Academic journal article Current Politics and Economics of Northern and Western Asia

Audit Market and Auditor Choice of Chinese Listed Firms

Academic journal article Current Politics and Economics of Northern and Western Asia

Audit Market and Auditor Choice of Chinese Listed Firms

Article excerpt

1. Introduction

Agency problems always exist between the principal (the owner) and the manager (the agent) in the contemporary corporation (Berle & Means, 1932). An independent or external audit (hereafter "audit") is one of the means to reduce such agency problems. An audit is defined as "a periodic examination of the financial statements of an entity by an independent auditor, to ensure that those financial statements have been properly prepared, are accurate and in accordance with generally acceptable accounting principles and legal requirements and give a true and fair view of the financial state of the entity"1.

An audit also plays an imporant role in the national stock market because audited financial statements are useful to investors, but their usefulness is contingent on their perceived creditability. In developed economies, real and/or perceived audit quality of Big 4 firms is greater than that of non-Big 4 firms as claimed by Cassell, Giroux, Myers and Omer (2013). Cassell et al. (2013) also point out that after the collapse of Anderson in 2000s, U.S. regulators encourage the use of Second-tier firms as an alternative to Big 4 firms and find that financial reporting creditability of Second-tier clients is indistinguishable from that of Big 4 clients. However, audit market in China is dominated by domestic firms which are neither Big 4 nor Second-tier firms, because of her own historical reasons and institutional frameworks.

1.2. Development of Accounting (Auditing) Profession in China

After the establishment of the People's Republic of China2 in 1949, Chinese accounting (or auditing) profession became non-existent because all enterprises were owned by the state and managed by the civil servants. After the open door policy in 1980s, auditing services are required for verification of capital contributions and audits of financial statements of the Sino-foreign enterprises and the purpose of such audit was to protect Chinese Government, but not to solve the agency problems. However, the establishment of two Chinese stock exchanges in 1990s facilitated the development of corporate governance framework and accounting profession in China because financial statements of any Chinese listed firm have to be audited by independent certified public accountants (CPAs) with specific license3, and therefore, the concept of agency theory in Chinese auditing profession has been developed since 1990s.

Most Chinese accounting firms were initially established or sponsored by government agencies or social institutions (Lin & Liu, 2009) and initially all accounting firms were domestically owned and operated. As Chinese stock market was open to foreign investors and the rapid growth of foreign-invested enterprises in 1990s, the demand for high-quality audits has increased accordingly, and foreign accounting firms (epecially Big 4 and Second-tier firms) were allowed to establish joint ventures with domestic firms to perform statutory audits (Wang, O & Iqbal, 2009). Because most Chinese listed firms were state-owned or established by the state and then owned by their senior executives (i.e., management buyout), those listed firms would prefer domestic firms to Big 4 and Second-tier firms. For such guanxi between the owners/management and the domestic auditors, the independence and audit quality of domestic auditors are always challenged by various user groups, and more specially, some scholars evidence that domestic auditors rarely issued modified (qualified) audit opinion to the financial statements of the local state-owned enterprises (SOEs) (Wang, Wong & Xia, 2008) and those private firms with political connections and the domestic auditors rarely issue modified (qualified) audit opinion even though they have found some irregularities (Liu, Wang & Wu, 2011). Liu et al. (2011) further find that two types of guanxi, "firm-level connections derived from state ownership and personal connections developed through management with external auditors", have a close association with auditors' independence in China. …

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