The Auditor Disaffiliation Program in China and Auditor Independence

Abstract

This study examines whether the disaffiliation program introduced by the Chinese government improved auditor independence and whether auditor quality affects this relationship. Auditor independence is measured in terms of the likelihood of receiving a qualified report and the level of earnings management (measured by non-core operating income). The results show that the likelihood of receiving qualified audit opinions for listed companies significantly increased and non-core operating earnings significantly decreased after auditors were disaffiliated. However, companies audited by auditors without any affiliation also showed an increase in the likelihood of receiving qualified opinions and a decrease in non-core operating earnings, possibly due to the increased surveillance by the regulatory bodies that accompanied the act of disaffiliation. The results also show that the association between the disaffiliation program and the likelihood of receiving qualified audit opinions is stronger for small auditors than for large auditors possibly because of the initial lower audit quality of small auditors. Auditor size, however, did not significantly affect the association between the disaffiliation program and non-core operating earnings.

Keywords: Auditor independence, Audit opinion, Audit quality, Earnings management, Non-core operating income, Emerging market

JEL Classification: M49, M41, M43, G38