Social Trust and Auditor Reporting Conservatism

61 Pages Posted: 14 Apr 2015 Last revised: 28 Jan 2018

See all articles by Deqiu Chen

Deqiu Chen

University of International Business and Economics (UIBE) - Business School

Li Li

University of International Business and Economics (UIBE)

Xuejiao Liu

University of International Business and Economics

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Date Written: October 27, 2016

Abstract

We examine the implications of social trust for auditor reporting conservatism. Using a sample of listed companies in China, we find that clients located in high trust regions are less likely to receive a non-clean audit opinion. This negative impact of social trust on auditor reporting conservatism increases (decreases) when the client’s parent firm operates in a region of higher (lower) social trust, suggesting that social trust is contagious from a parent firm to its subsidiaries in a consolidated entity. We provide evidence that the trust contagion is more pronounced for clients with a higher percentage of parent appointed directors on their boards and clients whose parent firm has fewer subsidiaries. These findings indicate that monitoring and, to a lesser extent, personnel rotation may serve as potential channels of trust contagion. We also find that the impact of trust is more pronounced when the client is located closer to its audit firm, when the client’s parent firm is a state-owned enterprise or holds a higher percentage of the client’s shares, and when the client is associated with greater discretionary accruals. We provide further evidence that it is client rather than auditor trustworthiness that influences auditor reporting conservatism, auditors charge trustworthy clients lower fees, and clients from high-trust regions are less likely to manipulate earnings. Overall, our evidence suggests that social trust alleviates auditor concern about client moral hazard.

Keywords: Auditor reporting conservatism, Geographic proximity, Monitoring, Personnel rotation, Social trust, Trust contagion

JEL Classification: M42, M14

Suggested Citation

Chen, Deqiu and Li, Li and Liu, Xuejiao and Lobo, Gerald J., Social Trust and Auditor Reporting Conservatism (October 27, 2016). Journal of Business Ethics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2593627

Deqiu Chen

University of International Business and Economics (UIBE) - Business School ( email )

Beijing
China

Li Li

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

Xuejiao Liu (Contact Author)

University of International Business and Economics ( email )

Beijing, Beijing
China

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

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