Profitability Regulation, Earnings Management and Modified Audit Opinions: Evidence from China

Posted: 29 Jan 2001

See all articles by Charles J.P. Chen

Charles J.P. Chen

City University of Hong Kong (CityU) - Department of Accountancy

Shimin Chen

Clarion University - Department of Accountancy

Xijia Su

City University of Hong Kong (CityU) - Department of Accountancy

Abstract

This study, using data from the Chinese stock market, investigates the relationship between earnings management induced by profitability regulation and modified audit opinions (MAOs). We review recent developments in the accounting profession and in independent auditing to foster an understanding of the environment in which Chinese auditing operates. Based on annual reports published by listed companies from 1995 to 1997, we analyze the underlying reasons for MAOs. Our test results show a significant association between receiving MAOs and reporting profits marginally above the target levels specified in stock de-listing and rights offering regulations. Our findings are consistent with the notion that asymmetric profitability requirements exacerbate managers' propensity to engage in earnings management which in turn is positively associated with receiving MAOs. Though based on Chinese data, our findings are of general interest because they address a fundamental issue of trade-offs between expected costs and expected benefits in deciding whether to avoid MAOs in a transitional economy.

Keywords: Accounting regulations; Modified audit opinions; Target profit levels

JEL Classification: G28, M41, M43, P21

Suggested Citation

Chen, Charles Jieping and Chen, Shimin and Su, Xijia, Profitability Regulation, Earnings Management and Modified Audit Opinions: Evidence from China. Available at SSRN: https://ssrn.com/abstract=256543

Charles Jieping Chen (Contact Author)

City University of Hong Kong (CityU) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China
+852 2788-7909 (Phone)
+852 2788-7944 (Fax)

Shimin Chen

Clarion University - Department of Accountancy ( email )

Wood Street
Clarion, PA 16214-1232
United States

Xijia Su

City University of Hong Kong (CityU) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China
+852 2788 7995 (Phone)
+852 2788 7944 (Fax)

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