The Economic Consequences of Voluntary Auditing

The Economic Consequence of Voluntary Auditing
IN-MU HAW* DAQING QI** WOODY WU***
A number of Chinese firms voluntarily acquire auditing services for their interim reports, even though the auditing of interim reports is mandatory only for a subset of firms in circumstances that are specified by the state regulators. This unique institutional setting in the Chinese market provides a natural experimental setting to directly investigate why listed firms voluntarily have their financial reports audited, and whether investors place more value on voluntarily audited earnings than on unaudited earnings. Based on a sample of 2,458 semi-annual interim reports released by listed Chinese firms from 1996 to 1999, we find that the choice of voluntary auditing is positively associated with the percentage of tradable shares, profitability, and company size. We also find that the earnings response coefficients of audited firms are higher than those of unaudited firms, especially when the auditing is voluntary. Our findings are consistent with theoretical propositions that managers voluntarily purchase external auditing to enhance the credibility of accounting numbers. This study contributes to the literature, especially on the economic value of voluntary auditing. Keywords: Voluntary auditing, earnings response coefficients, motivation, China
1. Introduction
In recent years, investors and policymakers have become increasingly aware of the importance of Chinas capital markets. As the largest and fastest-growing emerging market, China has made significant progress in developing a viable
*Texas Christian University **Cheung Kong Graduate School of Business ***Chinese University of Hong Kong We thank Paul Brockman, Edward Douthett, Lee-Seok Hwang, W. S. Kim, Steve Lim, Chul W. Park, and Bill Wempe for their helpful comments; Ma Yue and Yu Xin for their assistance. The work that is described in this paper was substantially supported by grant from the Research Grants Council of the Hong Kong Special Administrative Region (Project No. CUHK4288/01H) and the Neeley Summer Research Award Program at Texas Christian University. The first author acknowledges that a significant portion of work was completed when he visited Hong Kong Baptist University.
63
64
JOURNAL OF ACCOUNTING, AUDITING & FINANCE
capital market and more rigorous financial reporting and auditing regulations. DeFond, Wong, and Li (1999) find that the quality and independence of Chinese auditing firms have significantly improved in recent years, partly because of the implementation of rigorous new auditing standards. Listed Chinese firms have been required to issue interim (semi-annual) reports since 1994. While the auditing of interim reports is not required in China except for firms in circumstances specified by the state regulators (i.e., when there have been two consecutive annual losses, when stock rights are offered, and when declaring interim dividends), anecdotal evidence suggests that many listed firms voluntarily have their interim reports audited. This phenomenon does not exist in Western countries, where the auditing of interim reports is not required and empirically infrequent. The unique institutional setting in China provides an opportunity for a direct empirical assessment of both the motivating factors for having voluntary audits and the effect of voluntary audits on the credibility and informativeness of the interim reports. Prior studies postulate that one major reason for firms to hire an outside monitoring mechanism is to help control the conflict of interests between managers and stakeholders by allowing outsiders to verify the validity of financial statements (see, among others, Jensen & Meckling [1976]; Watts & Zimmerman [1986]). Chow (1982) empirically analyzes U.S. firms incentives to hire an external auditing service for their annual reports in 1926, when auditing was not required by law. He shows that leverage, accounting-based debt covenants, and firm size increase the probability that the firm voluntarily acquires external auditing. Ettredge, Simon, Smith, and Stone (1994) and Manry, Tiras, and Wheatley (2003) examine why some companies purchase timely reviews of quarterly financial statements while others do not. Their findings suggest that companies with higher agency costs are more likely to acquire timely reviews. Prior studies further argue that the certification of information by independent auditors improves its credibility, and conveys the image that its quality is high, thus increasing the value of the firm (e.g., Akerlof [1970]; Holthausen & Verrecchia [1988]; Beaver [1998]). Teoh and Wong (1993) report that the earnings response coefficients of firms audited by the Big Eight are higher than those of firms that are not audited by them, suggesting that the quality of auditing affects the credibility of the accounting numbers reported. Blackwell, Noland, and Winters (1998) show that auditor association leads to reduced interest rates on revolving bank loans to private firms. However, no empirical research has directly examined whether or not auditing, especially voluntary auditing, enhances the informativeness of the earnings report (Watts & Zimmerman [1983]; Healy & Palepu [2001]). Our study is motivated by the limited amount of direct empirical research on the economic value of auditing services (Kinney [1987]). This issue is especially important in emerging markets such as China, where publicly available, firm-specific information is scarce, corporate governance systems are not very effective, the enforcement of
THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING
65
the regulation has lagged behind other countries, and earnings management is pervasive.1 In an environment in which the quality of earnings is suspect due to these earnings management practices, coupled with evidence of increased audit quality in recent years (DeFond, Wong, & Li [1999]), we argue that the voluntary auditing of interim reports is an effective means at the disposal of Chinese managers for firms to make a public commitment that they are disclosing credible information. In this study, we first examine the determinants of the voluntary auditing of interim reports by listed Chinese firms. Because Chinese firms are not required to purchase interim audit services (unless they are subject to the regulated circumstances outlined above), their demand for auditor assurance is likely to be driven by the expected net benefits of the audit services purchased. We thus examine the economic value of voluntary auditing by hypothesizing that voluntary audits enhance the informativeness of interim reports. We test whether the earnings response coefficients (ERCs) for voluntarily audited firms are greater than those for unaudited firms. Our sample consists of 2,458 interim reports released by listed Chinese firms from 1996 to 1999. We find that the choice of voluntary auditing is positively associated with the percentage of tradable shares and profitability, reflecting Chinas unique institutional environment. We also report that larger firms, nonInitial Public Offering (IPO) firms, and firms with only A-shares (shares available to Chinese citizens) are more inclined to choose voluntary audits. For the economic value of audit services, we find that the ERCs for voluntarily audited firms are significantly higher than those for unaudited firms, which suggests that voluntary auditing increases the credibility and informativeness of interim reports. For comparative purpose, we examine the effect of mandated interim audits and report that the ERCs of voluntarily audited firms are greater than those of mandatorily audited firms. This suggests that investors perceive voluntary audits to be more informative than audits required by the regulators. We should be cautious of such an interpretation, however, as the effect of mandatory audits may be attributable to the firm-specific economic circumstances underlying mandated audits (namely, having two consecutive losses, offering rights, and making dividend payments). Overall, our findings suggest that, amid the prevailing concerns over earnings management in China, the voluntary auditing of the interim report appears to be an effective means for Chinese managers to make a commitment to disclose accurate information. Our results are robust after controlling for auditor quality, audit opinions, loss firms, and other ERC determinants.
1. The following example illustrates a typical case of earnings management in China. The parent company of Shanghai Video and Audio Electronics Company sold a piece of land to the listed company for 69.26 million yuan in June 1997. In November 1997, the listed company sold the land back to the holding company at 219.26 million yuan. Further, the holding company agreed to buy another subsidiary of the listed company for 94.135 million yuan on December 22, 1997, resulting in a nonoperating profit of 79.6 million yuan. This subsidiary incurred operating losses for the first nine months (Shanghai Security News, March 25, 1998).
66
This study contributes to the literature on voluntary auditing. Our first research question on the determinants of voluntary audits extends the prior studies of Ettredge et al. (1994) and Manry, Tiras, and Wheatley (2003) on timely reviews of quarterly reports by examining audited financial statements. It also extends the research of Chow (1982) on the sample of annual audits in 1926 by examining recent voluntary audits in an emerging market, where corporate governance systems are less effective than in the Western hemisphere.2 Our second research question is a direct examination of the effect of voluntary auditing on the informativeness of accounting information, which has not hitherto been addressed in the literature. It extends the research of Blackwell, Noland, and Winters (1998) on the value of using an auditing service in terms of interest rates charged to private firms by examining the market consequences of voluntarily audited reports. While theory suggests that auditing enhances the informativeness of financial data, prior research provides little empirical evidence for this important matter. We provide evidence that is consistent with managers making a commitment to quality reports and investors having the ability to place more value on the audited numbers. Our findings provide implications for international investors and auditors. China is further opening its capital market to the international community as a member of the World Trade Organization. Recently, the Chinese Securities Regulatory Commission (CSRC) granted licenses to foreign investment banks such as Morgan Stanley, Goldman Sachs, and Citibank to participate directly in Chinas A-share market, which up to this time has been reserved exclusively for Chinese investors.3 Our findings suggest that international investors need to be aware of the effectiveness of voluntary audit services and the informativeness of audited numbers. International auditors should pay more attention to the determinants of the voluntary audit demand for interim reports and the economic value attached by investors to audited interim reports. Our results imply that auditing has begun to play a more effective role in the Chinese market. The remainder of the paper proceeds as follows. Section 2 provides the institutional background. Section 3 discusses the hypotheses and research design. Section 4 describes the sample. Section 5 reports empirical findings, followed by concluding remarks in Section 6.
2. Institutional Background
2.1 Regulatory Infrastructure in China The Ministry of Finance promulgated a new accounting framework (the Accounting Standard for Business Enterprises) in 1993, which marked a significant
2. Begley and Fischer (1998) suggest the need of research based on the recent period sample as there have been significant changes in audit markets and the litigation environment because of the intensified litigation risks faced by management and auditors since the 1980s. 3. Financial Times, June 8, 2003.
67
change for the Chinese generally accepted accounting principles (GAAP) because it generally conforms to international accounting practices.4 Listed Chinese firms with A-shares (shares available only to Chinese citizens) prepare their financial statements according to Chinese GAAP, and their audited annual reports must be made available to the public within four months after the fiscal year-end. Unlike in mature markets, however, little predisclosure information exists in China, such as earnings forecasts or preliminary earnings announcements.5 Most listed Chinese firms provide only the minimum level of disclosure mandated by the CSRC, and seldom voluntarily release firm-specific information before releasing their annual reports. Moreover, financial analysts and the financial press are inexperienced and cannot act effectively as information intermediaries between listed firms and investors, leading to a scarcity of firm-specific information being available to investors. Although the CSRC requires listed firms to make timely disclosures of significant events (such as mergers and acquisitions) that may have material effects on their stock prices, a CSRC official has pointed out that firms tend to delay such disclosures until the release of their annual reports.6 As most listed stateowned enterprises (SOEs) are still under government control, and the chairman of their board and their chief executive officer is appointed by the government, managers have less incentive to make timely disclosures of firm-specific information. Critics argue that the lack of timely firm-specific information hinders the ability of investors to make accurate forecasts of firms future cash flows. To mitigate this problem, the CSRC has required listed Chinese firms to issue semiannual reports since 1994, even though detailed regulations on their content and format did not become available until 1996. Since then, the interim report has become the most important timely source of firm-specific information about listed Chinese firms before the release of the annual report. 2.2 Interim Reports and Auditing In June 1996, the CSRC issued Disclosure Standard No. 3 on the Content and Format of Semi-Annual Interim Reports. Listed firms are required to release interim reports by the end of August, which must contain the balance sheet, income statement, and footnotes to the statements. While the standard does not require the auditing of these interim reports, a subset of firms does so voluntarily. On June 24, 1997, the CSRC issued Pronouncement No. 39 (1997) that
4. To date, forty-two exposure drafts of proposed standards have been issued by the Ministry of Finance, sixteen of which have been promulgated. See www.snai.edu/asp for a list of all accounting standards and regulations in China. 5. Since 1999, the CSRC has required the listed firms to make a preliminary announcement if it is expecting an annual loss. Normally, the announcement only states that an annual loss is expected and provides no information about its magnitude. 6. Securities Times, June 23, 2003.
68
mandates the auditing of interim reports of listed firms that have reported losses in two consecutive years (called special treatment firms), will apply to offer stock rights in the second half of the fiscal year, or will distribute interim stock or cash dividends.7 The audits of these interim reports must follow the same independent auditing standards and procedures as annual reports, and the auditors reports must be issued and attached to the interim reports and made public. The auditor has to state whether the interim report is prepared in accordance with Chinese GAAP and issue an opinion on it. Independent Auditing Standard No. 7 on Auditor Opinions specifies the same conditions as those in the United States for each of the four types of opinions: unqualified, qualified, a disclaimer, and an adverse opinion.8 An examination of our sample indicates that auditors issue a qualified opinion if there is evidence of a departure from GAAP, a limitation to the scope of the audit, or a violation of the consistency principle. Explanatory paragraphs are also attached to unqualified opinions when there is substantial doubt about the going concern, significant related party transactions have occurred, important events have occurred subsequent to the postbalance sheet date, and material uncertainties are evident, such as contingencies and litigation. Appendix A illustrates three types of auditors reports for interim reports. In sum, the procedure and scope for auditing the interim report is the same as those for auditing the annual report at the end of the year. While an interim audit requires as comprehensive an evaluation as a year-end audit does, it differs from an interim review in terms of the degree of assurance, certification, precision, and credibility. It also differs in terms of the auditors legal obligation. A review is less comprehensive than an audit and generally does not include a detailed evaluation of the companys internal control structure, the collection of corroborative evidence, or tests of details of account balances and transactions. Instead, it relies mainly on limited inquires and analytical procedures. As a consequence, there is no assurance that the auditor of a review will be aware of all the significant matters affecting interim reports that would be uncovered by an audit. Moreover, while information about the existence, nature, and findings of an interim review is communicated to management or the board of directors, it is seldom provided to the public.
7. In addition, when necessary, the CSRC can make case-by-case decisions on whether the interim report of a firm needs to be audited. 8. However, there is an exception as Chinese auditors are required to issue qualified opinions if the consistency principle is violated. In the United States, the lack of a consistent application of the GAAP constitutes one of the circumstances for an unqualified opinion with an explanatory paragraph to be issued. Article 17 of the Standard also allows Chinese auditors to attach an explanatory note to their unqualified opinion. See DeFond, Wong, and Li (1999) and Xiang (1998) for details about the development of professional auditing and reporting in China. All auditing standards and regulations are available at www.cicpa.org.cn/FaguiResult.asp.
69
3. Hypotheses and Research Design

3.1 Why Do Chinese Firms Voluntarily Purchase Audits for Their Interim Reports? This section discusses why some Chinese firms are motivated to have their interim reports voluntarily audited. Prior studies based on mature markets argue that a firms demand for monitoring is associated with the level of its agency costs (Jensen & Meckling [1976]; Watts & Zimmerman [1986], among others). Companies that voluntarily purchase an interim audit choose to have an external auditor formally certify their internal control structures and financial statements. They contract for a higher level of outside monitoring if the benefits are expected to exceed the incremental costs, where the benefits of interim audits primarily result from improvement in the credibility of interim reports. We consider various supply-and-demand factors, including variables specific to the Chinese market, to examine the determinants of voluntary interim audits. Unlike in the United States, listed Chinese firms have a significant portion of nontradable shares, providing either the state or legal entities, mostly SOEs, with controlling ownership. Recent studies report that such ownership structures adversely affect these firms financial performance and information environment, resulting in high information asymmetries and low levels of informativeness in accounting earnings (e.g., Claessens, Djankov, Fan, & Lang [2002]; Fan & Wong [2002]). As the controlling shareholders may not report high-quality accounting information, and may even manipulate earnings (e.g., Haw, Hu, Hwang, & Wu [2004]), they have the incentive to avoid external monitoring, which further exacerbates the problem of low corporate transparency (Ball, Robin, & Wu [2003]). Under the government-controlled economy of China, managers of listed SOE firms are frequently appointed by the government, and strive not only to promote financial performance but also to meet nonfinancial strategic goals set by the government (such as producing and delivering strategic products to the state). The managers of listed firms with a heavy state and legal-entity ownership are strongly motivated to act in the best interest of the state and legal persons, and have less incentive to maximize the firms value of tradable shares for public shareholders. In contrast, firms with a high proportion of tradable shares are better motivated to act in the best interest of public shareholders, and therefore they are more likely to acquire interim audit as an outside monitoring mechanism for their interim reports (Ball, Kothari, & Robin [2000]). In such a context, voluntary auditing can effectively communicate a firms commitment to report highquality information to investors, reducing the level of information asymmetry between the management and shareholders of tradable shares. Thus, our first hypothesis is (in alternative form) as follows: H1: Managers of firms with a high percentage of tradable shares are more likely to purchase voluntary interim audits.
70
We consider profitability to be an important factor in the demand for voluntary audits in China as the current regulatory requirements are based on reported earnings. For example, a rights issue is the only primary source for listed Chinese companies to raise additional capital after the IPO. To make a rights offer, a listed firm must obtain approval from the CSRC. One of the main considerations of the CSRC is whether the company exceeds certain minimum profitability requirements. In January 1996, the CSRC began to require that the reported return on equity (ROE) be greater than 10 percent in each of the most recent three years.9 Prior studies have found that a large number of listed Chinese firms manipulate earnings to meet such regulatory requirements for rights offerings (Chen & Yuan [2004]; Haw, Qi, Wu, & Wu [2005]). They have provided evidence that a significant portion of applicants meeting the ROE benchmark do not receive approval from the CSRC for a rights offering because of suspect earnings management. Haw et al. (2005) find that the ERCs of Chinese firms with a greater degree of earnings manipulation are lower than those of firms with less earnings manipulation. In Chinas emerging market, where pervasive earnings management makes earnings less reliable, firms with a genuinely good economic performance may have strong incentives to have their interim reports voluntarily audited as their good earnings are likely to be suspected of earnings management. In a market where financial intermediaries do not act effectively and the corporate governance system is weak, voluntary external audits can credibly communicate firms commitment to disclose accurate information to investors and regulators, separating them from firms suspected of overstating their earnings and increasing the probability of their future rights offerings. Moreover, while a third-party audit certifies the quality of the earnings, it is costly for firms that have manipulated their earnings to mimic this quality. Thus, our second hypothesis is (in alternative form) as follows: H2: Managers of firms that report high profits are more likely to purchase voluntary interim audits. Our analysis includes other variables used in prior studies such as company size (SIZE), the proportion of assets held in receivables (REC), financial leverage (LEV), and the issuance of new securities (NEWSTOCK) (Chow [1982]; Ettredge et al. [1994]; Manry, Tiras, & Wheatley [2003]). We do not, however, consider the percentage of common stock owned by managers and directors in our analysis. Unlike in the United States, managers and directors of listed Chinese firms hold none or only insignificant amounts of shares in their company. We do, however, control for auditor switching, because the incremental cost of auditing is
9. On March 17, 1999, the CSRC modified the annual ROE requirement to be greater than 6 percent for each of the most recent three years, and the average ROE for the three years to be greater than 10 percent.
71
greater if the company changes an audit firm (Johnson & Lys [1990]; DeFond [1992]; Ettredge et al. [1994]). We include three additional control variables based on the findings of prior studies on Chinese markets. They are as follows: (1) whether firms have issued shares that are available to foreign investors (in addition to A-shares for Chinese investors), because their reporting and auditing environments are different (DeFond, Wong, & Li [1999]);10 (2) whether firms are IPOs (i.e., whether they have gone public in the last year), because Chinese IPO firms tend to manage earnings around the IPO year, and thus have less incentive to acquire voluntary interim audits (Aharony, Lee, & Wong [2000]); and (3) whether firms hire quality auditors, because joint venture auditors and large local Chinese auditors are more independent and more frequently issue modified opinions (DeFond, Wong, & Li [1999]).11 We test our hypotheses by estimating the coefficients in the following logit regression (with subscripts firm i and time t omitted):
where: Voluntary audit dummy a dummy variable that equals 1 for a voluntary interim audit, and 0 for an unaudited interim report. ROE net income divided by stockholders equity. TRADESHR the percentage of tradable shares. SIZE the natural logarithm of the sum of market value of equity and book value of short-term and long-term debt (Chow [1982]). REC receivables divided by total assets. LEV long-term debt divided by total assets. NEWSTOCK the proceeds received from new equity security issuance scaled by total assets (mainly attributable to previous rights offerings). IPO dummy a dummy variable that equals 1 for an IPO during the last year, and 0 otherwise.
10. Listed firms with shares available to foreign investors have to prepare financial statements under international accounting standards. Shares available to overseas investors include B-shares listed on the Shanghai and Shenzhen Stock Exchanges, H-shares listed on the Hong Kong Stock Exchange, and shares listed on other foreign stock exchanges. From 2001, B-shares are allowed for trading among domestic investors. 11. DeFond, Wong, and Li (1999) report that the frequency of modified opinions (the surrogate for independence) has increased ninefold subsequent to the adoption of the new auditing standards in 1996. They also report a large decline in market share by the independent auditors, interpreting the decline as flight from quality in the Chinese audit market, consistent with the argument that Chinese managers avoid auditors that are more likely to issue modified auditor opinions.
72
Foreign share dummy a dummy variable that equals 1 for firms that have issued shares available to foreign investors, and 0 for firms with only A-shares. Quality auditor dummy a dummy variable that equals 1 if a firms auditor is among the top-five local Chinese auditors or joint ventures affiliated to international auditors, and 0 otherwise. Auditor switch dummy a dummy variable that equals 1 if a firm switches its auditor during the year before the interim audit, and 0 otherwise. All continuous variables are measured based on the current interim period and defined similarly as prior studies. Hypothesis 1 predicts that b2 will be positive, and Hypothesis 2 predicts that b1 will be positive. Prior research predicts that b3, b5, and b6 will be positive, and b4 will be negative. 3.2 Impact of Auditing on the Informativeness of Interim Earnings This section develops the hypothesis and research design to test whether auditing, especially voluntary auditing, enhances the quality of interim earnings. Theoretically, investors responses to an earnings surprise are related to the perceived precision of the earnings report. Prior studies suggest that the ERCs vary with the quality of the earnings (e.g., Holthausen & Verrecchia [1988]). Auditors certify that financial statements have been prepared in conformance with the GAAP, which assures investors of their reliability. Because audited earnings are perceived to be more credible than nonaudited earnings and hence to reflect true economic value accurately, we expect them to have a greater effect on investors valuation of the firm, thus implying a higher ERC. As voluntary interim auditing is a costly but deliberate choice by managers, they can be expected to exercise discretion by comparing the costs of the auditing services with the anticipated increase in the value of the firm arising from investors perceptions of the enhanced quality of an audited report. Consistent with the argument that certification can improve the credibility of information and communicate the high quality of the securities, we posit that voluntary auditing lends credibility to interim earnings, and affects investors perception of their quality, and therefore increases the magnitude of investors responses to a given earnings surprise (e.g., Beaver [1998]; Holthausen & Verrecchia [1988]). Teoh and Wong (1993) report that the ERC is higher for earnings audited by audit firms perceived to be of higher quality. Whereas these studies examine the effect of high-quality auditors vs. low-quality auditors on the ERCs, our study directly compares the informativeness of audited reports with that of unaudited numbers. However, both studies focus on the credibility of reported accounting numbers. Given pervasive earnings management practices in China, we predict that voluntary auditing communicates the commitment of management to report accurate financial data to investors. Thus, our third hypothesis is (in alternative form) as follows:
73
H3: Firms that have interim reports voluntarily audited have higher ERCs than firms that have unaudited interim reports. Because the earnings announcement date is the first date that the earnings (as well as audit information) are publicly available, we develop the following cross-sectional regression model with the three-day window surrounding the announcement date (with subscripts firm i and time t omitted):12
where: CAR market-adjusted abnormal returns accumulated over the three trading days (1, 0, 1), where 0 is the interim earnings announcement date, adjusted for dividends and stock rights. DE unexpected semi-annual earnings, defined as the difference between reported earnings in the first half of years t and t 1, deflated by market value at the beginning of the three-day event window in year t. Voluntary audit dummy a dummy variable that equals 1 if the interim report is voluntarily audited, and 0 otherwise. Mandatory audit a dummy variable that equals 1 if the interim report dummy is mandatorily audited, and 0 otherwise. Modified opinion a dummy variable that equals 0 if the audit opinion dummy is clean, and 1 otherwise.13 Firm size dummy a dummy variable that equals 1 if the market value of the firm at the end of June of year t is above the sample median, and 0 otherwise. Market-to-book dummy a dummy variable that equals 1 if the market value of the common equity divided by the book value of common equity at the end of June of year t is above the sample median, and 0 otherwise.
12. The Chinese regulations do not allow listed firms to release preliminary earnings to the public before filing financial reports to the CSRC and the stock exchanges. While filing reports to the stock exchanges and the CSRC precedes the public announcement, the latter is the first time that earnings (as well as audit opinions) are made available to the public. 13. Auditors in China can emphasize events such as significant uncertainties, contingencies, and related party transactions in the explanatory note attached to unqualified opinions. Because the note usually carries a negative view from the auditor, we group audit opinions other than clean opinions as modified opinions (DeFond, Wong, & Li [1999]; Haw, Park, Qi, & Wu [2003]).
74
Beta dummy a dummy variable that equals 1 if the market beta of the firm at the end of June of year t is above the sample median and 0 otherwise. Quality auditor dummy a dummy variable that equals 1 if a firms auditor is among the top-five local Chinese auditors or joint ventures affiliated to international auditors, and 0 otherwise. Loss dummy a dummy variable that equals 1 if the semi-annual earnings is negative, and 0 otherwise. e error term. Since earnings forecasts for listed Chinese A-share firms are not available, we use the seasonal random walk model as a proxy for the market expectation of interim earnings prior to the announcement. In the model, b1 is the ERC for unaudited earnings and is expected to be positive. Our primary interest is in b2, the coefficient on the interaction between earnings news and a voluntary audit. If it is positive and significant, the ERC of voluntary audits will be greater than that of unaudited reports, implying that the voluntary audits enhance the credibility of the interim reports. We include the effect of mandatory auditing in eq. (2) for comparison. In contrast to voluntary audits, whether mandatory interim audits enhance the credibility of interim reports may depend on the firm-specific economic circumstances underlying mandated audits. While auditing in general enhances the quality of interim earnings, the enhanced effect for mandated audits may be offset by investors perceptions that these firms have stronger ex ante incentives for earnings manipulation, especially in the case of special treatment firms (those that report two consecutive annual losses and thus face the risk of being delisted), because they have strong incentives to manage their earnings upward. A significantly positive b3 would suggest that the ERC of mandated audits is greater than that of unaudited reports. Although we do not make directional predictions on whether the ERCs are different between voluntarily and mandatorily audited firms, we will provide empirical results for comparative purpose. Our model includes other standard ERC determinants. Previous studies report that the ERC differs systematically in size, growth, risk, and earnings persistence (e.g., Holthausen & Verrecchia [1988]; Collins & Kothari [1989]; Easton & Zmijewski [1989]). We control for firm-specific characteristics, such as firm size, growth, risk, auditor quality, and loss by including their interaction variables. We measure the first three control variables following Teoh and Wong (1993) and DeFond and Park (2001).14 To control for the effect of modified
14. Earnings persistence is not included as a control variable because the time series of interim earnings is too short for listed Chinese firms. Collins and Kothari (1989) suggest that the book-tomarket ratio is affected by both growth opportunities and persistence, and thus provides a normalization for persistence as well. Also not included is the number of analysts because of the unavailability of these data in China. We use indicator control variables, following DeFond and Park (2001).
75
opinions on the ERC, we include its interaction variable and predict g1 to be negative (Dopuch, Holthausen, & Leftwich [1986]; Choi & Jeter [1992]; Chen, Su, & Zhao [2000]).
4. Sample Description
Our sample consists of all Chinese firms with A-shares listed on the Shanghai and Shenzhen Stock Exchanges from 1996 to 1999. Their financial statements are prepared according to Chinese GAAP. Financial and market data are collected from the Taiwan Economic Journal. We hand-collect interim report announcement dates, audit status (whether audited or unaudited), the type of auditing undertaken (whether voluntary or mandatory), the names of the auditors, and the auditors opinions from financial reports released in China Security Daily, Shenzhen Security Times, and Shanghai Security News. We identify the reasons for mandated auditing from the Disclosure of Significant Events section of the interim reports.15 Our final sample is reduced to 2,458 interim earnings reports from the 2,781 available during 199699 because of missing returns data surrounding the announcement dates (200), interim earnings (113), and control variables (10). Table 1 provides the frequency of the interim reports in terms of their auditing status, their audit type, the auditor opinions, and the underlying reasons for mandated audits. Among our sample of 2,458 interim earnings, 676 reports (27.5%) are audited. The frequency of audited interim reports gradually increases from 13.7 percent (45) in 1996 to 30.6 percent (255) in 1999. Of the 676 audited reports, 161 audits (23.8%) are voluntary, whereas 515 (76.2%) are mandated. Among them, 89.1 percent (600) receive clean audit opinions, and 10.9 percent (76) receive modified opinions. None of the voluntarily audited firms receives modified opinions. The frequency of modified opinions increases from 2.2 percent (1) in 1996 to 17.3 percent (44) in 1999, reflecting the recent development of a more rigorous and independent audit environment in China. This trend toward interim reports is consistent with DeFond, Wong, and Li (1999), who also report an increasing frequency of modified opinions for annual reports. All together, it appears that auditor independence in China has improved over time. The last row of Table 1 provides reasons for mandated audits. Rights offerings are the main reason for mandated audits (62.4%). The others cite special treatment due to two consecutive losses (18.8%) and interim dividend distributions (18.8%). The frequency of special treatment firms increase from 0 in 1996 to 59 (29%) in 1999, reflecting the reduced financial performance of Chinese firms in recent years. Table 2, Panel A, presents descriptive information for the entire Chinese annual audit market of listed firms, including auditor affiliation, auditor size, and the number of listed clients by year. While the number of audit firms with at
15. It is possible that we misclassified some mandatory audits as voluntary audits because of insufficient disclosures in the interim and annual reports. However, this potential measurement error would work against finding significant results for voluntary audits.
76
TABLE 1 Attributes of Sample Firms: Auditing Status, Audit Type, Auditor Opinion, and Reasons for Mandated Audits
Full No. Auditing status: Unaudited 1,782 Audited 676 No. of obs. 2,458 Type of audit: Voluntary 161 Mandatory 515 No. of audits 676 Auditor opinion: Unqualified 600 Modified 76 No. of opinions 676 Reasons for mandated audit: Dividend 97 ST 97 Rights Offer 321 No. of mandated 515 % 72.5 27.5 100.0 23.8 76.2 100.0 89.1 10.9 100.0 1996 No. 284 45 329 18 27 45 44 1 45 % 86.4 13.7 100.0 40.0 60.0 100.0 97.8 2.2 100.0 1997 No. 407 156 563 38 118 156 152 4 156 % 72.3 27.7 100.0 24.4 75.6 100.0 97.4 2.6 100.0 1998 No. 513 220 733 56 164 220 193 27 220 % 70.0 30.0 100.0 25.5 74.5 100.0 87.7 12.3 100.0 1999 No. 578 255 833 49 206 255 211 44 255 % 69.4 30.6 100.0 19.2 80.8 100.0 82.7 17.3 100.0
18.8 18.8 62.4 100.0
2 0 25 27
7.4 0.0 92.6 100.0
18 12 88 118
15.2 10.2 74.6 100.0
41 26 97 164
25.1 15.8 59.1 100.0
36 59 111 206
17.0 29.0 54.0 100.0
Note: Modified opinions include opinions other than clean opinions, such as qualified, adverse, disclaimer, or unqualified opinion with an explanatory note. In China, auditors frequently emphasize events such as significant uncertainty, contingency, and related party transactions in the note, which usually reflects a negative view from the auditor. ST are special treatment firms due to reported losses in two consecutive years.
least one listed client increases slightly from 85 in 1996 to 88 in 1999, the number of public clients rises from 568 to 943, reflecting the substantial growth of the Chinese stock market during this period. Government-affiliated auditors dominate the market during our sample period, consisting of 85 percent of the auditing firms and accounting for 82 percent of the clients.16 The top-ten local Chinese auditors (ranked according to the number of listed firms audited) are mostly government affiliated, and collectively account for about one-third of the auditing market for listed firms. Appendix B reports both the identity and ranking of joint ventures and the top-ten 10 local Chinese auditors, showing that the identity of the top-five Chinese auditors is relatively stable during our sample period. Table 2, Panel B, classifies the interim audits in our sample based on the audit type, auditor affiliation, auditor size, and auditor opinion. Consistent with the findings of DeFond, Wong, and Li (1999) for annual audits, joint venture
16. All university- and government-affiliated CPA firms became independent legal entities by the end of 1998 (Securities Times, January 5, 1999).
TABLE 2
Descriptive Information on Auditor Affiliation, Auditor Size, Number of Clients, and Auditor Opinion
Panel A: Distribution of auditors and annual audits for the entire Chinese listed firms by auditor affiliation, auditor size, and year Number of audit firms by year Number of listed clients by year 1996 1997 1998 1999 1996 1997 1998 1999 7 6 72 85 2 8 4 64 2 8 4 66 2 8 4 66 2 8 4 67 53 156 25 298 56 179 31 428 87 87 88 568 733 7 6 74 7 6 74 7 6 75 36 78 454 39 87 607 50 101 703 854 63 203 38 500 59 106 778 943 64 232 42 546
All auditors Joint venture auditors Local auditors: University Government
Total Local auditors Top ten: University Government Nontop ten: University Government
Panel B: Distribution (%) of audited interim audits in our sample by auditor affiliation, auditor size, audit type, and auditor opinion Number of audits by audit type Number of audits by auditor opinion Auditor affiliation and auditor size Voluntary (%) Mandatory (%) Unqualified (%) Modified (%) 5 ( 1%) 22 ( 3%) 134 (20%) 161 (24%) 47 ( 7%) 109 (17%) 156 (24%) 19 ( 3%) 54 ( 8%) 442 (65%) 515 (76%) 137 (21%) 359 (55%) 496 (76%) 17 ( 3%) 62 ( 9%) 521 (77%) 600 (89%) 171 (26%) 412 (63%) 583 (89%) 7 ( 1%) 14 ( 2%) 55 ( 8%) 76 (11%) 13 ( 2%) 56 ( 9%) 69 (11%)
Affiliation Joint venture University Government
Total Top ten local auditors Top ten Nontop ten
Total
78
and university-affiliated auditors issue more modified opinions in 29 percent and 18 percent of their respective total interim audits, which is significantly higher than the 9.6 percent (55 divided by a sum of 521 and 55) of government-affiliated auditors.17 The type of auditing undertaken (voluntary vs. mandatory) is not significantly related to the type of auditor affiliation or auditor size.
5. Empirical Results
5.1 Reasons Why Chinese Firms Voluntarily Purchase Audits for Their Interim Reports This section provides descriptive statistics and results from the logit regression to identify motivating factors for voluntary interim auditing in eq. (1). We exclude mandatorily audited firms because they are mandated by regulations, not voluntarily initiated by managers. Table 3, Panel A, reports that on average, companies purchasing voluntary audits are significantly larger in size (SIZE) and more profitable (ROE) than unaudited companies. The percentage of tradable shares (TRADESHR) and the proportion of assets tied up in receivables (REC) do not differ significantly between the two subsamples. The long-term debt divided by total assets (LEV) and the proceeds from new equity issues (NEWSTOCK) are not significantly different between the two groups. Among the control variables, the proportion of IPO firms is significantly lower for the audited firms, consistent with the argument that IPO firms may have engaged more frequently in earnings management (Aharony, Lee, & Wong [2000]) and thus may have less incentive to acquire a voluntary audit. On the other hand, the proportions of firms that have issued shares available to foreign investors, used quality auditors, and switched auditors are not different between the two subgroups. Spearman correlations (not reported) for the explanatory variables indicate that the correlations are generally moderate. Table 3, Panel B, reports the coefficients and test statistics from the logistic regression in eq. (1). The Chi-square statistic indicates that the logistic model is highly significant, suggesting that it has a good overall explanatory power. The likelihood of acquiring an interim audit is significantly associated with the percentage of tradable shares (TRADESHR), profitability (ROE), and firm size (SIZE). Unlike the univariate statistics in Panel A, the coefficient for the proportion of tradable shares, b2, is positive and significant at the 5 percent level. The result is consistent with Hypothesis 1. The coefficient for SIZE, b3, is positive and significant at the 1 percent level, consistent with prior studies performed in
17. However, auditor size (the top ten or top five) is not significantly related to the type of the auditor opinions on interim reports issued by local Chinese auditors in our sample. While this differs from the results reported by DeFond, Wong, and Li (1999) for annual audits, our result is not directly comparable because we use only a subset of the interim reports that are audited and none of our voluntarily audited firms receives a modified opinion. Furthermore, DeFond, Wong, and Li (1999) rank Chinese auditors based on the value of firms they audit, while we rank them based on the number of listed firms they audit.
TABLE 3 Motivating Factors for Voluntary Interim Audits
Panel A: Univariate statistics for logistic regression variables Unaudited (N 1,782) 3,483.9 2,336.1 0.039 0.038 0.346 0.319 0.082 0.036 0.059 0.028 0.006 0.000 32.30% 15.45% 25.65% 5.30% 4,640.10 3,250.8 0.069 0.062 0.352 0.332 0.097 0.055 0.054 0.022 0.006 0.000 25.00% 11.25% 24.38% 3.13% Voluntary audit (N 161) t- (Z-) test statisticsa 10.68*** 3.78*** 44.33*** 10.68*** 0.35 1.18 1.43 1.29 0.46 0.83 0.06 0.42 2.03** 1.59 0.36 1.47
Firm size Mean (million yuan) Median ROE Mean Median TRADESHR Mean Median REC Mean Median LEV Mean Median NEWSTOCK Mean Median % of IPO firms % of firms with shares available to foreign investors % of firms with quality auditors % of firms with auditor switches
TABLE 3 (continued)
Panel B: Parameter estimates from logistic regression analysis Voluntary audit dummy a b1 ROE b2 TRADESHR b3 SIZE b4 REC b5 LEV b6 NEWSTOCK g1 IPO dummy g2 Foreign share dummy g3 Quality auditor dummy g4 Auditor switch dummy e (1)
Intercept a 0.367 (2.99)*** 0.369 (0.53) 0.348 (0.32) 5.407 (1.37) ? 0.527 0.587 (2.56)** (1.95)* ? 0.111 (0.54)
ROE b1
TRADESHR b2
SIZE b3
REC b4
LEV b5
NEWSTOCK b6
Foreign share IPO dummy dummy g1 g2
Quality auditor dummy g3
Auditor switch dummy g4 ? 0.639 (1.32)
ChiSquare
Predictions Coefficient t-statistics
? 10.981 9.337 1.288 (4.05)*** (5.80)*** (1.91)**
66.97***
The t- (Wilcoxon Z-) test examines whether mean and proportion (median) of each variable for unaudited firms equals that of voluntarily audited firms. ? indicates no predicted sign. *, **, and *** suggest statistical significance levels at the 10 percent, the 5 percent, and the 1 percent levels, one-tailed for predicted signs in Panel B, and two-tailed in Panel A, respectively. N 1,933. Note: The variables are defined as follows:
Voluntary audit dummy ROE TRADESHR SIZE
REC LEV NEWSTOCK IPO dummy Foreign share dummy Quality auditor dummy
Auditor switch dummy
a dummy variable that equals 1 for a voluntary interim audit, and 0 for an unaudited interim report. net income divided by stockholders equity. the percentage of tradable shares. the natural logarithm of firm size, which is defined as the sum of market value of equity and book value of short- and longterm debt. receivables deflated by total assets. long-term debt divided by total assets. the proceeds received from new equity security issuance scaled by total assets. a dummy variable that equals 1 for an IPO during the last year, and 0 otherwise. a dummy variable that equals 1 for firms that have issued shares available to foreign investors, and 0 otherwise. a dummy variable that equals 1 if a firms auditor is among the top-five local Chinese auditors or joint ventures affiliated to international auditors, and 0 otherwise. a dummy variable that equals 1 if a firm switches its auditor during the year before the interim audit, and 0 otherwise.
81
the United States (Chow [1982]; Ettredge et al. [1994]; Manry, Tiras, & Wheatley [2003]). The coefficient for ROE, b1, is positively significant at the 1 percent level, supporting Hypothesis 2 that the more profitable the firm, the more likely it is to have its interim reports voluntarily audited. Similar to the findings of Manry, Tiras, and Wheatley (2003), the coefficients for receivables (REC) and leverage (LEV) are not significant at the conventional level, and neither is that of the issuance of new equity shares (NEWSTOCK).18 Among the control variables, the coefficient on the IPO dummy is negative and significant at the 5 percent level. The fact that IPO firms are less likely to have their interim reports voluntarily audited is consistent with Aharony, Lee, and Wong (2000), who find evidence that IPO firms manage earnings in the period surrounding the IPO year. The coefficient for the firms with shares available to foreign investors (Foreign share dummy) is also negative and significant at the 10 percent level, suggesting that such firms are less likely to purchase an interim audit voluntarily. One plausible explanation is that the annual financial statements of these firms are audited by the Big Five international firms and are therefore already perceived as credible by investors, diminishing the need for the voluntary auditing of their interim reports. The coefficients on the auditor switch dummy and the quality auditor dummy are not significant.19 In summary, consistent with our hypotheses, the results indicate that the voluntary audit choice of interim reports is positively associated with the proportion of tradable shares and profitability, reflecting Chinas unique institutional environment. We also find that larger firms, non-IPO firms, and firms with only Ashares are more likely to acquire an interim audit. 5.2 Market Perception of the Quality of Audited Interim Reports Table 4, Panel A, reports the descriptive statistics for selected market and financial variables for the full sample. As shown in the top rows, the mean interim earnings and market capitalization are 29.4 and 2,576.9 million yuan respectively, and the mean (median) interim earnings change (DE) is 0.005 (0.00). The yearly statistics in the middle rows indicate that the average market value of
18. Ettredge, Simon, Smith, and Stone (1994) show that the purchase of a timely review is positively associated with company size, the issuance of new securities, and financial leverage, and negatively associated with the percentage of common stock owned by managers and directors, and the proportion of assets held in receivables (used as a proxy for the incremental cost). Manry, Tiras, and Wheatley (2003) find that only firm size and ownership variables are statistically significant as predicted. Our results reflect Chinas unique market and regulatory environment in which long-term debt is not a significant source of long-term financing for listed firms. For example, the average year-to-year changes of long-term debt are only 0.37 percent for the voluntarily audited firms and 0.15 percent for the unaudited firms, respectively, and are not significantly different. Almost none of the listed Chinese firms issues corporate bonds because the preference for bond issuance is given to nonlisted SOEs on the ground that listed firms are able to raise funds from shareholders through rights issues. Long-term borrowing from banks is also infrequent. 19. Results are similar when we include as quality auditors the sixth- to tenth-largest local Chinese auditors or use only joint ventures affiliated with international auditors, or when we measure auditor size by their clients total assets.
TABLE 4 Firm Characteristics for the Full Sample and by Audit Status and Audit Reasons
Panel A: Descriptive statistics for the full sample Mean and median values of selected variables Variable Net income MV DE CAR Mean 29.4 2,576.9 0.005 0.003 Std. Dev. 60.6 3,092.2 0.044 0.061 First Quartile 6.1 1,091.2 0.007 0.040 Median 17.3 1,737.0 0.000 0.002 Third Quartile 39.2 2,935.3 0.006 0.035
Mean values of selected variables by year. Year 1996 1997 1998 1999 F-statistics Obs. 329 563 733 833 Net Income 30.9 29.5 27.6 31.4 0.89 MV 1,777.4 2,311.9 2,359.3 3,263.2 24.27* DE 0.017 0.003 0.004 0.003 9.93* CAR 0.005 0.008 0.000 0.001 2.08***
Mean values of selected variables by stock exchange. Exchange Shanghai Shenzhen F-statistics Obs. 1,303 1,155 Net income 31.1 27.6 2.04 MV 2,763.3 2,366.6 10.16* DE 0.006 0.004 0.98 CAR 0.003 0.003 0.02
Panel B: Firm characteristics by audit status and audit reasons Descriptive statistics (means) by audit status. Variable Net income MV DE CAR No. of Obs. Total 29.4 2,576.9 0.005 0.003 2,458 Unaudited 27.4 2,497.5 0.006 0.005 1,782 Voluntary audit 50.8 3,415.0 0.000 0.003 161 Mandatory audit 29.8 2,589.6 0.002 0.001 515 F-statistics 11.10* 6.54* 3.45 2.50
Descriptive statistics (means) by mandatory audit reasons. Variable Net income MV DE CAR No. of Obs. Total 29.8 2,589.6 0.002 0.003 515 Interim dividend Special treatment Rights offering 41.4 2,760.8 0.002 0.014 97 18.4 1,740.9 0.011 0.003 97 40.8 2,794.3 0.000 0.003 321 F-statistics 43.04* 6.54* 4.66* 3.27**
*, **, and *** suggest statistical significance levels at the 10 percent, the 5 percent, and the 1 percent levels, respectively. The F-statistics test whether means are different between (among) partitioned groups. N 2,458. Note: Net income is interim earnings for the first half of year t (in million yuan). MV is market value of common equity at the date of interim earnings announcement (in million yuan). DE is the change in interim earnings from year t 1 to year t, deflated by the market value of equity at the beginning of the threeday window period. CAR is the three-day market-adjusted cumulative abnormal return around the earnings announcement date.
83
listed firms has nearly doubled from 1996 (1,777 million yuan) to 1999 (3,263 million yuan). The bottom rows do not show significant differences in market or financial performance measures between firms listed on the Shanghai and Shenzhen Stock Exchanges. Table 4, Panel B, provides descriptive statistics for selected variables by their auditing status and the reasons for having mandatory audits. The top rows suggest that voluntarily audited firms have significantly higher earnings and market capitalization than unaudited firms, and perform better in DE and three-day abnormal returns. Firms with voluntary audits are also larger in size and experience better earnings and market performance than firms with mandatory audits. The bottom rows indicate that, among firms with mandatory audits, those planning to distribute dividends perform better in DE and market returns than the special treatment firms and rights-offering firms. 5.2.1 Regression Results of Eq. (2) Table 5, Panel A, provides descriptive statistics for the first three control variables used in eq. (2). F-tests indicate that they vary with the status of the audits undertaken, and the voluntarily audited firms are larger in size and have a higher growth potential (in median) than the unaudited firms. This indicates the need for their inclusion as control variables. We first run the simple return-earnings regression testing the value relevance of interim earnings (not tabulated). The earnings response coefficient for interim earnings is positive and statistically significant at the 1 percent confidence level (with an adjusted R2 of 0.014). The result is consistent with those of prior studies in mature markets, and with those reporting that investors respond significantly to the announcement of annual earnings in the Chinese market. Table 5, Panel B, reports the regression results for eq. (2). The adjusted R2 is 0.028, consistent with the magnitude reported by most previous short-window studies. The coefficient for unaudited earnings (b1) is 0.465, significant at the 1 percent level. More important, the ERCs are higher for the audited firms than for the unaudited firms, as evidenced by the positive coefficients for the interaction terms between the voluntary and mandatory audit dummies and earnings news. The coefficient for voluntary audits (b2) is 1.196, significant at the 1 percent level. The coefficient for mandatory audits (b3) is 0.450, significant at the 5 percent level. The results suggest that auditing enhances the credibility and informativeness of interim earnings. Among the control variables, the coefficients for the interaction terms with modified auditor opinions, firm size, and loss firms are statistically significant at conventional levels.20
20. Following Basu (1997) and DeFond and Park (2001), we also control for good and bad news effects by partitioning earnings surprises into positive and negative items and interacting them with variables of interest. The regression results (not tabulated) show that the ERCs are asymmetric between good news and bad news. The coefficient of the interaction term between voluntary (mandatory) audit and good earnings news is 1.805 (0.485), significant at the 1 percent (10%) level, consistent with the results reported in Table 5, Panel B.
TABLE 5
Regression of Three-Day Market-Adjusted Returns on Earnings Changes and Audit Status
Panel A: Univariate statistics for control variablesa Unaudited Voluntary audit Mean 4639.8 0.186 0.977 3250.6 0.172 0.950 3490.0 0.215 0.971 2645.4 0.159 0.939 Median Mean Median Mandatory audit F-statistics 5.58*** 80.61*** 2.97* Median 2443.6 0.198 0.960
Mean
w2-statistics 17.59*** 41.49*** 4.46*
Market value Book/market ratio Beta
3600.8 0.170 0.939
Panel B: Regression analysisb
CAR a b1 DE b2 (Voluntary audit dummy DE) b3 (Mandatory audit dummy DE) g1 (Modified opinion dummy DE) g2 (Firm size dummy DE) g3 (Market-to-book dummy DE) g4 (Beta dummy DE) g5 (Quality auditor dummy DE) g6 (Loss dummy DE) e Control variables
(2)
Audit status and earnings surprise
Intercept a ? 0.450 (2.29)** 1.196 (3.52)*** 0.415 (1.95)*
DE b1
Voluntary Mandatory audit dummy audit dummy DE DE b2 b3 ?
Modified opinion dummy DE g1
Firm size dummy DE g2
Market-tobook dummy Beta dummy DE DE g3 g4 0.222 (2.09)** 0.091 (1.45) 0.075 (1.29)
Quality auditor dummy DE g5 0.149 (0.65)
Loss dummy DE g6 0.353 (3.54)***
Predictions
Coefficient t-statistics
0.004 (3.27)***
0.465 (4.52)***
Panel C: Statistical difference between coefficients for voluntary audit and mandatory audit
F-statistic to test b2 = b3: 3.78**
*, **, and *** indicate statistical significance levels at the 10 percent, the 5 percent, and 1 percent levels, respectively, one-tailed for predicted signs in Panel B, others are two-tailed, respectively. N 2,458. ? indicates no prediction for direction. a The variables are defined as follows: Market value is the market value of common equity at the date of interim earnings announcement in million yuan. Book/market ratio is the book value of common equity divided by the market value of common equity at the end of June of year t. Beta is the market beta of the firm at the end of June of year t. b The adjusted R2 is 2.80 percent. The variables in the regression are defined as follows:
CAR market-adjusted abnormal returns accumulated over the three trading days (1, 0, 1), where 0 is the interim earnings announcement date, adjusted for dividends and stock rights. DE unexpected semi-annual earnings, defined as the difference between reported earnings in the first halves of years t and t 1, deflated by the market value at the beginning of the three-day event window in year t. Voluntary audit dummy a dummy variable that equals 1 if the interim report is voluntarily audited, and 0 otherwise. Mandatory audit a dummy variable that equals 1 if the interim report is mandatorily audited, and 0 otherwise. dummy Modified opinion a dummy variable that equals 0 if the audit opinion is clean, and 1 otherwise. dummy Firm size dummy 1 if the market value of the firm at the end of June of year t is above the sample median, and 0 otherwise. Market-to-book dummy 1 if the market value of the common equity divided by the book value of common equity at the end of June of year t is above the sample median, and 0 otherwise. Beta dummy 1 if the market beta of the firm at the end of June of year t is above the sample median, and 0 otherwise. Quality auditor dummy a dummy variable that equals 1 if a firms auditor is among the top-five local Chinese auditors or joint ventures affiliated to international auditors, and 0 otherwise. Loss dummy 1 if the semi-annual earnings is negative, and 0 otherwise.
86
Table 5, Panel C, tests the difference in market reaction to voluntary and mandatory audits. The F statistic is 3.78 and significant at the 5 percent level, indicating that the coefficient for voluntary audits (b2) is greater than that for mandatory audits (b3). This suggests that investors perceive that voluntary audits are more credible than mandatory audits in our interim sample. However, we should be cautious of this interpretation, as the effect of mandatory audits might merely reflect their unique economic circumstances (such as two consecutive losses and rights offering). In sum, audits enhance the credibility of interim earnings, and voluntary audits in particular convey a strong management commitment to disclose accurate and reliable earnings reports to investors. Our finding also provides insights in the quality of auditing in China (DeFond, Wong, and Li [1999]).21 5.2.2 Regression Results for Specific Reasons of Mandatory Audits This section examines whether investors respond differently to the release of interim reports that are mandated for audit because of their economic circumstances, as specified by the CSRC (namely, special treatment due to two consecutive annual losses, applying for offering stock rights, or distributing interim stock or cash dividends). As each of these reasons underlying mandated audits may convey different information on the quality of a firms earnings and future cash flows, we further partition mandated audits into three subgroups and allow separate coefficients in regression. The interim dividend dummy equals 1 if dividend distribution is the reason for a mandated audit, and 0 otherwise. Special treatment and rights-offer dummies are defined analogously. We make no directional predictions for the coefficients on the interactions between these dummies and earnings as their ERCs will depend on the trade-off between the enhanced credibility resulting from audits and the ex ante perception by investors of their earnings quality related to specific economic circumstances. The regression results shown in Table 6 remain consistent with Hypothesis 3. The coefficient for the voluntary audit dummy, b2, remains positive and significant at the 1 percent level. Among mandated audits, only the ERC for rights offer dummy is significantly positive at the 10 percent level, and others are not significant at conventional levels.
21. Teets and Wasley (1996) argue that cross-sectional ERCs based on pooling observations across firms and over time are likely to be biased because the cross-sectional model assumes the equality of the coefficient and equal variance of unexpected earnings across firms. They point out that the bias depends on the cross-firm variability of earnings and the ERC in the sample. While we control for firm-specific factors such as growth, size, and risk, it is possible that the ERCs of our sample are downward biased. Because the history of listed Chinese firms is relatively short, however, we are not able to evaluate the potential effect of this bias on our results.
TABLE 6
Regression of Three-Day Market-Adjusted Returns on Earnings Changes, Audit Status, and Mandated Audit Reasonsa
CAR a b1 DE b2 (Voluntary audit dummy DE) b3 (Interim dividend dummy DE) b4 (Special treatment dummy DE) b5 (Rights offer dummy DE) g1 (Modified opinion dummy DE) g2 (Firm size dummy DE) g3 (Market-to-book dummy DE) g4 (Beta dummy DE) g5 (Quality auditor dummy DE) g6 (Loss dummy DE) e Control variables
(3)
Specific mandated audits and earnings surprises
Intercept a ? 0.353 (0.83) 0.472 (1.42) 0.472 (1.78)* 0.436 (1.29) 0.222 (2.07)** ? ? ?
DE b1
Voluntary audit dummy DE b2 Firm size dummy DE g2 0.090 (1.45) 0.075 (1.29) Beta dummy DE g4
Interim dividend dummy DE b3
Special treatment dummy DE b4
Rights offer dummy DE b5
Modified opinion dummy DE g1
Marketto-book dummy DE g3
Quality auditor dummy DE g5 0.145 (0.63)
Loss dummy DE g6 0.353 (3.54)***
Predictions
Coefficient 0.004 0.465 1.196 t-statistics (3.27)*** (4.52)*** (3.52)***
*, **, and *** indicate statistical significance levels at 10 percent, 5 percent, and 1 percent, one-tailed for predicted signs, others are two-tailed, respectively. N 2,458.The variables in the regression are defined as those of Table 5, except for the following:
Interim dividend dummy 1 if dividend distribution is the reason for mandated audit, and 0 otherwise. Special treatment dummy 1 if special treatment (two consecutive annual losses) is the reason for mandated audit, and 0 otherwise. Rights offer dummy 1 if rights offering is the reason for mandated audit, and 0 otherwise.
88
5.2.3 Sensitivity Analyses Our hypotheses are still supported even after the following sensitivity analyses. (1) We add intercept dummies for voluntary and mandatory audits to regression eq. (2). (2) We rerun the regression by adding year dummies. (3) We rerun the regression, after excluding A-share firms that have also issued shares that are available to overseas investors. (4) We delete loss firm-years from the sample, because the ERC of loss firms is lower than that of profitable firms (Hayn [1995]). (5) To reduce the undue influence of outliers, we winsorize (and alternatively drop) each of continuous variables used in this study at the first and ninety-ninth percentile. We also replicate the regression by partitioning our sample into the more recent two-year period (199899) and the earlier two-year period (199697) because of the rapid changes in auditing and the market environment in China. We find that our results are stronger in the more recent period than in the earlier one. This implies that the credibility-enhancing effect of auditing has become stronger over time, as the CSRC has tightened up financial reporting and auditing regulations.
6. Conclusion
Theory suggests that auditing enhances the credibility of financial data, but prior research provides little empirical evidence on whether voluntary auditing increases the economic value of the accounting numbers. In this paper, we use the unique institutional setting provided by the Chinese stock market to investigate why some listed firms voluntarily have their financial reports audited, and whether voluntary auditing enhances their credibility. Our first research question adds onto the prior studies of Chow (1982), Ettredge et al. (1994), and Manry, Tiras, and Wheatley (2003). Our second research question is a direct examination of the economic value of voluntary auditing for the informativeness of accounting information, which has not been addressed in the existing literature. Thus, our study contributes to the literature on voluntary auditing. Based on 2,458 interim reports from 1996 to 1999, we find that the choice of voluntary auditing is positively associated with the percentage of tradable shares, profitability, and company size. We also show that the ERCs of voluntarily audited firms are greater than those of unaudited firms, suggesting that voluntary auditing enhances the credibility and informativeness of interim earnings. They are also greater than the ERCs of mandated audits. However, we should be cautious of this interpretation as the ERCs of mandated audits depend on firmspecific economic circumstances, such as reporting two consecutive annual losses and applying for stock rights issues. Our main results are robust even after controlling for auditor quality, auditor opinions, loss firms, and other ERC determinants.
89
Overall, our results are consistent with theoretical propositions that managers voluntarily acquire auditing services to enhance the credibility of accounting numbers (e.g., Akerlof [1970]; Beaver [1998]) and that certified information reduces information risk when investors assess the future cash flows of firms (e.g., Collins & Kothari [1989]). Given the prevalence of earnings management in China, the voluntary purchase of auditing service has become an effective means for listed firms to communicate credibly the higher quality of their interim earnings. This differentiates them from firms that might have manipulated earnings, hence enhancing the informativeness of their earnings. The empirical regularities shown in this study provide useful insights to foreign investors and international auditors. As a member of the World Trade Organization, China is attracting more and more direct and financial investment from the international community. Chinese regulators recently granted licenses to selected foreign investment banks to participate directly in Chinas A-share market, which had hitherto been reserved exclusively for Chinese investors. Our findings suggest that the users of financial statements of listed Chinese firms should be aware of the managerial incentives in acquiring voluntary interim audits and the informativeness of audited interim reports. International auditors need to pay more attention to the determinants of the audit demand for interim reports and the economic value attached by investors to the audited reports. Our study sheds light on the effectiveness of the recent reporting and auditing regulations in China, suggesting that auditing has begun to play a more effective role in the Chinese market. APPENDIX A
Examples of Interim Audit Reports in China 1. Unqualified Auditor Report (by Shenzhenshi CPAs on August 18, 1998) We were appointed to audit the consolidated balance sheet of Shenzhen Hongkai (Group) Co., Ltd (the Company) as of June 30, 1998, and the income statement and cash flow statement for the period from January to June 1998. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Independent Audit Standards for Chinese CPAs. Our audit also includes an examination, on a test basis, of the Companys accounting records and other audit procedures which we consider appropriate. In our opinion, the Companys financial statements have been prepared in accordance with the requirements of Accounting Standards for Enterprises, Accounting System for Joint Stock Companies, and the relevant laws and regulations, and present fairly, in all material respects, the financial position of the Company as of June 30, 1998, and the results of the operations and cash flows for the half-year then ended, and the accounting policies have been consistently applied.
90
2. Unqualified Auditor Report with Explanatory Notes (by Shekou Xinda CPAs on August 17, 1998) We were appointed to audit the consolidated balance sheet of Shenzhen Energy Investment Co., Ltd (the Company) as of June 30, 1998, and the income statement and cash flow statement for the period from January to June 1998. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Independent Audit Standards for Chinese CPAs. Our audit also includes an examination, on a test basis, of the Companys accounting records and other audit procedures which we consider appropriate. In our opinion, the Companys financial statements have been prepared in accordance with the requirements of Accounting Standards for Enterprises, Accounting System for Joint Stock Companies, and the relevant laws and regulations, and present fairly, in all material respects, the financial position of the Company as of June 30, 1998, and the results of the operations and cash flows for the half-year then ended, and the accounting policies have been consistently applied. In addition, we noticed that: 1. As discussed in Note 4 to the financial statements, a subsidiary of the CompanyShenzhen Mawan Electricity Ltd.recorded an interest income of RMB35.56 million yuan, which is yet to be confirmed. 2. As discussed in Note 41 to the financial statements, as of June 30, 1998, the contingent loss of the Company amounts to RMB16.6 million yuan. (Renminbi [RMB] is the official currency on the mainland of the Peoples Republic of China [PRC]).
3. Qualified Auditor Report (by Shenzhen Tongren CPAs in 1999) We were appointed to audit the consolidated balance sheet of Shenzhen Huabao Co., Ltd (the Company) as of June 30, 1999, and the income statement and cash flow statement for the period from January to June 1999. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with the Independent Audit Standards for Chinese CPAs. Our audit also includes an examination, on a test basis, of the Companys accounting records and other audit procedures which we consider appropriate. As discussed in footnote 5.6 to the financial statements, the construction of the Dongguan Waterpark, a property project invested and constructed by the Company, stopped for a long time, and the book value of the project amounts to RMB253.5 million yuan as of June 30, 1999. The Company is studying the alternatives about the project in the future. There is no reliable evidence indicating whether there exists substantial writedown in the value of the property. In our opinion, except for the effects of such adjustments, the Companys financial statements have been prepared in accordance with the requirements of Accounting Standards for Enterprises, Accounting System for Joint Stock Companies, and the relevant laws and regulations, and present fairly, in all material respects, the financial position of the Company as of June 30, 1998, and the results of the operations and cash flows for the half-year then ended, and the accounting policies have been consistently applied.
APPENDIX B
Market Share of Quality Auditors in Terms of Number of Listed Clients

Number of Listed Clients 1997 1998
d
Ranking 1999
d
Ranking by year 1996 1997 1998
1996
1999
Joint ventures 1 2 3 4 5 6 7 Top ten local auditors 1 2 3 4 5 6 7 8 9 10 Pricewaterhouse KPMG Andersen BDO Ernst & Young C&L Deloitte & Touche Shanghai Dahua Shenzhen Zhonghua Lixin Shenzhenshi Sichuanc Zhejiang Shenzhen Zhongcheng Chengduc Hubei Daxin Dahua Shanghai Shangkuai Shenzhen Zhongtian Shenzhen Zhongshen Sichuan Junhe Zhejiang Lixin Hunan Kaiyuan Hubei Daxin Shenzhen Tongren Dahua Shanghai Shangkuai Shenzhen Zhongtian Shenzhen Zhongshen Sichuan Junhe Zhejiang Tianjian Shenzhen Tongren Beijing Jingdu Hunan Kaiyuan Lixin 37 31 22 22 20 18 16 16 15 12 37 34 24 22 22 21 20 19 18 18 Andersen Pricewaterhouse BDO KPMG C&L Deloitte & Touche Ernst & Young BDO Andersen Pricewaterhouse KPMG C&L Deloitte & Touche Ernst & Young 7 7 6 6 4 4 2 7 7 7 6 5 5 2
Pricewaterhouse BDO (17) Ernst & Young (4) KPMG (3) C&L Andersen Deloitte & Touche
13 9 8 7 6 5 2 41 36 28 27 25 23 22 22 21 21
12 11 8 8 6 6 4 41 34 32 30 29 28 28 26 25 23
Shanghai (2) Dahua (1) Shenzhen Zhonghua (5) Lixin (7) Shenzhenshi (10) Sichuan (6)c Guangzhou (9) Zhejiang (N/A) Chengdu (N/A)c Shekou Zhonghua (8)
Numbers in parentheses are the 1996 rankings of the respective auditors in Table 8 of DeFond, Wong, and Li (1999). All joint ventures were affiliated with Big Six international auditors, except Shekou Xinda BDO, which was one of the top-ten auditors in China during 199395 in DeFond, Wong, and Li (1999). c Sichuan CPAs and Chengdu CPAs were dissolved by the Ministry of Finance in 1998 for severe violations of laws and regulations in auditing. d All university and government affiliated CPA firms became independent legal entities by the end of 1998 (Securities Times, January 5, 1999). Consequently, the following CPA firms were transformed to new entities: Shanghai CPAs to Shanghai Shangkuai, Shenzhen Zhonghua to Shenzhen Zhongtian, Shenzhenshi to Shenzhen Zhongshen, and Shenzhen Zhongcheng to Shenzhen Tongren.
92

REFERENCES
Aharony, J., C. J. Lee, and T. J. Wong. 2000. Financial Packaging of IPO Firms in Traditional Economy: The Case of B-shares and H-shares in China. Journal of Accounting Research 1 (Spring): 103125. Akerlof, G. A. 1970. The Market for Lemons: Quality Uncertainty and the Market Mechanism. Quarterly Journal of Economics, 488500. Ball, R., S. P. Kothari, and A. Robin, A. 2000. The Effect of Institutional Factors on Properties on Accounting Earnings: International Evidence. Journal of Accounting and Economics 29: 1 52. Ball, R., A. Robin, and J. S. Wu. 2003. Incentives Versus Standards: Properties of Accounting Income in Four East Asian Countries. Journal of Accounting and Economics 36: 235270. Basu, S. 1997. The Conservatism Principle and the Asymmetric Timeliness of Earnings. Journal of Accounting and Economics 24: 337. Beaver, W. H. 1998. Financial Reporting: an Accounting Revolution. 2nd edition. Upper Saddle River, NJ: Prentice-Hall. Begley, J., and E. Fischer. 1998. Is There Information in an Earnings Announcement Delay? Review of Accounting Studies 3: 347363. Blackwell, D. W., T. R. Noland, and D. B. Winters. 1998. The Value of Auditor Assurance: Evidence from Loan Pricing. Journal of Accounting Research 36 (Spring): 5770. Chen, C. J. P., X. Su, and R. Zhao. 2000. An Emerging Markets Reaction to Initial Modified Audit Opinions: Evidence from the Shanghai Stock Exchange. Contemporary Accounting Research (Fall): 429455. Chen, K. C. W., and H. Q. Yuan. 2004. Earnings Management and Capital Resource Allocation: Evidence from Chinas Accounting-Based Regulation of Rights Issues. The Accounting Review 79 (July): 645665. Choi, S. K., and D. C. Jeter. 1992. The Effect of Qualified Audit Opinion on Earnings Response Coefficients. Journal of Accounting and Economics 2 & 3: 229247. Chow, C. W. 1982. The Demand for External Auditing: Size, Debt and Ownership Influences. The Accounting Review (April): 272291. Claessens, S., S. Djankov, J. P. H. Fan, and Larry H. P. Lang. 2002. Disentangling the Incentive and Entrenchment Effects of Large Shareholdings. Journal of Finance 57 (6): 27412771. Collins, D. W., and S. P. Kothari. 1989. An Analysis of Intertemporal and Cross-Sectional Determinants of Earnings Response Coefficients. Journal of Accounting and Economics (July): 143 181. DeFond, M. L. 1992. The Association between Changes in Client Firm Agency Costs and Auditor Switching. Auditing: A Journal of Practice and Theory 11 (Spring): 1631. DeFond, M. L., and C. W. Park. 2001. The Reversal of Abnormal Accruals and the Market Valuation of Earnings Surprises. The Accounting Review (July): 375404. DeFond, M. L., T. J. Wong, and S. Li. 1999. The Impact of Improved Auditor Independence on Audit Market Concentration in China. Journal of Accounting and Economics 28 (December): 269305. Dopuch, N., R. Holthausen, and R. Leftwich. 1986. Abnormal Stock Returns Associated with Media Disclosures of Subject to Qualified Audit Opinions. Journal of Accounting and Economics (June): 93118. Easton, P., and M. Zmijewski. 1989. Cross-Sectional Variation in the Stock Market Response to Accounting Earnings Announcements. Journal of Accounting and Economics 11: 117141. Ettredge, M., D. Simon, D. Smith, and M. Stone. 1994. Why Do Companies Purchase Timely Quarterly Reviews? Journal of Accounting and Economics 18: 131155. Fan, J. P. H., and T. J. Wong. 2002. Corporate Ownership Structure and the Informativeness of Accounting Earnings in East Asia. Journal of Accounting and Economics 33: 401425. Haw, I. M., D. Qi, D. Wu, and Y. W. Wu. 2005. Market Consequences of Earnings Management in Response to Security Regulations in China. Contemporary Accounting Research 22: 95140. Haw, I. M., B. Hu, L. Hwang, and Y. W. Wu. 2004. Ultimate Ownership, Income Management, and Legal and Extra-Legal Institutions. Journal of Accounting Research 42: 423462. Haw, I. M., K. Park, D. Qi, and Y. W. Wu. 2003. Audit Qualification and Timing of Earnings Announcements: Evidence from China. Auditing: A Journal of Practice and Theory 2: 121 146.
93
Hayn, C. 1995. The Information Content of Losses. Journal of Accounting and Economics 20: 125153. Healy, P., and K. Palepu. 2001. Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature. Journal of Accounting and Economics 31: 405440. Holthausen, R., and R. Verrecchia. 1988. The Effects of Sequential Information Releases on the Variance of Price Changes in an Intertemporal Multi-Asset Market. Journal of Accounting Research (Spring): 82106. Jensen, M. C., and W. H. Meckling. 1976. Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure. Journal of Financial Economics 3: 305360. Johnson, W. B., and T. Lys. 1990. The Market for Audit Services: Evidence from Voluntary Auditor Changes. Journal of Accounting and Economics 12: 281308. Kinney, W. 1987. Attestation Research Opportunities: 1987. Contemporary Accounting Research, 4: 416425. Manry, D., S. Tiras, and C. Wheatley. 2003. The Influence of Interim Auditor Reviews on the Association of Returns with Earnings. The Accounting Review (January): 251274. Teets, W. R., and C. E. Wasley. 1996. Estimating Earnings Response Coefficients: Pooled versus Firm-Specific Models. Journal of Accounting and Economics (June): 279295. Teoh, S. H., and T. J. Wong. 1993. Perceived Auditor Quality and the Earnings Response Coefficient. The Accounting Review (April): 346386. Watts, R. L., and J. L. Zimmerman. 1983. Agency Problems, Auditing and the Theory of the Firm: Some Evidence. Journal of Law and Economics (October): 613634. Watts, R. L., and J. L. Zimmerman. 1986. Positive Accounting Theory. Englewood Cliffs, NJ: Prentice-Hall. Xiang, B. 1998. Institutional Factors Influencing Chinas Accounting Reforms and Standards. Accounting Horizons 12: 105119.

The Economic Consequences of Voluntary Auditing

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

The Economic Consequences of Voluntary Auditing

Uploaded by

Copyright:

Available Formats

The Economic Consequence of Voluntary Auditing

IN-MU HAW* DAQING QI** WOODY WU***

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

3. Hypotheses and Research Design

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

18.8 18.8 62.4 100.0

7.4 0.0 92.6 100.0

15.2 10.2 74.6 100.0

25.1 15.8 59.1 100.0

17.0 29.0 54.0 100.0

All auditors Joint venture auditors Local auditors: University Government

Affiliation Joint venture University Government

Total Top ten local auditors Top ten Nontop ten

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

TABLE 3 Motivating Factors for Voluntary Interim Audits

Foreign share IPO dummy dummy g1 g2

Quality auditor dummy g3

Auditor switch dummy g4 ? 0.639 (1.32)

Predictions Coefficient t-statistics

? 10.981 9.337 1.288 (4.05)*** (5.80)*** (1.91)**

Voluntary audit dummy ROE TRADESHR SIZE

Auditor switch dummy

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

Regression of Three-Day Market-Adjusted Returns on Earnings Changes and Audit Status

w2-statistics 17.59*** 41.49*** 4.46*

Market value Book/market ratio Beta

3600.8 0.170 0.939

Panel B: Regression analysisb

Audit status and earnings surprise

Intercept a ? 0.450 (2.29)** 1.196 (3.52)*** 0.415 (1.95)*

Voluntary Mandatory audit dummy audit dummy DE DE b2 b3 ?

Modified opinion dummy DE g1

Firm size dummy DE g2

Quality auditor dummy DE g5 0.149 (0.65)

Loss dummy DE g6 0.353 (3.54)***

F-statistic to test b2 = b3: 3.78**

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

Specific mandated audits and earnings surprises

Interim dividend dummy DE b3

Special treatment dummy DE b4

Rights offer dummy DE b5

Modified opinion dummy DE g1

Quality auditor dummy DE g5 0.145 (0.63)

Loss dummy DE g6 0.353 (3.54)***

Coefficient 0.004 0.465 1.196 t-statistics (3.27)*** (4.52)*** (3.52)***

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

THE ECONOMIC CONSEQUENCE OF VOLUNTARY AUDITING

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

Market Share of Quality Auditors in Terms of Number of Listed Clients

Ranking by year 1996 1997 1998

JOURNAL OF ACCOUNTING, AUDITING & FINANCE

IN-MU HAW* DAQING QI WOODY WU*

? 10.981 9.337 1.288 (4.05)* (5.80)* (1.91)**

w2-statistics 17.59* 41.49* 4.46*

Intercept a ? 0.450 (2.29) 1.196 (3.52)* 0.415 (1.95)*

Coefficient 0.004 0.465 1.196 t-statistics (3.27)* (4.52)* (3.52)***