Political Connections, Audit Opinions and Auditor Choice: Evidence from Corruption Cases

Abstract

In this paper, we examine the joint impact of corporate political connections and ownership structures on the auditor reporting behaviours and firms’ auditor choice patterns in the Chinese market. We construct a natural experiment that alleviates endogeneity concern by employing 56 corruption cases involving high-level government bureaucrats from 2004 to 2012, and a set of publicly traded companies whose managers or directors directly involve in the bribing activities or were connected with the corrupt bureaucrats through family or previous job affiliations. Our empirical findings suggest that once the political connections are broken because of the corruption events, politically connected non-SOE firms are more likely to receive unfavourable audit opinions and have less chance to hire local small auditors in subsequent years, compared with the non-connected firms. However, relative to those without political ties, SOEs connected to the corrupt bureaucrats would have a higher possibility to get favourable opinions at the occurrences of corruption cases, and are more likely to choose local small auditors in the following years. Moreover, further study indicates that the market reactions to the corruption events are significantly negative for non-SOE firms, but positive for SOEs. In summary, our study suggest that corporate political connections have a substantial effect in deciding the auditor reporting behaviours, auditor choice patterns and firm value. More important, the effect of political connections is subject to firms’ ownership structures.

Keywords: Auditor reporting behaviours; Auditor choice patterns; Political connections; Ownership structure

JEL Classification: F32; M40