Are independent commissioners able to mitigate higher audit fees in politically connected firms?

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Illustration by Tom MC Life

Political connections in business have shown considerable interest from researchers. Previous studies found that these companies gained several benefits such as favorable audit opinions (He et al., 2017), and higher company performance (Brockman et al, 2013; Lee et al., 2014). However, political connections also have disadvantages such as high audit fees (Bliss et al., 2011; Gul, 2006; Wahab et al., 2011).

For example, politically connected companies have a higher inherent risk because when companies can secure their capital financing using their political connections, they have less need to provide high quality accounting information (Harymawan & Nowland, 2016). This makes the auditor must put more effort into improving their quality, which is represented as high audit costs. In contrast, independent directors tend to reduce audit fees because of their role in monitoring company operations.

Indonesia is a country that has an inseparable business and political history. Since the late 1970s, political connections in Indonesian business have increased substantially, with Suharto’s cronies at the center. (Harymawan et al., 2019). After the fall of Suharto, hopes arose for firms with no political connections. More than half of the politically connected companies were destroyed because they were unable to maintain their business. However, Indonesian businesses have not yet fully freed themselves from this relationship, because the old Suharto company managed to consolidate their business and start a new relationship with politicians and government officials after the Suharto government (Winters, 2013).

Funding political parties in Indonesia comes from three sources: internal (member contributions), state grants, and external (Mietzner, 2015). National-level political parties need funds of around 3.5 million USD per year, while member contributions and state donations are only 43 thousand USD each (Barid et al., 2018). So politics is really involved in business, because the source of its central funding comes from the private sector. On the other hand, a business has access to special regulations as a token of gratitude.

Harymawan, Putra, Ekasari, and Sucahyati conducted a research in 2019 involving 961 companies listed on the Indonesia Stock Exchange for the period 2014 – 2018 as samples. Financial data were obtained from the ORBIS database, while non-financial data were obtained manually from annual reports, and financial reports , a company that can be downloaded at www.idx.co.id

The results of the analysis revealed that political connections (independent commissioners) have a positive (negative) relationship with audit fees, where the relationship of independent commissioners dominates the relationship of political connections. We also documented that the relationship between political connections and audit fees mainly comes from the board of directors, CEOs, and affiliations of certain organizations weakened by the presence of independent commissioners. This implies that regardless the type of political connection, an independent commissioner is very important for the company to reduce the risk caused by political connections, resulting in lower audit fees.

Author: Iman Harymawan, Ph.D.

Details of this research available at: https://www.ijicc.net/index.php/ijicc-editions/2020/159-vol-11-iss-8

Harymawan, I., Putra, F.K.G., Ekasari, W.F., Sucahyati, D. Are Independent Commissioners Able to Mitigate Higher Audit Fees in Politically Connected Firms? Evidence from Indonesia. International Journal of Innovation, Creativity, and Change.

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