Academic journal article International Journal of Business and Information

Can Auditors Restrain Firms from Earnings Management?

Academic journal article International Journal of Business and Information

Can Auditors Restrain Firms from Earnings Management?

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Since Taiwan became a member of the World Trade Organization (WTO) and relaxed regulations on investments in China in 2002, there has been a dramatic increase in the number of domestic companies setting up factories and entering the market on the Mainland and in Hong Kong in order to reduce the costs of production. This shift led to a decline in 2006 in the number of firms listed on the Taiwan Stock Exchange (hereafter, TWSE), a fact that adversely affects development of the capital market in Taiwan. As indicated in Table 1, the volume of funds entering the capital market has fallen progressively, with the annual stock turnover in the secondary market falling from its peak of 37.7 trillion in 1997 to 24.2 trillion in 2006. In addition, the average P/E ratio dropped from 41.77 in 2002 to 15.31 in 2007.

In order to expand the financial services industry, Taiwanese government agencies strive to provide a stable and secure financial environment by strengthening the administration system and creating a diverse, globalized, and reliable financial market. The first phase of a three-year sprint plan, named "Financial Market Packages," was launched by the Executive Yuan on September 27, 2006. The plan reviewed the criteria for listing on the stock exchange and simplified its process. It also called for expanding the scale of the stock market by listing 90 more companies by the end of 2009. The Taiwan Securities Exchange, in trying to meet the targets, has held many conferences with business leaders to encourage OTC companies traded on Gre Tai Securities Market (hereafter, GTSM) to get listed on the TWSE. In 2007, TWSE again implemented the previously halted simplified regulation for transferring listings by revising the "Criteria for Review of Securities Listings" to eliminate on-site inspections and to greatly reduce the batch-filing review periods for listingtransfer applications.

The TWSE implemented a simplified review process for GTSM companies transferring to TWSE between 1990 and 2004. During this period, a total of 204 GTSM companies made the transfer, of which 195 satisfied the criteria for transfer to TWSE. The listing-transfer firms were expected to make up a large portion of the newly listed companies when the government promoted the simplified review policy to encourage transfer listing, especially when the market was booming. In 1999, the average P/E reached a peak at 47.7. The data in Table 2 indicate that 78.75% and 73.85% of the newly listed firms were made up of listing-transfer firms in the years 2000 and 2001, respectively. Between 2002 and 2004, the percentage of listing-transfer firms in the newly listed firms exceeded 50%, which is not surprising.

There were some unexpected consequences, however. Several listingtransfer firms were later embroiled in the 2004 financial scandals that involved several TWSE-listed companies. To rebuild and improve the quality of the IPO market, TWSE decided in 2005 to terminate the preferential measure for transferring firms. The TWSE has revised the review process for listing-transfer, and it is now the same as that of a regular IPO. IPO firms must pass on-site inspection and have their listings endorsed by the Board of Directors of TWSE after being discussed by the Review Committee. The number of listing-transfer firms among the IPOs was only 5 in 2005 and 3 in 2006. Even after restoration of the simplified review process, the number of GTSM-TWSE transfer firms increased slightly to 13 in 2007 and to 19 in 2008. After that, it dropped to 9 in 2009, to 8 in 2010, and to 6 in 2011. The changes in behavior of the listing-transfer firms may indicate that CPA firms have changed their assurance quality, a factor that will examined later in this study.

Lee [2001] pointed out that the average accumulated abnormal returns during the IPO periods of non-simplified-review listing-transfer firms are significantly higher than those of the simplified-review listing-transfer firms. …

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