Military reform, militarily-connected firms and auditor choice

Abstract

Purpose One of the strongest connections in politics in developing countries is through military links. This study aims to examine the auditor choice preference of the militarily-connected firms in Indonesia, an emerging country where there is a strong influence from the military on political decision-making. Design/methodology/approach The analysis used 3,473 firms-year observations listed on the Indonesian Stock Exchange spanning from 2003 to 2017 using regression and other statistical tests. Findings The results reveal that firms with a militarily-connected director are less likely to appoint one of the Big 4 auditors. Using the military reform as a natural experiment, the finding shows that militarily-connected firms did not change their auditor choice preference even after the military reform. Interestingly, I find that connected firms are associated with high earnings management. In addition, the different retirement position level and military affiliations of the connected directors generate different outcomes related to the auditor choice decision. Overall, the results indicate that militarily-connected firms were less likely to appoint one of the Big 4 auditors both before and after the military reforms. These results are robust, even after the author controlled for political connections, year fixed effects and industry fixed effects. Research limitations/implications Because of the limitations of the prior literature on military connections, this study is developed based on the assumption that the militarily-connected directors have identical behavior whether they serve in either public or private companies. However, this assumption could be invalid which potentially affects the interpretation of some of the results in this study. Originality/value This paper provides direct evidence of the auditor choice preference of firms with a military connection. The evidence builds on the existing literature on the difference in auditor choice preference between politically and militarily-connected firms.