Can Enforcement Actions on Engagement Auditors Improve Audit Quality?

50 Pages Posted: 14 Jan 2015 Last revised: 14 Feb 2016

See all articles by Baolei Qi

Baolei Qi

Xi'an Jiaotong University (XJTU) - School of Management

Liuchuang Li

Independent

Ashok Robin

Rochester Institute of Technology (RIT)

Rong Yang

Rochester Institute of Technology

Date Written: January 13, 2015

Abstract

A unique feature of Chinese auditing and one under consideration for adoption in the U.S. is regulatory oversight of individual auditors. This paper analyzes enforcement actions by the China Securities Regulatory Commission (CSRC) against engagement auditors and investigates whether audit quality improves for sanctioned auditors. Our results indicate lower discretionary accruals for client firms following sanctions. Complementing this, and indicative of greater skepticism and independence by sanctioned auditors, we find that the probability of issuing a modified audit opinion increases following sanctions. We conjecture that audit quality increases because sanctions increases the likelihood of job loss and also damages reputations; consistent with this, we find evidence of job loss among some of the sanctioned auditors and of stock market losses for clients audited by sanctioned auditors. These adverse consequences appear to encourage sanctioned auditors to “clean up their act.” Finally, we examine one channel through which sanctions improve audit quality: we find evidence of a longer lag between fiscal year end and the date of the audit report, a metric interpreted in the literature as a measure of auditor effort. Thus, it appears that sanctions, by raising the specter of job and/or reputation loss, compel sanctioned auditors to increase effort in such a way that audit quality rises. Overall, our results indicate that governmental sanctions improve audit quality. This suggests that auditor incentives stemming from oversight mechanisms play a critical role in determining audit quality.

Keywords: Governmental Sanctions; Accruals; Audit Quality

JEL Classification: M42

Suggested Citation

Qi, Baolei and Li, Liuchuang and Robin, Ashok and Yang, Rong, Can Enforcement Actions on Engagement Auditors Improve Audit Quality? (January 13, 2015). Available at SSRN: https://ssrn.com/abstract=2549041 or http://dx.doi.org/10.2139/ssrn.2549041

Baolei Qi

Xi'an Jiaotong University (XJTU) - School of Management ( email )

28,Xianning West Road
Xi'an, Shaanxi 710049
China

Liuchuang Li

Independent ( email )

No Address Available

Ashok Robin

Rochester Institute of Technology (RIT) ( email )

College of Business
Rochester, NY 14623
United States
585-475 5211 (Phone)

Rong Yang (Contact Author)

Rochester Institute of Technology ( email )

Saunders College of Business
Rochester Institute of Technology
Rochester, NY 14623
United States

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