State Control, Related-Party Transactions and Audit Reporting: Evidence from Key Audit Matters

Abstract

We examine whether political forces in Chinese State-Owned Enterprises (SOEs) influence audit reporting, specifically the disclosure of Key Audit Matters (KAMs). We test two competing predictions that offer alternative explanations for the relation between SOEs and KAMs disclosure. Using a sample of Chinese listed firms and controlling for related determinants of KAMs reporting, we document that, compared to non-SOEs, SOEs have fewer abnormal KAMs (relative to their industry peers). SOEs are also more likely to avoid the disclosure of expected KAMs, especially in the subject areas of inventory, revenue and related party transactions (RPTs). Taken together, results suggest that SOEs have strong political motives and power to obscure transparency and withhold potentially costly news. In line with this conjecture, we show that the aforementioned effects are more pronounced when SOEs have more concentrated state ownership, operate in industries of strategic importance to the state, or are involved in tunneling RPTs. Supplementary analysis indicates that SOEs have less extensive KAMs disclosures and auditor responses, which moreover are less risk-oriented. Overall, our study provides new evidence on how state control and related institutional factors affect audit practices.

Keywords: Key audit matters, SOEs, political control, related party transactions

JEL Classification: G39, M41, M42