The impact of corporate governance on auditor choice: Evidence from China

As the largest and fastest growing emerging market, China is becoming more and more important to investors throughout the world. The purpose of this paper is to investigate the determinants of firms’ auditor choice in China in respect of their corporate governance mechanism. Normally firms have to take a trade-off in their auditor choice decisions, i.e., to hire high-quality auditors to signal effective audit monitoring and good corporate governance to lower their capital raising costs, or to select low-quality auditors with less effective audit monitoring in order to reap private benefits derived from weak corporate governance and less-transparent disclosure (the opaqueness gains). We develop a logit regression model to test the impact of firms’ internal corporate governance mechanism on auditor choice decisions made by IPO firms getting listed during a bear market period of 2001–2004 in China. Three variables are used to proxy for firms’ internal corporate governance mechanism, i.e., the ownership concentration, the size of the supervisory board (SB), and the duality of CEO and chairman of board of directors (BoDs). We classify all auditors in China into large auditors (Top 10) and others (non-Top 10), assuming the large auditors can provide higher quality audit services. The empirical results show that firms with larger controlling shareholders, with smaller size of SB, or in which CEO and BoDs chairman are the same person, are less likely to hire a Top 10 (high-quality) auditor. This suggests that when benefits from lowering capital raising costs are trivial, firms with weaker internal corporate governance mechanism are inclined to choose a low-quality auditor so as to capture and sustain their opaqueness gains. On the other hand, with improvement of corporate governance, firms should be more likely to appoint high-quality auditors.     

产权性质、制度环境与内部控制

内部控制是近年来国内外监管部门、实务界和学术界关注的热点与前沿问题。本文研究我国上市公司最终控制人的产权性质与地区制度环境对公司内部控制质量的影响。利用厦门大学内控课题组(2010)构建的2007-2009年我国上市公司内部控制指数,本文主要发现:首先,相比于中央政府控制的公司,地方政府控制的公司内部控制质量相对较差,而非政府控制的公司内部控制质量与中央政府控制的公司之间则没有明显差异;其次,上市公司所在地区的市场化程度越高或政府对经济的干预程度越低,公司的内部控制质量越高,尤其是对于地方政府控制和非政府控制的上市公司,并且,良好的外部制度环境有助于缩小地方政府控制和非政府控制公司的内部控制与中央政府控制公司之间的差距。本文的研究结果对相关主管部门及监管机构具有一定的政策启示意义。     

Government ownership,audit firm size and audit pricing: Evidence from China

The present study provides empirical evidence on the impact of government ownership on audit pricing behaviour based on data from Chinese listed companies between 2001 and 2008. Our findings, having controlled for auditor choice, indicate that state-owned enterprises (SOEs) incur significantly lower audit fees than non-SOEs. The results also reveal a significant interaction between the type of SOE (i.e., owned by central vs. local government) and audit firm size, which also affects audit fees. More specifically, large auditors tend to charge the central-SOEs lower audit fees than local-SOEs (province, city and county), while small auditors charge central-SOEs higher fees than local-SOEs. We explore a political economy rationale from a supply-side perspective in explaining the results.     

供应商-客户关系与审计师选择

采用2002-2009年中国制造业上市公司数据,本文检验了供应商集中度和客户集中度对公司审计师聘用决策的影响。研究结果显示,对于非国有公司来说,供应商集中度或客户集中度越高,公司聘用大所进行审计的概率越低。对于国有公司来说,随着供应商集中度或客户集中度的上升,公司聘用大所进行审计的概率先逐渐下降,但随后又逐渐上升,呈现出U型关系;但是,这种U型关系只在国有股比例较高的公司中存在。本文的研究结果表明,公司会通过聘用高质量的审计师向供应商或客户发送信号,换言之,审计信号理论对于投资者之外的利益相关者也是适用的。     

Industry specialist auditors, outsider directors, and financial analysts

This study investigates the relationships among industry specialist auditors, outside directors, and financial analysts. Specifically, we examine the effect of analyst coverage on the association between auditor industry specialization and outside directorship. We find that outside directors are less likely to hire industry specialist auditors for firms with high analyst coverage than for firms with low analyst coverage. Our findings suggest that analyst coverage moderates outside directors’ demand for industry specialist auditors, that is, financial analysts may compete with industry specialist auditors to some extent in monitoring financial reporting process.     

How do political connections cause SOEs and non‐SOEs to make different M&A decisions/performance? Evidence from China

This study examines the impact that political connections have on Mergers and Acquisitions (M&A) performance and the decisions of Chinese listed firms. We find that political connections destroy (create) value in SOEs (non‐SOEs). Our findings show that connected SOEs are more likely to acquire local targets, especially when the local unemployment rate is high and when the firms are controlled by the local government, and they are less likely to conduct vertical mergers. M&A decisions of connected non‐SOEs are less influenced by the government; instead, political connections in non‐SOEs help bidders to integrate vertically and obtain external financing support.     

Top management turnover,firm performance and government control: Evidence from China's listed state-owned enterprises

Using a sample of 916 Chinese listed state-owned enterprises (SOEs) from 2001 to 2005, we find that the likelihood of top management turnover is negatively associated with firm performance, suggesting the existence of an effective corporate governance mechanism in an emerging economy that is highly controlled by government. We also find that the negative turnover–performance relationship is stronger when the SOE is directly held by the central or local government, holding a monopolistic position in a local economy or in a strategic/regulated industry. The results indicate that the market-based corporate governance mechanism that disciplines top executives as a result of poor performance is not only used in Chinese SOEs, but is used more frequently when the governance control of SOEs is more intense. Our findings support the notion that government control strengthens rather than weakens the turnover–performance governance mechanism. Our additional analysis shows that this complementary effect is stronger in regions that lack pro-market institutions, such as investor protections and a functioning capital market.     

Price informativeness and state-owned enterprises: Considering their heterogeneity

State owned enterprises (SOEs) play a pivotal role in the world economy. However, how state ownership affects price informativeness is less-explored, much less the impacts of differing forms of state ownership. We find that the price synchronicity of SOEs is about 9.0% to 15.4% larger than that of non-SOEs, indicating that SOEs have less informative stock prices. Institutional environment and government regulations such as anti-corruption campaigns are important mediating factors in reducing price synchronicity, but the price synchronicity of SOEs is still significantly larger than that of non-SOEs. Differences in state ownership matters for price synchronicity. SOEs associated with local governments (SOELGs), as well as those represented by state assets management bureaus (SAMBs), have larger price synchronicity than non-SOEs. Although SOEs controlled by central governments (SOECGs) also have larger price synchronicity than non-SOEs based on univariate tests, this difference becomes statistically insignificant when controlling for other factors. SOEs are less likely to be publicly exposed for fraud, implying that state ownership provides a buffer for SOEs. Overall, we evidence that state ownership has an important role in deprecating stock-price informativeness, with the impact differing depending on whether SOEs are controlled by central or non-central governments.     

Auditor quality,audit fees,organizational structure,and risk taking in the US life insurance industry

Using a system of simultaneous equations, this study examines the relation among external audit monitoring, in the US life insurance industry. We find insurers with higher leverage risk and surplus risk are more likely to use Big‐4 auditors and to pay higher fees. In return, insurers hiring Big‐4 auditors and paying higher audit fees have lower leverage risk and surplus risk. Second, the results suggest that mutual life insurers have a higher leverage risk and surplus risk than stock life insurers. This evidence is in contrast to that for property–liability insurance companies. Third, we find insurers are less likely to hire Big‐4 auditors and to pay higher audit fees after implementation of the Sarbanes–Oxley Act (SOX). Finally, life insurers with Big‐4 auditors or paying higher audit fees are more likely to take lower risks after the implementation of SOX.     

Does Internal Corporate Governance Complement or Substitute for External Auditing? Evidence from China's Anti‐corruption Campaign

Two competing hypotheses have been developed for the relationship between internal corporate governance and external auditing. One proposes a complementary relationship, while the other suggests it is substitutable. This study takes advantage of China's recent anti‐corruption campaign as a quasi‐natural experiment to explore this relationship. Using a difference‐in‐differences approach, we find that, after the campaign, internal corporate governance improved more in SOEs (state‐owned enterprises) than in non‐SOEs. SOEs were less likely to choose Big 10 auditors after the campaign, while audit firms assigned less experienced auditors to their SOE client firms and charged lower audit fees. These effects were more pronounced in SOEs that exhibited greater improvement in corporate governance. Overall, we find the anti‐corruption campaign improved corporate governance in SOEs but, at the same time, reduced external audit quality, which supports the substitution view. We argue that this result might be driven by the fact that SOEs have limited demand for high‐quality accounting information because the Chinese government maintains strong control over the capital markets.     

The effect of constrained processing on auditors’ judgments

This study examines whether constraining experienced auditors’ processing by having them process evidence in a pre-established sequence (an experimental control technique used in previous studies) prevents them from using their usual processing strategies and thereby affects their judgments. We compare the relative attention to evidence and judgments of experienced and inexperienced auditors in a constrained versus an unconstrained processing condition. Consistent with expectations, experienced auditors’ going-concern judgments differed from inexperienced auditors’ judgments only when processing was unconstrained. This difference in judgments was the result of differential attention to evidence. These results demonstrate that the failure to consider how experienced auditors process evidence can result in inadvertently adopting control techniques that limit the generalizability of experimental findings. Although our study used a going-concern task, our conclusions are likely to apply to a variety of ill-structured audit tasks that require a goal-oriented, directed evaluation of evidence.     

Does audit quality matter more for firms with high investment opportunities?

This paper examines the association of firms with high investment opportunities with high quality audits (proxied by Big 5 auditors) and whether that association results in a lower likelihood of earnings management. Firms with high investment opportunities may demand high quality audits for curbing earnings management. This is because they have more flexibility in the provision of discretionary accruals that arises from the attendant operating uncertainty which creates particular monitoring problems. Big 5 auditors will provide high quality audits that will constrain earnings management for firms with high investment opportunities because the risk of losing (and hence the likelihood of maintaining) auditor independence is higher. Results show the following. First, firms with high investment opportunities are more likely to hire Big 5 auditors than firms with low investment opportunities. Second, firms with high investment opportunities are more likely to have more discretionary accruals but this relationship is weaker when they have Big 5 auditors. These results are robust to various sensitivity tests.     

Mythical representations of trust in auditors and the preservation of social order in the financial community

The present paper investigates financial practitioners’ use and perception of audited financial statements. In-depth interviews, which we conducted with Canadian institutional investors, financial analysts and bankers, indicate: (1) a firm tendency to favour the quality of management over the content of financial statements in investment decisions and recommendation processes; and (2) a fundamental scepticism regarding the work of auditors. However, representations of auditor trustworthiness abound in formal texts surrounding the financial analysis domain—as if audited financial statements and the trust they convey towards numbers are indispensable to the work of financial analysts. Based on the work of Roland Barthes, we argue that financial practitioners’ trust in auditors constitutes a mythical representation whose main function is to maintain order and reproduce status quo within the financial system.     

The unethical practices of accountants and auditors and the compromising stance of professional bodies in the corporate world: Evidence from corporate Nigeria

Investors in Nigeria have lost several billions of dollars through the collusion of accountants and external auditors with companies’ management and directors to falsify and deliberately overstate companies’ accounts. As a consequence of unethical practices by accountants and auditors, which have resulted in the distress or occasionally the closure of companies, some indigenous Nigerian Managing Directors of multinational corporations such as Lever Brothers Nigeria Plc and Cadbury Nigeria Plc have been sacked and replaced with expatriates. Some companies placed under receivership have also lost billions of dollars due to professional misconduct by their official receivers. Contrary to the claim of ‘protecting the public interest,’ accountants and auditors may be partly responsible for cases of distress and closure of companies and banking institutions in Nigeria. However, the various Statutory Provisions and Acts relating to companies and professional bodies all place the responsibility on the accountants and auditors to detect and report to the regulators cases of suspected fraud and accounting malpractice. Through detailed consideration of cases of fraud, falsifications and deliberate overstatement of companies’ accounts, this paper examines the claim that the professional bodies are capable of protecting the public interest. It utilizes archival documents to provide evidence that suggests professional misconduct by accountants, particularly the members of the Institute of Chartered Accountants of Nigeria (ICAN). The paper provides further evidence that ICAN has been reluctant to either investigate or sanction its erring members. The paper posits that the reluctance or inability of the ICAN's “Investigation and Disciplinary Machinery” to either investigate or discipline the erring accountants and auditors suggests that whether by design or default, the ICAN's “Investigation and Disciplinary Machinery” operates to shield the activities of its erring members in accountancy firms from critical scrutiny.     

Effects of audit committee chair characteristics on auditor choice,audit fee and audit quality

We investigate whether the characteristics of audit committee (AC) chairs are associated with decisions about auditor choice, audit fees and audit quality. Using hand-collected Australian data, firms with AC chairs who have longer tenure and multiple AC memberships across several boards are found to be more likely to choose Big 4 and/or industry specialist auditors, pay higher audit fees and have lower discretionary accruals. Those AC chairs with higher business qualifications are more likely to hire a Big 4 auditor, pay higher audit fees and have lower discretionary accruals, while AC chairs with professional qualifications are more likely to hire a Big 4 and/or industry specialist auditor. In contrast, firms with AC chairs who are executive directors are less likely to hire a Big 4 auditor and have higher discretionary accruals. Our findings contribute to the literature by documenting that various characteristics of AC chairs are important for enhancement of auditor selection and audit quality.     

Auditors’ decision-making under going-concern uncertainties in low litigation-risk environments: Evidence from Hong Kong

This study examines the audit opinions issued by auditors in a low litigation-risk environment at a time of high economic uncertainty – that of Hong Kong in the period immediately after the Asian financial crisis of 1997. Empirical research using United States data has shown that, contrary to professional guidance which restricts the issue of “disclaimer of opinion” only to situations where existing uncertainties prevent the auditor from forming an opinion, auditors tend to use the “disclaimer” report (in the going concern context) to signal more extreme client firm’s distress. In the high litigation-risk environment of the US, researchers have attributed this tendency to the idea that “disclaimer of opinion” reports are used by auditors to provide some protection against potential legal liability. The results of this study provide evidence that, even in the low litigation-risk environment of Hong Kong, auditors still use “disclaimer” reports to signal more extreme client firm financial distress. Thus, the maintenance of a high litigation-risk environment does not appear to be a necessary pre-requisite for high quality audits.     

The civil justice system and going concern audit reports: Comments on “Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong”

Lam and Mensah [Lam, K., Mensah, Y.M., 2006. Auditors’ decision-making under going concern uncertainties in low litigation risk environments: Evidence from Hong Kong. J. Account. Public Pol. 25 (6), this issue] provide some valuable insight on auditors’ choice of going concern audit reports in an environment where the civil justice system affords, from the standpoint of the plaintiff, fewer remedies and is more difficult to file a complaint than it is in the US. Hence, from the auditor’s standpoint, this environment can appropriately be described as a “low litigation risk environment”. In this comment, I first question whether a disclaimer of an opinion is any indication of either a quality audit or professionalism. Secondly, three alternative explanations for the empirical regularities are discussed. The Gatekeeper Story suggests auditors are simply not willing to risk reducing their reputational capital by acquiescing to clients that are not likely to survive their own financial distress. The Herding Story suggests that, when auditors are faced with uncertainties or a gap in the authoritative literature, auditors will herd together to form a common response that mimic one-another. The Value of Incumbency Story holds that as the value of incumbency declines with the client’s inability to survive, auditors will have fewer incentives to incur the incremental costs to gather sufficient competent evidential matter necessary to support an unqualified opinion.     

政府控制对审计质量的双重影响

本文从上市公司和会计事务所的产权性质与区域属性的角度,研究了政府控制对审计质量的影响。研究发现,国有企业和本地会计事务所审计的公司的盈余管理水平较低;而较低的盈余管理水平能够降低审计师出具非标意见的概率;同时,国有企业在控制了盈余管理水平的情况下,其得到非标意见的概率相对要低。研究结果表明,政府控制对审计质量的影响具有双重性:一方面,政府控制增强了会计事务所的"本土知识"优势和抵御公司压力的能力,进而提高了公司报表质量;另一方面,政府控制依据它对审计市场的控制降低了出具非标意见的概率,损害了审计质量。     

Assessing business risk: The case of Premier Punch, Inc

The recently issued Statement on Auditing Standards No. 109, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement, emphasizes the need for auditors to understand the client’s business and environment, particularly the client’s business risk [American Institute of Certified Public Accountants (AICPA) (2006a), understanding the entity and its environment and assessing the risks of material misstatement, Statement on Auditing Standards No. 109. New York, NY: AICPA]. However, the manner in which auditors obtain such an understanding, especially an auditor’s assessment of a client’s business risk, is often challenging for students because they lack the business experience necessary to perform such an assessment. This case provides students with an opportunity to assess business risk in a realistic context that includes evidence beyond the content of the financial statements. Company information is provided via a webpage (www.premierpunch.com) with content similar to that of an actual investor relations site. Students must evaluate the information presented in the company’s annual report, press releases and other sources, and consider the impact of that information on several facets of business risk. Students also perform an analytical review of the company’s financial statements and synthesize the case information into a professional memo containing their assessment of business risk.     

State ownership and the cost of debt: Evidence from corporate bond issuances in China

Corporate credit risk can be reduced through implicit government guarantees. State-owned enterprises (SOEs) in China provide a distinctive setting to investigate government roles in corporate debt financing. We find that non-SOEs’ corporate bond issuance costs are significantly higher than those of SOEs. We also observe relatively lower bond issuance costs for firms controlled by the central government (CSOEs) than those controlled by local governments (LSOEs). In addition, we demonstrate that compared with SOEs, non-SOEs’ financial constraints are mitigated to a larger extent after the bond issuances. Overall, we show that state ownership plays an important role in determining corporate bond issuance costs.