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Institutional Environment and the Quality of Big 4 Auditors. Bin Ke Nanyang Technological University Clive Lennox Nanyang Technological University Qingquan Xin Chongqing University. Motivational question. Do Big 4 accounting firms provide the same audit quality around the world? - PowerPoint PPT Presentation
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Institutional Environment and the Quality of Big 4 Auditors
Bin Ke Nanyang Technological University
Clive Lennox Nanyang Technological University
Qingquan Xin Chongqing University
Motivational question
• Do Big 4 accounting firms provide the same audit quality around the world?– Do Big 4 deliver the same quality in China?
• Potential economic forces governing Big 4’s quality– Ability– Incentives (litigation risk, reputation, quasi-rent)
• Focus of this study is the incentives of Big 4
Is the idea interesting?
• I think so because Big 4 auditors play a direct role in determining the quality of financial reporting
• There is a debate on whether Big 4 can deliver the same high quality audit in weak investor protection countries as in strong investor protection countries
Is the idea interesting?
• Relevance to China and HK: – H shares’ financial reports are allowed
to be audited by domestic auditors after December 15, 2010
How to test the idea?
• What is the ideal experiment?• The most obvious approach is to
compare the audit quality of Big 4 across different countries
• Common limitations of cross country studies– Accounting standards – Auditing standards– Other cross-country differences
Prior research
• Compare Big4 vs. non-Big4 across countries– This approach does not directly examine the
effect of institutional environment on Big 4– Unclear whether the cross-country differences
are effectively controlled for because the effects of country factors could be different for Big4 and non-Big4
– Any differences in results between Big4 vs. non-Big4 could be due to systematic differences of the clients audited by Big4 and non-Big4
Our approach
• Publicly traded firms listed on mainland China and audited by a domestic Big4 over 1995-2009– Pure A shares– AH firms– AB firms
Our specific research question
• Do domestic Big4 accounting firms provide the same audit quality in China for– Pure A shares, – AB firms, and – AH firms?
Mainland ChinaBig 4
of Pure A Firm
MainlandChina
Mainland ChinaBig 4
of AH Firm
HK Big 4
of AH firm
HongKong
MainlandChina
?
Mainland ChinaBig 4
of AB Firm
HK Big 4
of AB firm
HongKong
MainlandChina
?
?
Incentives of HK Big4: AH firms versus AB firms
H report of AH firm
B report ofAB firm
HK
HKSE √ X
HKSFC √ X/?
HKICPA √ √/?
HK court √ √/?
Market √ √/?
Mainland
CSRC √/? √
market X X
Mainland China Big4Of
AB Firms
Mainland ChinaBig4Of
AH Firms
Mainland ChinaBig4Of
Pure A Firms
HongKong
MainlandChina
?
Advantages of our approach
• We directly examine the effect of institutional environment on Big 4’s behavior
• We can effectively isolate the country effects because we compare the audit quality of Big4 in the same country
• We do not compare Big4 vs. non-Big4 and thus our results cannot be due to systematic differences of the clients audited by Big4 and non-Big4
Pure A share firms (firm years)
Domestic auditor
Big 4=1 Big4=0
Cell5 N=377 Cell6 N=12,649
AH share firms (firm years)
Domestic and HK auditors are the same for 256 firm years
Domestic auditor=375
Big 4=1 (cell13) Big4=0 (cell24)
HK auditor is big4=1 (cell12) Cell1 N=258 Cell2 N=68
HK auditor is big4=0 (cell34) Cell3 N=1 Cell4 N=48
AB firms (firm years)
Domestic (i.e., A share) auditor=1205
Auditor of B share report Big 4=1 (cell135) 253 Big4=0 (cell246) 937
B share auditor is big4=1 (cell12)
Cell1 N= 201 Cell2 N= 363
B share auditor is big4=0 (cell34)
Cell3 N= 1 Cell4 N= 362
No B share auditor Cell 5 N=51 Cell 6 N=212
Research design
• Y = α0 + α1 HK_MONITOR + α2
MULTIPLE_OFFICES + CONTROL VARIABLES + u– Dependent variable=
• Audit opinion• Earnings management (accruals and loss)• Audit fees (mainland)
Audit opinion model: key variables
OPINION = 1 if not clean opinion and zero if clean opinion in year t.
HK_MONITOR = Dummy variable, 1 if the firm is an AH firm and its HK auditor is a big4 and zero otherwise;
MULTIPLE_OFFICES = Dummy variable, 1 if the firm is audited by more than one office, and zero otherwise.
Audit opinion model: control variables
SIZE = Natural log of total assets in year t;
LEV = The ratio of the client’s total liabilities to total assets at the end of current fiscal year t;
CURRENT = The ratio of the client’s current assets to current liabilities.RETURN = Annual market adjusted abnormal return over the fiscal year t;
BETA = the firm’s beta estimated using a market model over the fiscal year
VOL =the variance of the residual from the market model over the
fiscal year;
INVESTMENT =cash, cash equivalents, and short- and long-term investment
securities deflated by total assets at fiscal year-end;
ARINV = accounts receivable and inventory divided by total assets in year t;
ROE = net income over year-end total owners’ equity for year t;
LOSS = 1 if the firm reports a loss for the current year, and 0 otherwise;
SOE = Dummy variable, 1 if the audit firm is stated owned enterprise, and 0 otherwise.
Audit opinion model
Signed abnormal accrual model: dependent variable
Signed abnormal accrual model: control variables
Signed abnormal accrual model
Loss model
Loss model
Audit fee model
Audit fee model
Endogeneity of HK_MONITOR
• Cross-listing bonding hypothesis would suggest that AH firms are better and thus the self selection would bias against our predictions
• assess the severity of endogeneity:– SHORT is 1 if the distance between the fiscal year end and the HK IPO date for all AH firm years is less than 5 years (or 8) and zero otherwise
Endogeneity of HK_MONITOR
Descriptive stat for all regression variables
Descriptive stat for all regression variables