The impact of government ownership and institutions on the reporting behavior of local auditors in China

Abstract

This paper updates and extends the study of Chan et al. (2006) by investigating whether regional differences in the political and institutional environment in China have a significant impact on auditor reporting behavior. Adopting a within-country setting, which precludes cross-country confounding factors, we find that in regions with a low level of institutional development, local auditors are more likely than non-local auditors to issue standard unqualified opinions to listed companies controlled by local governments. In addition, compared with local auditors in institutionally strong regions, those in institutionally weak regions are more likely to issue unqualified opinions to these companies. We also find that companies in institutionally weak regions that switch to a local auditor after receiving a qualified opinion can succeed in opinion shopping. The results have implications for legislators and regulators in China and other transitional economies, foremost among which is that improvement in institutional structures is essential for countries striving to build a credible independent auditing profession.