Legal Liability,Government Intervention,and Auditor Behavior: Evidence from Structural Reform of Audit Firms in China

This paper investigates how legal liability influences audit quality and audit fees, particularly in the presence of government intervention. Since 2010, all Chinese audit firms were required to transform from a structure of limited liability company (LLC) to limited liability partnership (LLP), which removes the cap on the liability exposure of negligent auditors. By adopting this natural experiment, we document the following findings: first, after audit firms reorganize as LLPs, auditors are more likely to (1) issue modified audit opinions and going-concern opinions, (2) constrain clients’ earnings management, and (3) charge a premium in audit fees, which suggest that exerting unlimited legal liability on negligent auditors improves both audit quality and audit fees. Second, the effect of the LLP adoption is more pronounced when auditors are from local audit firms, and clients are controlled by local governments. Further analyses suggest that the stock prices of clients positively react to the reform event, which indicates that LLP adoption improves the overall value of audits. In summary, our empirical findings are consistent with the argument that legal liability is able to effectively shape auditor behavior in emerging markets where the other institutional mechanisms are relatively weaker and government intervention is heavy.     

控股股东股权质押是否影响审计师定价策略？——来自中国上市公司的经验证据

审计成本与风险溢价是影响审计师定价的两个重要因素。以2007—2014年间我国A股上市公司为对象,研究控股股东股权质押对审计师定价的影响,并考察了产权性质、审计师特征以及法制环境对两者之间关系的调节作用。研究发现：总体而言,相较于非控股股东股权质押的公司,审计师对控股股东股权质押公司的审计定价更高,且控股股东股权质押比例越高,审计定价越高。进一步地,在民营企业、“四大”审计的企业及在法制环境好的地区,审计师对控股股东股权质押公司的审计定价都更高。这表明审计师能够识别上市公司控股股东股权质押带来的风险,并将其反映在审计定价中。     

Ownership concentration,modified audit opinion,and auditor switch: New evidence and method

This study investigates: 1) how does the ownership structure of listed firms influence the relation between their earnings management behavior and auditor opinion; 2) how does the ownership structure influence the relation between the auditor opinion and auditor switch. We find that the level of listed firms’ earnings management is positively associated with the propensity of being issued modified audit opinions (MAOs) by auditors when their ownership structure is highly concentrated. However, the issuance of MAOs is not associated with the auditor switch under such condition. On the contrary, a high level of earnings management is not associated with the propensity of being issued MAOs when firms’ ownership structure is less concentrated. Further, the issuance of MAOs may increase the likelihood of auditor switch. The empirical findings suggest that auditors may cater for the preferences of the real controller of listed firms when issuing audit opinions. Moreover, the “auditor opinion shopping” behavior by listed firms is also affected by listed firms’ ownership structure.     

Market Implications of the Audit Quality and Auditor Switches: Evidence from China

Independent audits enhance the credibility of corporate financial reports and assist investors to make rational decisions in the capital market. Nonetheless, the utility of the auditing function depends upon the quality of audits, which is determined by the independence and expertise of auditors. Hence, auditor choice and switch will not only affect an audit's quality, but will also influence decisions made by investors and other market participants. The purpose of this paper is to investigate how investors respond to the quality of audits and auditor switches in the Chinese context. Empirical results show that the quality of an audit and switching to a larger auditor have a positive (negative) impact on earnings response coefficients (ERCs) for firms with positive (negative) abnormal earnings. In contrast, switching to a smaller auditor has a negative (positive) impact on ERCs for firms with positive (negative) abnormal earnings. These results suggest that large auditing firms (Top 10) in China are perceived as more effective for curbing income-increased earnings management, which leads to higher (lower) ERCs for clients with positive (negative) abnormal earnings. Firms' switching to a larger auditor may signal high-quality earnings. Therefore, investors more often increase stock prices when firms have positive abnormal earnings and less often depreciate prices for negative abnormal earnings. Similarly, switching to a smaller auditor may signal lower earning quality, resulting in opposite market responses. In general, the empirical evidence suggests that audit information is valued by the capital market in China. Large auditing firms have been able to product-differentiate themselves within the Chinese stock market.     

The impact of litigation risk on the association between audit quality and auditor size: Evidence from China

We examine whether audit quality varies across different sizes of CPA firms under high or low auditor‐specific litigation risk exposure. We measure audit quality by the issuance of modified audit opinions and the audit fees charged to clients, and we use the organizational form of CPA firms as the proxy for auditors’ litigation risk exposure, where a partnership (limited liability) CPA firm represents a high (low) litigation risk exposure. Built on Choi, Kim, Liu, and Simunic's (2008) theoretical framework, we hypothesize that the litigation risk exposure of CPA firm moderates the association between auditor size and audit quality. Our results show that when the auditor's liability is capped (i.e., registered as a limited liability form of CPA firm), larger size CPA firms are associated with higher audit quality when compared to smaller size CPA firms. However, this positive association between auditor size and audit quality disappears for audit firms that are subject to high litigation risk exposures (i.e., registered as a partnership form of CPA firm). Our research provides new insights on the impact of auditor‐specific litigation risks on the relation between audit quality and auditor size. In particular, we show that only when auditor‐specific litigation risk is limited, do large CPA firms appear to perform higher quality audits than small CPA firms.     

Investor legal protection,capitalized development costs,and audit fees: A cross‐country analysis

Our study explores the association between capitalized development costs and audit fees. International Accounting Standard No. 38 stipulates the discretion to capitalize the development costs of internally generated intangible assets. We find a positive association between capitalized development costs and audit fees, which reflects auditors’ concern that managers may use the discretion of development cost capitalization to manipulate earnings. Moreover, this positive association is mitigated by stronger investor legal protection because stronger investor legal protection alleviates the earnings management concern from capitalized development costs. These results suggest that country‐level legal regimes affect auditors’ perception on client firms’ accounting choices. Our study contributes to the literature exploring how legal regimes affect auditor behaviors.     

The Provision of Tax Services by Incumbent Auditors and Earnings Management: Evidence from Korea

This study examines the associations between the provision of tax services by incumbent auditors and earnings management. We investigate whether three different effects of tax service provision play different roles in accounting practices. The three effects include the audit independence effect, the knowledge spillover effect, and the tax avoidance effect. If the provision of tax services by incumbent auditors harms auditor independence, firms may exercise greater earnings management (audit independence effect). However, if incumbent auditors gain incremental knowledge by offering tax services, the quality of their audit services could be enhanced, and therefore, reported earnings could be more conservative (knowledge spillover effect). If tax service fee leads to low taxable income, it could depress book income when book-tax conformity is high (tax avoidance effect). We find that the provision of tax services generally improves earnings quality by curtailing opportunistic accounting practices. The results also suggest that the negative association between the provision of tax services and discretionary accruals seems to be primarily driven by the knowledge spillover effect as opposed to the tax avoidance effect. Additional analysis is conducted in examining whether the tax avoidance effect exists in a sub-sample.     

European Market Reaction to Audit Reforms

Abstract

This paper investigates European stock market reaction to events associated with the proposed EU audit reforms that were ultimately implemented in 2016. These include, inter alia, mandatory audit firm rotation, prohibition of non-audit services, and fee caps. We find that investors react positively to the proposals, lifting aggregate market value by approximately €108,630 million. In cross-sectional analysis at both country and firm level, we find that these net benefits arise from the prohibition of non-audit services and the placing of a cap on total fees charged by the auditor. Furthermore, we find investors in firms with low earnings quality appear to perceive the greatest benefits from the proposed reforms.     

频繁并购重组与异常审计收费

以2012—2017年A股上市公司为样本,采用异常审计费用衡量审计师对上市公司频繁并购重组的风险溢价,探究企业频繁并购重组与审计师风险溢价收费的关系,研究发现企业频繁并购重组会导致审计师风险溢价提高。从商誉和盈余管理角度探究其路径机制发现,商誉和真实盈余管理是频繁并购重组导致更高审计师风险溢价两个重要中介变量,而应计盈余管理并没有发挥中介作用,即频繁并购重组企业操纵利润的手段倾向于采用真实盈余管理,而非应计盈余管理。     

An Experimental Analysis of the Effects of Non‐audit Services on Auditor Independence in Appearance in the European Union: Evidence from Germany

The provision of non‐audit services by the statutory auditor may have a negative impact on auditor independence. Therefore, the European Union decided to prevent auditors from offering a significant extent of non‐audit services to audit clients. Prior research has revealed that different advisory services have different effects on perceived auditor independence. This could be caused by differences in number and intensity of independence threats (self‐interest, familiarity, self‐review, advocacy). Therefore, this experimental study investigates the effect of such threats on independence perceptions in the case of German individual investors. Multivariate analyses indicate that a high self‐interest and a high‐familiarity threat may impair auditor independence in appearance. On the other hand, our findings do not reveal a significant effect of an existing advocacy threat on investors’ trust in auditor independence. A negative effect of a self‐review threat is not directly confirmed. However, the provision of services with regard to internal controls, and thus the self‐review threat, interacts with the self‐interest threat. They potentially impact perceived auditor independence negatively when non‐audit fees are high. In contrast, no significant interactions with familiarity are found. Based on these findings, a general prohibition of non‐audit services does not seem to be necessary. On the other hand, a non‐audit fees cap might be reasonable.     

Toward the Effect of Audit Quality on Earnings Management——Empirical Evidence from Manufacturing Enterprises Listed in Shanghai Stock Market

Nowadays, earnings management is a hot issue, but most of the researches focus on the incentives of earnings management and few of them refer to the effect of audit quality on earnings management. In this study, we directly examine the effect of external audit quality on earnings management by using discretionary accruals. We find that the discretionary accruals of non-dual audit companies are significantly greater than those of dual audit companies. We also find that clients of non-First Ten auditors intend to report greater discretionary accruals than those of First Ten auditors.     

Governance Role of Auditors and Legal Environment: Evidence from Corporate Disclosure Transparency

In a sample of firms originating from 20 countries, we examine whether and how auditor size (our proxy for audit quality) associates with corporate disclosure transparency. While prior studies examine the relation between auditor size and several aspects of financial reporting quality (e.g. discretionary accruals, restatements, etc.), there is limited evidence on how auditor size relates to disclosure transparency. There is also mixed evidence on how auditor size relates to reporting quality in different legal environments. We find that auditor size is positively associated with disclosure transparency around the world and that the association is stronger in code law regimes than in common law regimes. The latter finding supports the view that audits play a greater governing role in weaker legal environments.     

What matters in disclosures of key audit matters: Evidence from Europe

New regulation in the European Union has introduced the mandatory disclosure of key audit matters (KAMs) to audit reports. The EU has identified KAMs as significant risks, significant transactions or events, or significant judgments by auditors. This paper aims to determine the factors that influence the number of KAMs that auditors disclose in the main European countries under the new regulation. We predict that the litigation risk, reputation loss, auditor–client relationship, precision of accounting standards, and the effect of regulators and supervisors’ activities affect the number of KAMs that auditors disclose. The sample consists of firms on the FTSE 100, CAC 40, or AEX 25 that have disclosed KAMs at the 2016 fiscal year‐end. In line with our hypotheses, the findings show that a higher number of business segments (complexity) and more precise accounting standards lead to the disclosure of a higher number of KAMs. Contrary to our expectations, the results indicate that a positive association exists between the audit fee and the number of KAMs disclosed. As audit fees can be related to higher client risk, this finding could indicate that litigation risk dominates any auditor–client dependence. Further, although auditors often view their audits of banks as complex, the findings show a negative association between banks and the number of disclosed KAMs. This evidence may be related to the fact that financial institutions are in a highly regulated and supervised industry that reduces the need to disclose the KAMs.     

胁迫威胁下的审计独立性问题研究

审计独立性是决定审计质量能否得到保证和审计目的能否实现的关键因素。在我国,审计人员受被审单位管理当局胁迫而出具不实审计报告的问题十分突出,胁迫威胁的存在严重地影响了审计的独立性。本文试图通过博弈分析来专门探讨经营者的胁迫威胁对审计人员独立性的影响,并据此提出保护审计独立性的有效手段。     

Loss Aversion,Audit Risk Judgments,and Auditor Liability

Abstract

I investigate how different legal regimes affect auditor's effort and investors' investment decisions when the auditor is subject to probability weighting and loss aversion, which are two important characteristics of Prospect Theory. Probability weighting encourages an auditor to overrate the audit risk and the likelihood of damages leading to inflated audit fees which could help to explain the BigN audit-fee premium. With loss aversion, an auditor is sensitive to the risk of damage compensation and, thus, tends to exert excessive caution which also generates excessive audit fees. Consequently, investors may choose not to hire an auditor and, as a result, may forego an otherwise profitable investment. These effects are more intense with a strict liability regime than with a negligence rule because with the latter, the auditor is not held liable when due care has been exerted. This removes the risk of incurring losses. The paper highlights the robustness of the negligence regime when preferences are unobservable.     

诉讼风险如何影响事务所低价揽客经济后果?——来自公司盈余管理的经验证据

近年来,会计师事务所低价揽客行为频发,其经济后果受到广泛关注。在此背景下,基于诉讼风险视角,实证检验事务所低价揽客行为对企业盈余管理的影响。研究发现,存在低价揽客行为的事务所审计的客户公司有着更高程度的盈余管理,但这种关系主要由非十大所的低价揽客行为所驱动;当诉讼风险增加时,事务所低价揽客与公司盈余管理之间的正向关系有所减弱,诉讼风险的这种调节作用主要存在于非十大所审计的企业以及进行正向盈余管理的企业中。这些结果表明,与大所相比,小所的低价揽客行为在加剧企业盈余管理方面产生的经济后果更为严重,而较高的诉讼风险可缓解这一行为带来的不良后果。因此,抑制企业盈余管理,应有针对性地规范小所的审计定价行为,加大其低价揽客行为的诉讼成本。     

The changing public sector: from transition to transformation

This paper contributes to the empirical audit-quality literature and provides evidence on (the lack of) audit-quality differentiation in the private client segment of the Belgian audit market. Auditor size is used as audit-quality proxy. Prior evidence on audit-quality differentiation between Big Six and non-Big Six auditors in the private client segment of the Belgian audit market is mixed. In this paper we investigate whether these mixed results stem from the inability of the dichotomous Big Six/non-Big Six variable to capture auditor-size differences in a less concentrated audit market. To that end we examine whether alternative continuous measures of audit-firm size (i.e. auditor market share, number of audit-firm clients, number of partners in the audit firm, total assets and operating profit of the audit firm) have a constraining impact on earnings management in a large sample of privately held Belgian companies (n?=?1,302). Overall, we do not find evidence that is supportive of quality differentiation in the private client segment of the Belgian audit market.     

Mandatory Audit Firm Rotation and Audit Quality

In a setting where mandatory audit firm rotation has been effective for more than 20 years (i.e. Italy), we analyse changes in audit quality during the auditor engagement period. In our research setting, auditors are appointed for a three-year period and their term can be renewed twice up to a maximum of nine years. Since the auditor has incentives to be re-appointed at the end of the first and the second three-year periods, we expect audit quality to be lower in the first two three-year periods compared to the third (i.e. the last) term. Assuming that a better audit quality is associated with a higher level of accounting conservatism, and using abnormal working capital accruals as a proxy for the latter, we find that the auditor becomes more conservative in the last three-year period, i.e. the one preceding the mandatory rotation. These results are confirmed using Basu's [1997. The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economics, 24(1), 3–37] timely loss recognition model. In an additional analysis, we use earnings response coefficients as a proxy for investor perception of audit quality, and we observe results consistent with an increase in audit quality perception in the last engagement period.     

Consequences of the Abandonment of Mandatory Joint Audit: An Empirical Study of Audit Costs and Audit Quality Effects

This paper focuses on the unique Danish setting in examining the consequences of abandoning a mandatory joint audit regime. We study the effects on audit costs (measured by audit fees) and audit quality (measured by abnormal accruals) of the abandonment of the mandatory joint audit in Denmark in 2005. We perform our analysis on non-financial listed Danish companies for the 2002–2010 period. Our results show that a joint audit is associated with higher fees, but that the association between joint audit and abnormal accruals is insignificant. This suggests that the higher audit fees cannot be explained by higher audit quality. Our results are robust to alternative measurements of fees and audit quality. Additional analyses show that the fee premium related to a joint audit decreases over time and that the Big 4 concentration in our sample has increased since the switch from mandatory to voluntary joint audit. Our results are consistent with the motivations driving the regulatory change in Denmark and are of interest to regulators and actors in the audit market.