Audit Qualification and Timing of Earnings Announcements: Evidence from China

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INTRODUCTION

This study investigates the effects of audit opinions and earnings surprises on the timeliness of annual earnings announcements of listed Chinese firms, after controlling for firm size, the presence of losses, financial distress, auditor switches, and changes in the Chinese regulatory environment. (1) Our research contributes to the existing literature in two dimensions. It extends the research on the determinants of the timeliness of annual earnings announcements made in mature economies to the emerging capital market in China. Moreover, in addition to the main effects scrutinized in previous studies, it includes the interaction effect between audit opinions and earnings surprises in regression analysis. Such an enhancement offers additional insights on whether the previously documented good news early and bad news late phenomenon is conditional on audit opinions.

This study builds on previous research findings in the U.S. and Australian markets that suggest that both audit opinions and earnings surprises are significant determinants of the timeliness of annual earnings announcements. Whittred (1980), Keller (1986), and Bamber et al. (1993) report that qualified audit opinions delay the release of preliminary earnings and auditor reports. Pastena and Ronen (1979), Givoly and Palmon (1982), Kross and Schroeder (1984), Chambers and Penman (1984), and Penman (1984) find that managers release good news earlier and bad news later than expected, and that timely filing is one of the most consistent determinants of the informativeness of disclosures. The issue of timeliness has recently become popular again. (2) For example, Begley and Fischer (1998) reassess whether prior findings still hold for the period of 1983-1992, when the litigation environment changed significantly. Carter and Soo (1999) also investigate the timeliness of Form 8-K reports.

This study extends this line of timing research into the Chinese market. Our motivation is threefold. First, the Chinese stock market has developed rapidly in the last decade, from being virtually nonexistent to the second largest in Asia (after Japan) in terms of market capitalization. More involvement by international investors is expected in light of China's continuing economic growth and recent entry into the World Trade Organization. These international investors are likely to be interested in the information dissemination process in the Chinese market, including what factors determine the timeliness of annual earnings announcements.

Second, annual earnings announcements are more important as a source of firm-specific information in China than in mature markets, due to the absence of alternative timely sources of information. Unlike mature markets such as the U.S., little firm-specific information is available to investors prior to annual earnings releases. Listed Chinese firms seldom provide voluntary information or earnings forecasts. (3) Moreover, financial analysts and the financial press are still in their infancy and cannot act effectively as the information intermediaries between listed firms and investors. Consequently, investors have little information available to predict earnings and especially have no warnings of negative earnings surprises before their official releases. (4) The timing pattern of good news early, bad news late, if it exists, could be a valuable source of firm-specific information in China.

Third, a recent study indicates that the quality and independence of Chinese audit firms have significantly improved in recent years (DeFond et al. 1999). Since the first batch of independent auditing standards became effective in January 1996, a significant number of listed firms have received modified opinions. The relative inexperience of listed firms and auditors in dealing with modified opinions may make the delay of annual earnings announcements more pronounced than in mature markets. Moreover, listed Chinese firms announce annual earnings concurrently with the filing of their annual reports. …