance and auditor choice among Chinese
IPO firms, which are commonly state-controlled.
3.2. Audit quality and its determinants
In examining the utility of independent audits, extant studies in the literature commonly
use agency theory (e.g. DeAngelo, 1981; Watts and Zimmerman, 1983). External audits play
an important role due to their independent examinations on financial statements published by
management. The audits make such statements reliable to be referred to by various groups of
stakeholders, including shareholders and potential investors. Hence, in the corporate
governance perspective, independent audits provide bonding or monitoring mechanisms to
mitigate agency conflicts or reduce agency costs.
As suggested by Fan and Wong (2005), a firm’s manager “may consider hiring high-
quality reputable information intermediaries—in our case, auditors—to enhance his or her
credibility with investors” (p. 40). In addition, Lin and Liu (2009) suggest that varied nature
of agency conflicts leads to heterogeneous demands for audit quality. Audit quality affects
the ability of an auditor to detect material misstatements in the firm’s financial statements, as
well as the auditor’s willingness to report such misstatements (DeAngelo, 1981). For
example, Becker et al. (1998) show that earnings management is lower in firms audited by
reputable audit firms. However, the difficulties in observing audit quality lead to the use of
various indicators in the literature. One of the widely-used measures used by scholars is audit
10
fees, as found in Chan et al. (1993), Pong and Whittington (1994), O’Sullivan (2000), and
Carcello et al. (2002). As contended by Francis (2004), a higher fee implies higher audit
quality, which can be observed through more audit efforts and greater auditor expertise. It is
important to note that not all market regulators require disclosure on audit fees in the
corporate report. In their study on eight East Asian markets, Fan and Wong (2005) state that
audit fees are mandatorily disclosed only in three countries, namely Hong Kong, Malaysia,
and Singapore[1]. Another widely-used measure is the size or reputation of the audit firm, as
used in such studies as DeAngelo (1981), Palmrose (1986, 1988), and Francis and Krishnan
(1999). These studies generally argue that larger or highly-reputable audit firms can provide
higher-quality audit services than their smaller counterparts. Since larger audit firms have a
larger market share, they tend to maintain high-quality audits to protect their reputation and
avoid high litigation costs (Francis and Krishnan, 1999).
A considerable number of studies examining the determinants of auditor choice have
addressed various determinants like firm-specific characteristics, including firm size,
leverage, and business complexity (e.g. Thornton and Moore, 1993; Cravens et al., 1994;
Copley and Douthett, 2002; Broye and Weill, 2008; Knechel et al., 2008). Other studies
investigate the influence of corporate disclosure (Lee et al., 2003), culture (Che-Ahmad et al.,
2006; Hope et al., 2008), board characteristics (Beasley and Petroni, 2001; Lin and Liu,
2009), and audit committee (Abbott and Parker, 2000). With respect to ownership structure as
one of the important corporate governance mechanisms, prior studies also examine how
various types of ownership are associated with auditor selection. For instance, the influence
of state ownership on auditor choice is investigated by Wang et al. (2008) and Guedhami et
al. (2009). Other types of ownership addressed in the literature include institutional
ownership (Velury et al., 2003), managerial ownership (Niskanen et al., 2011b), and foreign
ownership (Che-Ahmad et al., 2006).
11
Given the worldwide phenomenon of ownership concentration and family control,
studies examining the influence of such ownership structure on auditor choice are
surprisingly very limited, particularly in developing economies. Piot (2001), El-Ghoul et al.
(2007), and Lin and Liu (2009) investigate the association between ownership concentration
and auditor choice, whilst how family control of the firm is related to auditor choice has been
examined by El-Ghoul et al. (2007), Francis et al. (2009), and Niskanen et al. (2010, 2011a).
3.3. Hypothesis development
In firms with concentrated ownership, agency problems may be exacerbated or
mitigated. On the one hand, effective control in the hand of a dominant shareholder may
enable the expropriation of corporate resources at the expense of minority shareholders, such
as through suboptimal risk taking and excessive compensation packages. Such practices are
suggested to be inversely related to financial reporting quality (Cohen et al., 2002). Chau and
Leung (2006) also report that ownership concentration is negatively associated with the
strength of internal corporate governance. Opaqueness in financial reporting process may
persist, leading the controlling shareholder to accruing private benefits (Fan and Wong,
2002). As such, to lower the degree of monitoring so that the expropriation behavior remains
uncovered, the controlling shareholder may choose to have its financial statements audited by
a lower-quality auditor (Lin and Liu, 2009).
On the other hand, the controlling shareholder may be concerned to employ additional
bonding or monitoring mechanisms, limiting his or her ability to extract private benefits from
control. He or she may believe that the firm needs to convince minority shareholders and
potential investors regarding the credibility of its corporate governance and financial
reporting in order to ensure that their interests are well-protected (Reed et al., 2004). This
12
concern can lead to the appointment of a high-quality auditor to examine the firm’s financial
reports.
Evidence on the relationship between ownership concentration and auditor choice is
provided by prior empirical research. The degree of ownership concentration is negatively
associated with the likelihood of hiring large audit firms in the US and France, as shown by
Copley and Douthett (2002) and Francis et al. (2009), respectively. Such a negative
association is also found by El-Ghoul et al. (2007), who study 13 Western European
economies. From the developing world, Lin and Liu (2009) demonstrate that Chinese firms
with larger ownership concentration are less likely to hire Big 10 auditors. In contrast,
employing a broad sample of firms from eight East Asian markets, Fan and Wong (2005)
indicate that firms subject to greater agency problems, which can be seen from higher
ownership concentration, are more likely to hire Big 5 auditors; supporting the view that the
large audit firms can enhance the confidence of capital market investors.
The institutional environment and investor protection in the Indonesian capital market
is relatively weaker than those in more developed markets. Given this condition, in listed
firms with concentrated ownership structure, the controlling shareholder may have greater
opportunities to maintain their opaqueness gains. A lower level of audit quality may be
employed in order to protect the private interests, leading to the exacerbation of Agency
Problem II. Based on this prediction, the first hypothesis is formulated as follows:
Hypothesis 1: There is a negative association between ownership concentration and the
likelihood to hire high-quality audit firms.
Next, this study examines whether ownership and control concentration in the hand of a
family influences corporate governance mechanisms, particularly the likelihood of choosing
highly-reputable external auditors. In addition to ownership concentration, family control
13
may also play an important role in either exacerbating or mitigating agency problems
between the controlling family and other shareholders. As suggested by Steijvers et al.
(2010), family-controlled firms tend to be more vulnerable to agency problems. On the one
hand, since it has effective control of the firm and assigns its members to sit on either the
boardroom or management team, the controlling family may have greater opportunities to
extract private benefits and lower corporate transparency. Given this condition, family-
controlled firms may be reluctant to impose external monitoring and, hence, are more likely
to hire low-quality auditors to protect the family’s private interests (Niskanen et al., 2011a).
On the other hand, family-controlled firms are relatively more concerned on their long-term
survivability and reputation, leading them to providing high-quality financial information to
maintain investors’ confidence (Dey et al., 2011). This condition may lead to the appointment
of high-quality auditors. El-Ghoul et al. (2007) also suggest that family-controlled firms may
still hire smaller audit firms since investors realize that they have no incentives to behave
opportunistically.
To the best of our knowledge, prior studies examining the association between family
control and auditor choice all indicate that family-controlled firms are less likely to hire high-
quality auditors. Employing a sample of US firms, Dey et al. (2011) provide evidence on the
negative association, suggesting that Big 4 audit firms can constrain the controlling family in
extracting private benefits. From Europe, such a negative association is reported by Francis et
al. (2009) and Niskanen et al. (2010, 2011a), based on a sample of French and Finnish firms,
respectively. Based on a broad sample of firms from 13 Western European countries, El-
Ghoul et al. (2007) also find that firms whose CEO or board chairman is a member of the
controlling family have lower likelihood to appoint high-quality firms. The influence of
family control on auditor selection in developing economies, to the best of our knowledge,
has not been examined in the literature.
14
Within the context of Indonesia, due to the country’s weaker institutional environment,
it seems that the controlling family tends to use its effective control to maintain opacity rather
than transparency. Previous studies indicate that family-controlled firms in the Indonesian
capital market show lower quality of internal corporate governance compared to that in their
non-family-controlled counterparts. For example, Achmad (2007) and Darmadi and Sodikin
(2013) find that Indonesian family-controlled firms tend to exhibit a lower level of voluntary
disclosure in the annual report. Hence, the second research hypothesis is consistent with the
finding of prior studies conducted in developed markets:
Hypothesis 2: There is a negative association between family control and the likelihood to
hire high-quality audit firms.
We also consider a number of firm-specific characteristics that potentially influence
auditor selection. A higher degree of oversight by the boardroom may lead to better corporate
governance practices, thereby increasing the likelihood to appoint a Big 4 audit firm. Beasley
and Petroni (2001) suggest that boards with a higher degree of independence tend to prefer
higher-quality auditors in order to impose more effective monitoring of corporate
management. Lin and Liu (2009) find that firms with greater oversight by the board are more
likely to choose highly reputable auditors.
Firms with larger size may prefer high-quality auditors since they want to maintain
their reputation, due to their relatively higher visibility in the market. Besides, such firms
seem to have more financial resources to hire high-quality auditors. Previous studies have
documented that firm size is positively associated with the demands for high-quality auditors
(Fan and Wong, 2005; El-Ghoul, 2007). With respect to financial leverage, firms with higher
leverage tend to have more severe agency problems (Fan and Wong, 2005). Given the
relatively weaker institutional environment, such firms may be less likely to appoint high-
15
quality auditors. Further, firms with a higher level of firm performance tend to demonstrate a
higher likelihood to engage high-quality auditors (El-Ghoul, 2007; Lin and Liu, 2009).
4. Research design
4.1. Sample description

Data are collected for the financial years 2005, 2006, and 2007, since these years are
considered the most recent normal period when this study is initially conducted. The initial
sample comprises all firms listed on the IDX, previously known as the JSX, as of 31
December of respective years. Firms from the financial sector are excluded because the sector
is subject to specific regulatory requirements. Further, firms with a negative book value of
equity and firms with incomplete data are also subject to the exclusion. The final sample
comprises an unbalanced panel data set of 787 firm-year observations, which consist of 240,
258, and 289 firms from the financial years 2005, 2006, and 2007, respectively. There are
300 unique firms captured in our sample.
Data are mainly obtained from several editions of the “IDX Watch”, previously known
as the “JSX Watch”, an annual capital market directory published by Bisnis Indonesia, a
prominent business newspaper in the country. To ensure validity, some of the directorship
data are also obtained from the annual reports or financial statements of the sample firms,
which are downloadable from the IDX’s website. Table 1 reports the selection procedure
(Panel A) and industry breakdown (Panel B) of the final sample.
[Insert Table 1 about here]
16
4.2. Model and variable measurement
This study uses the size or reputation of the audit firm to proxy for audit quality,
following DeAngelo (1981) and Lee et al. (2003), among others. However, previous
empirical studies employ different measures regarding the number of audit firms considered
of high quality, either Big 10, Big 8, Big 6, Big 5, or Big 4[2]. Following some recent studies
(e.g. Hope et al., 2008; Guedhami et al., 2009; Dey et al., 2011), the present study uses Big 4
audit firms to proxy for higher-quality auditors and non-Big 4 audit firms to proxy for lower-
quality auditors. The dependent variable (auditor choice, AUD) is dichotomous, which equals
1 if the firm is audited by one of the Big 4 audit firms (PricewaterhouseCoopers International,
Deloitte Touche Tohmatsu, Ernst & Young Global, and KPMG International) and 0
otherwise.
Since the dependent variable is binary, a logit regression model appears to be the most
appropriate estimation technique, as also employed in previous studies. The logit regression
equation is specified as follows:
AUDit = α + β1 OWNCONCit + β2 FAMILYit + β3 INDEPit + β4 FSIZEit + β5 LEVERit
+ β6 PROFITit + β7 TOBINQit + εit (1)
where AUD is auditor choice; OWNCONC is ownership concentration; FAMILY is the
presence or degree of family control; INDEP is the proportion of independent commissioners
on the Board of Commissioners; FSIZE is firm size; LEVER is firm leverage; PROFIT is
profitability; and TOBINQ is firm value, for sample firm i at year t.
Ownership concentration (OWNCONC) is indicated by the proportion of common
shares held by the largest shareholder, following Lin and Liu (2009). FAMILY is proxied by
two different variables, namely FAMCON and FAMOWN. FAMCON is a dichotomous
17
variable, which equals 1 if the firm is family-controlled and 0 otherwise. FAMOWN is the
proportion of common shares held by the controlling family. Since previous studies suggest
that ownership concentration in Indonesian listed firms tends to be significant, we define the
controlling shareholder as the largest shareholder that holds at least 20 percent of the firm’s
common shares, enabling effective control of the firm. This 20-percent cutoff is also used in
Claessens et al. (2000) and Setia-Atmaja et al. (2009), among others. We are able to identify
several types of the controlling shareholder of the IDX’s listed firms, namely the government,
foreign entities, financial institutions, individuals, unlisted companies, and another listed
firm. Similar to Faccio and Lang (2002) and Maury (2006), a firm is considered family-
controlled when its controlling shareholder is an individual or a privately-held, non-listed
company. When a listed firm is controlled by another listed firm on the IDX, we trace the
ultimate shareholder (i.e. the controlling shareholder of the parent company).
We control for board independence, firm size, firm leverage, profitability, and firm
value in the regression model. In Indonesia, where a two-tier board system is adopted, all
corporations are required to have a supervisory board (called “Board of Commissioners”,
subsequently “BOC”) and a management board (called “Board of Directors”, subsequently
BOD). The BOC acts as the representatives of shareholders and conducts monitoring and
advising roles on management, while the BOD conducts the day-to-day management of the
firm. Hence, board independence is defined to be the number of independent BOC members
divided by the total number of members on the BOC.
The book value of assets is used as a proxy for firm size. Further, firm leverage is
defined to be total liabilities divided by total assets. Finally, we also include two measures of
firm performance in the regression model, namely profitability (PROFIT) as a proxy for
accounting-based performance; and Tobin’s Q (TOBINQ) as a measure of market-based
performance. Profitability is defined to be net income divided by the book value of assets;
18
whereas Tobin’s Q is defined to be the ratio of the firm’s market value to its book value of
assets, where market value is calculated as the book value of liabilities plus the market value
of equity. Based on Hirsch and Seaks (1993), TOBINQ is included in regression models in its
natural log form. Table 2 presents the operationalization of research variables.

5. Empirical results and discussions
5.1. Descriptive statistics
Table 3 reports the descriptive statistics of variables used in the present study. Big 4
audit firms show their strong position in the Indonesian audit market, which can be seen from
44 percent of the 787 firm-year observations being audited by the highly-reputable audit
firms. In terms of ownership concentration, the descriptive statistics provide some support for
the documentation of Claessens et al. (2000), who find that Indonesia has the highest
concentration among East Asian countries being studied. Among our sample firms, the
average fraction of common shares held by the largest shareholder is 49 percent, with the
median proportion of 50 percent. Further, the descriptive statistics also shows that family
control is common in the Indonesian capital market, where 53 percent of the observations
(416) are family-controlled. Among these family-controlled firms, it is found that the
proportion of shares held by the controlling family is 50 percent on average, indicating strong
intention of such a family to maintain effective control of the firm. Foreign control is also
considered for our further analysis. Among the sample firms, the proportion of foreign-
controlled firms is 34 percent. This implies that foreign control appears to be the second most
common type of firm control on the IDX.
19
5.2. Correlation analysis and tests of differences
The results of the Spearman rank-order correlation analysis between selected variables
are presented in Table 4. Auditor choice is positively correlated with ownership
concentration, contrary to our prediction in Hypothesis 1. In firms whose ownership is
highly-concentrated, the likelihood of appointing Big 4 audit firms tends to be higher. This
positive influence will be further tested in regression analysis. The table also demonstrates
that ownership concentration is positively correlated with both measures of firm performance.
This seems to imply that when ownership concentration is higher, firms tend to hire Big 4
audit firms to enhance the market’s favorable view on their good performance.
Providing preliminary support for Hypothesis 2, auditor choice and family control are
negatively correlated. Such firms seem to be less likely to appoint Big 4 firms so that they
can maintain the controlling shareholder’s private interests despite their inferior performance.
Further, we also conduct t-tests of differences in means of selected variables for
different types of firms based on external auditors, ownership concentration, and family
control. The results are presented in Table 5. Panel A differentiates between firms audited by
Big 4 firms and those audited by non-Big 4. Firms audited by Big 4 are found to have
significantly higher ownership concentration than that of their non-Big 4-audited
counterparts. This in part implies that firms with higher ownership concentration are more
likely to choose Big 4 firms. Differently, family control is more prevalent among firms
audited by non-Big 4, suggesting that family-controlled firms tend to choose non-Big 4
auditors.
Panel B compares firms with high and low ownership concentration. A firm’s
ownership concentration is defined to be high if the share ownership of its largest shareholder
is above the median value (0.50). Consistent with the result of Panel A, Big 4 auditors are
20
more likely to be engaged in firms with a higher level of ownership concentration. Contrary
to our prediction in Hypothesis 1, it seems to suggest that high-quality audits are employed to
mitigate agency issues in firms with highly-concentrated ownership. However, the degree of
family control is not significantly different in both types of firms, indicating that family
control is prevalent in both levels of ownership concentration.
In Panel C, comparisons between family-controlled and non-family-controlled firms are

reported. Providing preliminary support for Hypothesis 2, family-controlled firms are more
likely to appoint non-Big 4 audit firms than their non-family counterparts. This preliminarily
suggests that the controlling family is more likely to sustain opaqueness gains and protect
private interests by hiring lower-quality audit firms.
5.3. Regression analysis
The results of regression analysis, based on Equation (1), are reported in Table 6. Since
the dependent variable is dichotomous, pooled logistic regressions are performed to test
hypotheses. The z-statistics is reported based on robust standard errors. Additionally, year
and industry dummy variables are included in all models. We perform two different models
to capture the variables of family control (FAMCON) and controlling family ownership
(FAMOWN).
In both models, ownership concentration is found to be positive and significant in
influencing the firm’s auditor choice. Hence, the direction contradicts our expectation in
Hypothesis 1. Supporting the finding of Fan and Wong (2005), this suggests that the
likelihood to appoint Big 4 auditors is higher when ownership concentration is larger. This
finding may imply that firms with larger ownership concentration are aware of the presence
of agency issues, so that they employ stronger mechanisms to convince minority shareholders
21
and potential investors. When the ownership becomes more concentrated, the controlling
shareholder seriously considers additional monitoring functions to show stakeholders the
credibility of the firm’s corporate governance and financial reporting process (Reed et al.,
2004), thereby leading to the engagement of high-quality auditors. In short, high-quality
audits are employed to mitigate agency issues in firms with highly-concentrated ownership.
Interestingly, this finding contradicts previous single-country studies providing

evidence on a negative association between ultimate ownership and the appointment of high-
quality auditors, such as Copley and Douthett (2002), Francis et al. (2009), and Lin and Liu
(2009). To a particular extent, this seems to suggest that audit quality serves as a corporate
governance function in an environment characterized by high ownership concentration and
weak investor protection, including in Indonesia. However, since there are different types of
shareholders, in our further analysis, we will have ownership concentration interacted with
the type of the controlling shareholder in order to investigate how the type of the controlling
shareholder influences the relationship between ownership concentration and auditor choice.
Both FAMCON and FAMOWN are negative and significant at the 1 percent level,
implying that family-controlled firms are less likely to engage Big 4 auditors. Hence, this
finding supports Hypothesis 2 and is consistent with Francis et al. (2009), Niskanen et al.
(2010, 2011a), and Dey et al. (2011), which also indicate such a negative effect. Additionally,
DeFond (1992) also indicates that there is an inverse relationship between insiders’
ownership and the demands for high-quality audits. This implies that family-controlled firms
are less likely to experience information asymmetry problems because the firm’s ownership
and control are less separated, leading to lower demands for high-quality audits (Francis et
al., 2009).
As cotended by Niskanen et al. (2011a), family-controlled firms may be reluctant to
impose stronger external monitoring (including to appoint Big 4 auditors) to enable the
22
controlling family to pursue private interests and maintain this situation. Model (2) is also
found to have a slightly stronger explanatory power than that of Model (1), suggesting that
the likelihood to engage Big 4 auditors decreases when the fraction of shares held by the
controlling family increases. Overall, the results reported in Table 6 suggest that even though
ownership concentration and the demands for high-quality audits are positively associated,
such an association may turn into a negative one when the controlling shareholder is a family.
We include the interaction term between ownership concentration and the type of the
controlling shareholder in further analysis.
With respect to control variables, the likelihood of the appointment of Big 4 auditors
increases when the firm is larger and more profitable. Firm size and profitability are found to
be positively significant in both models. The proportion of independent commissioners is
insignificant, indicating that auditor appointment is not influenced by board independence.
Similarly, leverage is not significantly associated with the demands for high-quality external
audits.
5.4. Further analysis
As suggested by Achmad (2007), the most common types of ownership among
Indonesian listed firms are family control and foreign control. The other types of control,
which belong to only a few firms, include government control, financial-institution control,
and widely-held ownership. In further analysis, we include the interaction between ownership
concentration and two most common types of the controlling shareholder, namely family
(FAMCON) and foreign entities (FORCON). The results are reported in Table 7.
As shown in Model (1) of Table 7, the interaction term between ownership
concentration and family control is significant and negative at the 1 percent level, suggesting
23
that family control explains the strong negative association between ownership concentration
and auditor choice. As such, when the fraction of shares held by the controlling family
increases, the firm’s likelihood to appoint Big 4 auditors will decrease. Even though
ownership concentration itself is positively related to Big 4 engagement, the association turns
negative when the firm’s controlling shareholder is a family. It seems that in the Indonesian
market, which is featured by relatively weaker institutional environments and investor

protection, family control is associated with a lower level of corporate governance quality.
In addition, the standalone OWNCONC variable is positive and significant. This implies
that when the controlling shareholder of a firm is not a family, higher ownership
concentration would lead to the appointment of higher-quality auditors. Again, this supports
the proposition that the controlling family tend to maintain opaqueness gains and protect
private benefits by appointing lower-quality auditors.
As reported in descriptive statistics in Table 3, 34 percent of our observations are
foreign-controlled firms, indicating relatively strong presence of foreign control in the
Indonesian capital market. Model (2) of Table 7 shows that the interaction term between
ownership concentration and foreign control is positive at the 1 percent level, implying that
foreign control explains the robust and positive association between ownership concentration
and the demands for high-quality audits. When a foreign entity acts as the controlling
shareholder, the likelihood to hire Big 4 auditors increases with the proportion of shares it
owns. This result, hence, provides some support for the findings reported by prior studies that
foreign participation leads to improved corporate governance practice (e.g. Johnson et al.,
2000; Gillan and Starks, 2003), which can be seen from the appointment of Big 4 audit firms
in situations where agency issues tend to be more prevalent. Another possible interpretation is
that foreign-controlled firms prefer to be audited by audit firms following international best
24
practice (Ghosh, 2011). Based on a sample of Indian firms, Ghosh (2011) finds that a positive
relationship exists between foreign control and audit fees.
5.5. Robustness checks
Based on the existing studies, we define the controlling shareholder as the largest
shareholder that holds at least 20 percent of the firm’s common shares, enabling effective
control of the firm. This 20-percent cutoff is also used in such studies as Claessens et al.
(2000), Faccio and Lang (2002), Maury (2006), Setia-Atmaja et al. (2009), and Darmadi and
Sodikin (2013). Nevertheless, it is worth to note that Indonesian listed firms tend to have a
higher degree of ownership concentration compared to its East Asian counterparts (Claessens
et al., 2000). Our descriptive statistics in Table 3 also indicates that the proportion of shares
held by the largest shareholder of Indonesian listed firms is 49 percent, on average. Hence,
we employ a 40-percent cutoff in our robustness check. We then repeat our regression
analysis and find that our results are generally unchanged, as reported in Table 8. Employing
the 40-percent cutoff, corporate control in the hand of a family is associated with a lower
likelihood to appoint a high-quality auditor.
In previous regression analysis, auditor choice is proxied by the likelihood of a firm to
be audited by Big 4 audit firms. However, we are aware that different proxies are employed
in the extant literature to proxy for auditor choice. Hence, in another robustness check, we
use the likelihood to be audited by Big 10 affiliates as the dependent variable, as also
employed by Lin and Liu (2009). For the purpose of this study, Big 10 audit firms are defined
to be top ten members by income of the Forum of Firms in 2008. The Forum of Firms is a
forum set up by the International Federation of Accountants (IFAC) to promote consistent
25
and high-quality standards of financial reporting and auditing practices worldwide. The Big
10 audit firms are PricewaterhouseCoopers International, Deloitte Touche Tohmatsu, Ernst &
Young Global, KPMG International, BDO International, RSM International, Grand Thornton
International, Horwath International Association, Baker Tilly International, and PKF
International (Insider, 2008). Among our 787 sample firms, 454 firms (57.69 percent) are
audited by Big 10 audit firms. Using this alternative proxy, the results are also generally
unchanged, as presented in Table 9.
6. Concluding remarks
This paper attempts to examine the association between auditor choice and two
common features of Indonesian listed firms, namely ownership concentration and family
control. In such firms, concentrated ownership may align the interests of managers and
shareholders, but it can also lead to the tendency of expropriation behavior by the controlling
shareholder at the expense of minority shareholders. With respect to the external mechanisms
of corporate governance, external audits provide independent checks on financial information
issued by management, providing stakeholders with assurance on the credibility of such
information. Auditor choice is considered one of the important corporate governance
mechanisms, where high-quality audits are expected to play an important role in mitigating
agency issues between the controlling shareholder and other shareholders.
Our results show that there is a robust and positive association between ownership
concentration and the demands for Big 4 audits, contradicting the findings of prior single-
country studies indicating a negative relationship. This may imply that when the fraction of
shares held by the largest shareholder increases, firms are more aware of the presence of
26
agency issues, leading them to hiring higher-quality auditors to impose an additional
monitoring function. In other words, high-quality audits are used to mitigate agency issues
that may arise between the controlling shareholder and minority shareholders. This finding
then underlines Fan and Wong (2005), who find a positive association between ownership
concentration and auditor choice in eight East Asian markets.
However, when the controlling shareholder is a family, the association between

ownership concentration and the demands for high-quality audits turns negative, suggesting
that family-controlled firms are significantly less likely to have their financial statements
audited by Big 4 auditors. This finding suggests that family-controlled firms are less likely to
experience information asymmetry problems because the firm’s ownership and control are
less separated, leading to lower demands for high-quality audits. However, it also suggests
that such firms may be reluctant to impose stronger external monitoring in order to maintain
opaqueness gains of the controlling family. Hence, our result is consistent with previous
findings from developed markets.
Our focus on one single economy may be one of the limitations of this study. However,
since accounting and auditing environments differ between countries, single-country studies
are still considered important (Niskanen et al., 2010). Additionally, the limitation may be also
located in the proxy for high-quality audits. The use of audit fees seems to be difficult within
the Indonesian context, since such fees are not required to be disclosed by listed firms in their
financial statements.
With respect to practical implications, our results may provide financial statement users
with additional insights when they set expectations regarding the credibility and quality of
financial statements issued by listed firms. Our findings also suggest that family-controlled
firms in the Indonesian capital market seem to have a lower level of corporate governance
quality, leading to the needs of greater minority shareholder protection in such firms. Hence,
27
this study underlines the recommendations provided by the World Bank (2010). The World
Bank’s report recommends that, given high ownership concentration, various aspects of
corporate governance regulations in the Indonesian capital market need to be reformed in
order to impose stronger monitoring mechanisms, thereby enhancing the level of minority
shareholder protection.
Notes
1. Indeed, applicable regulations in the Indonesian capital market do not require listed firms
to disclose audit fees in financial statements. Hence, using publicly-available information
to collect data, the present study uses the size or reputation of the audit firm (in this case,
Big 4 audit firms) to proxy for audit quality.
2. For example, Lin and Liu (2009) use Big 10 audit firms as a proxy for audit quality. Other
studies use Big 8 (Craswell et al., 1995; Cravens et al., 2004), Big 6 (Piot, 2001; Copley
and Douthett, 2002; Knechel et al., 2008), or Big 5 (Chaney et al., 2004; Hay and Davis,
2004; Fan and Wong, 2005). Studies using Big 5 generally employ data prior to the
collapse of Arthur Andersen. Big 4 is also widely used in the existing literature, in either
cross-country (e.g. El-Ghoul et al., 2007; Hope et al., 2008; Guedhami et al., 2009) or
single-country studies (Francis et al., 2009; Wan-Abdullah et al., 2009; Niskanen et al.,
2010, 2011a, 2011b; Dey et al., 2011).
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32
Table 1
Sample description
Description 2005 2006 2007 Total
Panel A: Sample selection process

IDX’s listed firms as at 31 December 336 344 383 1,063
Financial firms (62) (65) (68) (195)
Firms with negative book value of equity (23) (20) (23) (66)
Firms with incomplete data (11) (1) (3) (15)
Sample firms 240 258 289 787
Panel B: Industry breakdown

Agriculture 9 10 14 33
Basic and chemical 49 50 50 149
Consumer goods 33 33 32 98
Infrastructure, utilities, and transportation 16 19 22 57
Mining 12 11 14 37
Miscellaneous 35 36 40 111
Property, real estate, and building construction 28 33 42 103
Trade, service, and investment 58 66 75 199
Sample firms 240 258 289 787
33
Table 2
Operationalization of research variables
Variable Acronym Operationalization
Auditor choice
Auditor choice AUD Dichotomous, equaling 1 if the firm is audited by one of the
Big 4 audit firms and 0 otherwise
Ownership structure
Ownership concentration OWNCONC Proportion of common shares held by the largest shareholder
Family control FAMCON Dichotomous, equaling 1 if the firm is family-controlled and

0 otherwise
Controlling family ownership FAMOWN Proportion of common shares held by the controlling family
Foreign control FORCON Dichotomous, equaling 1 if the firm is foreign-controlled and
0 otherwise
Control variables
Proportion of independent INDEP Number of independent commissioners divided by the total
board members number of members on the Board of Commissioners
Firm size FSIZE Book value of assets
Leverage LEVER Book value of liabilities divided by the book value of assets
Profitability PROFIT Net income divided by the book value of assets
Tobin’s Q TOBINQ Market value (the book value of liabilities plus the market
value of equity) divided by the book value of assets
34
Table 3
Descriptive statistics
See Table 2 for variable definitions.
Variable Number Mean Median Standard Minimum Maximum

of obs. deviation
Auditor choice
AUD 787 0.44 0 0.50 0 1
Ownership structure
OWNCONC 787 0.49 0.50 0.21 0.05 0.99
FAMCON 787 0.53 1 0.50 0 1
FAMOWN 416 0.50 0.51 0.18 0.20 0.99
FORCON 787 0.34 0 0.47 0 1
Control variables
INDEP 787 0.37 0.33 0.12 0.00 1.00
FSIZE (in billion IDR) 787 2,951 682 7,689 7 82,059
LEVER 787 0.50 0.52 0.23 0.00 1.00
PROFIT (percent) 787 3.32 2.70 11.11 ─89.50 93.65
TOBINQ 787 1.54 1.10 2.61 0.12 65.40
35
Table 4
Correlation matrix
Correlations are based on Spearman rank-order. See Table 2 for variable definitions. ** and ***
indicate statistical significance (two-tailed) at the 5 and 1 percent levels, respectively.
AUD OWNCONC FAMCON INDEP FSIZE LEVER PROFIT TOBINQ
AUD 1.00
OWNCONC 0.16*** 1.00
FAMCON ─0.26*** 0.08** 1.00

INDEP ─0.02 0.06 0.05 1.00
FSIZE 0.42*** ─0.03 ─0.21*** 0.11*** 1.00
LEVER 0.03 ─0.04 0.02 ─0.05 0.16*** 1.00
PROFIT 0.29*** 0.14*** ─0.19*** 0.05 0.30*** ─0.26*** 1.00
TOBINQ 0.17*** 0.18*** ─0.16*** 0.04 0.28*** 0.09** 0.32*** 1.00
36
Table 5
Tests of mean differences
This table reports the results of t-tests of differences in means of selected variables for different types
of firms. Panel A compares firms audited by Big 4 audit firms to those audited by non-Big 4. Panel B
compares firms having high ownership concentration to those having low ownership concentration. A
firm is defined to have high ownership concentration if the share ownership of its largest shareholder
is above the median proportion (0.50). Panel C compares family-controlled to non-family-controlled
firms. See Table 2 for variable definitions. Standard deviations are in parentheses. ** and *** indicate
statistical significance (one-tailed) at the 5 and 1 percent levels, respectively.
Panel A: Comparison of firms audited by Big 4 and non-Big 4

Variable Audited by Big 4 Audited by non-Big 4 t-statistics
(n = 346) (n = 441)
OWNCONC 0.53 (0.22) 0.45 (0.20) 4.856***

FAMCON 0.38 (0.49) 0.64 (0.48) 7.403***
Panel B: Comparison of firms with high and low ownership concentration

Variable High concentration Low concentration t-statistics
(n = 387) (n = 400)
AUD 0.51 (0.50) 0.37 (0.48) 4.036***

FAMCON 0.54 (0.50) 0.51 (0.50) 0.633
Panel C: Comparison of family-controlled and non-family-controlled firms

Variable Family-controlled Non-family-controlled t-statistics
(n = 416) (n = 371)
AUD 0.32 (0.47) 0.57 (0.50) 7.391***

OWNCONC 0.50 (0.18) 0.47 (0.25) 1.946**
37
Table 6
Regression of auditor choice on ownership concentration and family control/ownership
See Table 2 for variable definitions. The z-statistics is based on robust standard errors. ** and ***
indicate statistical significance (one-tailed) at the 5 and 1 percent levels, respectively.
Model (1) Model (2)
Coefficient z-statistics Coefficient z-statistics
Intercept ─4.296*** ─7.129 ─4.558*** ─7.588

OWNCONC 2.133*** 4.962 3.027*** 6.249

FAMCON ─0.926*** ─5.138
FAMOWN ─2.206*** ─6.233
INDEP ─0.896 ─1.211 ─0.902 ─1.205
Log (FSIZE) 0.632*** 8.990 0.643*** 9.104
LEVER 0.091 0.218 ─0.013 ─0.030
PROFIT 0.031*** 2.645 0.029** 2.556
Log (TOBINQ) 0.209 1.205 0.218 1.247
Year dummy Included Included
Industry dummy Included Included
Number of observations 787 787

Pseudo R2 0.247 0.260
LR statistics 266.383*** 280.551***
38
Table 7
Regression of auditor choice on ownership concentration under different types of the
controlling shareholder
See Table 2 for variable definitions. The z-statistics is based on robust standard errors. *, ** and ***
indicate statistical significance (one-tailed) at the 10, 5, and 1 percent levels, respectively.
Model (1) Model (2)
Coefficient z-statistics Coefficient z-statistics

Intercept ─4.850*** ─7.724 ─4.352*** ─6.984

OWNCONC 3.538*** 6.183 ─0.002 ─0.003
FAMCON 0.805** 1.783
FORCON ─1.260*** ─2.534
OWNCONC * FAMCON ─3.646*** ─4.102
OWNCONC * FORCON 5.148*** 5.233
INDEP ─0.883 ─1.175 ─0.988* ─1.280
Log (FSIZE) 0.654*** 9.202 0.690*** 9.427
LEVER ─0.090 ─0.212 ─0.083 ─0.192
PROFIT 0.029*** 2.557 0.033*** 2.882
Log (TOBINQ) 0.231* 1.316 0.220 1.225
Year dummy Included Included
Industry dummy Included Included
Number of observations 787 787

Pseudo R2 0.263 0.289
LR statistics 283.730*** 311.641***
39
Table 8
Robustness check: Using 40-percent cutoff to indicate corporate control
See Table 2 for variable definitions. FAMCON and FAMOWN are based on the 40-percent cutoff. The
z-statistics is based on robust standard errors. *** indicates statistical significance (one-tailed) at the 1
percent level.
Model (1) Model (2) Model (3)
Coefficient z-statistics Coefficient z-statistics Coefficient z-statistics

Intercept ─4.958*** ─8.442 ─5.083*** ─8.608 ─5.378*** ─8.823

OWNCONC 2.765*** 5.802 3.263*** 6.357 3.657*** 6.773
FAMCON ─0.969*** ─4.619 2.302*** 3.000
FAWOWN ─2.002*** ─5.592
OWNCONC * FAMCON ─5.775*** ─4.357
INDEP ─0.843 ─1.147 ─0.817 ─1.105 ─0.655 ─0.876
Log (FSIZE) 0.638*** 9.192 0.641*** 9.192 0.647*** 9.202
LEVER 0.020 0.049 ─0.036 ─0.086 ─0.107 ─0.253
PROFIT 0.031*** 2.691 0.030*** 2.661 0.031*** 2.724
Log (TOBINQ) 0.182 1.049 0.192 1.103 0.226 1.300
Year dummy Included Included Included
Industry dummy Included Included Included
Number of observations 787 787 787

Pseudo R2 0.238 0.248 0.256
LR statistics 256.734*** 267.680*** 276.865***
40
Table 9
Robustness check: Using Big 10 audit firms as a proxy for high-quality auditors
See Table 2 for variable definitions. The dependent variable is dichotomous, equaling 1 if the firm is
audited by one of the Big 10 audit firms and 0 otherwise. The z-statistics is based on robust standard
errors. ** and *** indicate statistical significance (one-tailed) at the 5 and 1 percent levels,
respectively.
Model (1) Model (2) Model (3)
Coefficient z-statistics Coefficient z-statistics Coefficient z-statistics

Intercept ─3.340*** ─6.044 ─3.609*** ─6.604 ─3.921*** ─6.787

OWNCONC 1.010*** 2.408 1.969*** 4.029 2.530*** 4.271
FAMCON ─0.799*** ─4.570 0.751** 1.764
FAWOWN ─2.009*** ─5.660
OWNCONC * FAMCON ─3.372*** ─3.938
INDEP ─0.142 ─0.199 ─0.150 ─0.208 ─0.159 ─0.220
Log (FSIZE) 0.551*** 8.230 0.558*** 8.331 0.569*** 8.451
LEVER 0.262 0.656 0.176 0.438 0.110 0.272
PROFIT 0.037*** 3.162 0.035*** 3.078 0.035*** 3.081
Log (TOBINQ) 0.025 0.156 0.024 0.151 0.037 0.230
Year dummy Included Included Included
Industry dummy Included Included Included
Number of observations 787 787 787

Pseudo R2 0.196 0.208 0.211
LR statistics 209.839*** 222.760*** 225.883***
Acknowledgments (if applicable):
The views expressed in this paper are those of the author and do not represent the views of
the Indonesian Financial Services Authority (OJK). The author gratefully acknowledges
helpful comments from the anonymous reviewers and the Editor. The usual caveats apply.
Biographical Details (if applicable):
Salim Darmadi is an analyst at the Indonesian Financial Services Authority (OJK). He is also
a casual lecturer at the Indonesian College of State Accountancy (STAN). His research
interests include corporate governance, financial reporting, and corporate disclosure. His
research papers have been published in a number of international journals, namely Corporate
Ownership and Control, Managerial Finance, Corporate Governance: The International
Journal of Business in Society, International Journal of Commerce and Management,
Humanomics, and Asian Review of Accounting.
41

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Keywords: Auditor choice, Big 4, corporate governance, external audit, family-controlled

including international organizations, governments, market regulators, and stock exchanges.

Corporate governance includes various internal and external mechanisms to alleviate

expense of the latter (Shleifer and Vishny, 1997).

controlling shareholder and minority shareholders, information asymmetry exists in the

statements to serve as a monitoring mechanism. As suggested by Jensen and Meckling (1976)

provided by management, which plays an important role in reinforcing confidence in the

financial information. Additionally, the controlling shareholder may employ an independent

auditor as a monitoring mechanism, limiting its opportunity to pursue expropriation behavior

credibility of corporate governance and financial reporting process (Wan-Abdullah et al.,

environments, corporate governance structure, share ownership, and firm-specific

the most common features of corporate ownership in capital markets worldwide, as

Hence, this study is intended to fill this gap.

Indonesian publicly-listed firms is associated with ownership concentration and family

Second, the present study focuses on an emerging economy, where ownership

protection than do their emerging counterparts. Indonesia provides an interesting setting

crisis. As contended by Rosser (2005), the corporate governance improvement in post-crisis

The present paper is structured in the following manner. Section 2 provides an

presented in Section 5. Finally, Section 6 concludes.

2. Accounting and auditing environments in Indonesia

attract foreign investments. In 1973, the government’s tentative committees in conjunction

Accountants (AICPA), appeared to be Indonesia’s first set of accounting standards, even

though in a simple form (Rosser, 1999). As explained by Ninsuvannakul (1988), the

Standards (Pernyataan Standar Akuntansi Keuangan or PSAK). PSAKs provide a

statements based on the revised PSAKs.

set up to promulgate professional standards for public accountants. As stated by Kurniawan

international audit firms should have a domestic affiliate.

to have its financial statements audited.

3. Literature review and hypothesis development

3.1. Ownership concentration, family control, and corporate governance

ownership is a common phenomenon in capital markets of a few developed countries, such as

Canada, Ireland, Japan, the UK, and the US.

(1999) contend that highly-concentrated shareholdings and a predominance of controlling

ownership appear to be the norm of corporate governance worldwide. This finding is

from control, leading to potential misalignments of interests between the controlling

higher in firms with a higher level of ownership concentration, as well as in less-developed

following dimensions: share ownership, the participation of family members in the

management team or boardroom, and transgenerational management succession or ownership

family-controlled when its controlling shareholder is an individual or a non-listed, privately-

monitoring on management and, hence, aligned interests between shareholders and

control can also lead to greater managerial entrenchment.

Differences of interests between shareholders and management, or between controlling

and minority shareholders, stresses the importance of corporate governance mechanisms to

regard to information asymmetry, a number of studies examine the association between

concentration or family control on executive compensation (e.g. Gomez-Mejia et al., 2003;

Atmaja et al., 2009). In terms of the external mechanisms of corporate governance, an

IPO firms, which are commonly state-controlled.

3.2. Audit quality and its determinants

an important role due to their independent examinations on financial statements published by

stakeholders, including shareholders and potential investors. Hence, in the corporate

governance perspective, independent audits provide bonding or monitoring mechanisms to

mitigate agency conflicts or reduce agency costs.

avoid high litigation costs (Francis and Krishnan, 1999).

A considerable number of studies examining the determinants of auditor choice have

addressed various determinants like firm-specific characteristics, including firm size,

ownership (Che-Ahmad et al., 2006).

3.3. Hypothesis development

In firms with concentrated ownership, agency problems may be exacerbated or

strength of internal corporate governance. Opaqueness in financial reporting process may