Compared with the audit markets in China and abroad, the disciplinary risks faced by the firms are different. In China, the Ministry of Finance and China Securities Regulatory Commission （hereinafter referred to as CSRC） as the government supervision and administration departments raise the auditors’ disciplinary risks. In recent years, CSRC has gradually stepped up the penalties for accounting firms that fail to provide fair audits due to the disclosure of low-quality audit reports; for instance, Shenzhen Pengcheng （the largest accounting firm in South China） was revoked securities business license because of the auditing failure of Green Globe IPO in May 2013. In 2017, Ruihua, the largest accounting firm with Chinese domestic equities, was judged sparing in its efforts to the business of Yatai Industrial Company and its business partners were required not to leave, step out or change the firm by CSRC. Xinyongzhonghe, another famous audit firm in China was punished for 4.4 million RMB for the lack of diligence in the audit of Dengyun Auto-Parts Co. Therefore, under the circumstance that the trend of supervision and punishment of CSRC is intensified, whether audit quality of accounting firms is improving or not is receiving more and more attention in China. In theory, penalties affect the reputation of accounting firms, resulting in reduced audit fees and the risk of loss of customers. However, penalties could be seen as a signal that leads to changes in audit quality including firms having been punished or not. Their choice could improve the audit quality or do nothing. The existing research only deals with the accounting firms that have been punished; however, the strategies of both punished and unpunished firms about how they react to punishment are worth considering. Therefore, this paper focuses on studying whether accounting firms choose to improve the audit quality or not after being punished by CSRC, and whether those unpunished firms choose to improve the audit quality or not due to the signal of penalty announcement, to probe deeply into the effectiveness of regulatory penalties in the audit industry. Based on the issuance of the Administrative Punishment Announcement of CSRC between 2002 and 2015, the public companies are classified into four types: companies whose punished audit firms are not changed before and after the announcement, companies whose punished audit firms are changed into unpunished one after the announcement, companies whose unpunished audit firms are changed into punished one after the announcement, and companies whose audit firms have never been punished. We match the first three types to the last type. This paper provides a detailed analysis of possible strategy choices made by different firms, and empirically shows that the punished firms may have a passive reputation reshaping behavior due to the increasing disciplinary risk after the announcement, thus improving the audit quality. Contrarily, the unpunished firms, whose audit quality has no significant change, are not affected by the punishment announcement. The ultimate audit qualities of the punished firms are not less than the unpunished ones, indicating the effective supervision of CSRC in improving the quality of the audit industry. Different from the paired sample studies conducted by previous scholars, this paper further analyzes the audit quality of the industry as a whole after a game analysis of the behavior strategies of the unpunished and the punished. The results bring more empirical evidence for the effectiveness of CSRC’s administrative punishment and confirm the restraint effect of the reputation mechanism on the CPA. It also has the policy reference to the regulatory authorities such as CSRC, China AICPA and the Ministry of Finance; moreover, signing an audit contract with an accounting firm also has a very important reference.
The Effectiveness of Audit Industry Supervision: Empirical Evidence Based on Firm Strategy Choice after CSRC Administrative Punishment
Journal of Finance and Economics Vol. 44, Issue 03, pp. 56 - 67 (2018) DOI:10.16538/j.cnki.jfe.2018.03.005
Fang J X. Study on the effectiveness of reputation mechanism in a transitional economy: Evidence from China’s audit market[J]. Journal of Finance and Economics, 2011, (12): 16-26. (In Chinese)
Li S, Wu X. Audit failure and securities audit market supervision: Thinking based on the punishment announcement of China Securities Regulatory Commission[J]. Accounting Research, 2002, (2): 28-36. (In Chinese)
Liu F, Lin B. Decoupling of accounting firms and government selection: An explanation[J]. Accounting Research, 2000, (2): 9-15. (In Chinese)
Liu X X. Audit sanction and pricing: Based on the data of listed clients of auditors disciplined by CSRC[J]. Auditing Research, 2013, (2): 90-98. (In Chinese)
Song Y H, Xiao X. Supervision risk, auditor size and audit quality[J]. Auditing Research, 2012, (3): 83-89. (In Chinese)
Wang B, Li J, Su W B, et al. Can administrative penalties improve the audit quality? Based on the evidence of the punishment of the China Securities Regulatory Commission[J]. Accounting Research, 2011, (12): 86-92. (In Chinese)
Wu H M, Wu CH X, Yang X Q. Disciplinary risk, auditor size and audit quality: Evidence from China audit market[J]. Auditing Research, 2015, (1): 75-83. (In Chinese)
Zhang Q F. Does government regulation improve the reputation of accounting firms? Empirical evidence from China’s securities market[J]. Management World, 2005, (12): 14-23. (In Chinese)
Basu S. The conservatism principle and the asymmetric timeliness of earnings[J]. Journal of Accounting and Economics, 1997, 24(1): 3-37. DOI:10.1016/S0165-4101(97)00014-1
Chan K H, Wu D. Aggregate quasi rents and auditor independence: Evidence from audit firm mergers in China[J]. Contemporary Accounting Research, 2011, 28(1): 175-213. DOI:10.1111/care.2011.28.issue-1
Chang C-H J, Chou L-T L. Can individual CPA sanction improve audit quality of the firm?[R]. SSRN Working Paper, 2008.
Choi J H, Kim C, Kim J B. Audit office size, audit quality, and audit pricing[J]. Social Science Electronic Publishing, 2009, 29(1): 73-97.
Fafatas S A. Auditor conservatism following audit failures[J]. Managerial Auditing Journal, 2010, 25(7): 639-658. DOI:10.1108/02686901011061333
Firth M, Mo P L L, Wong R M K. Incentives for auditor independence: An analysis of the effectiveness of formal sanctions in China[R]. Working Paper, 2004.
Skinner D J, Srinivasan S. Audit quality and auditor reputation: Evidence from Japan[J]. Accounting Review, 2012, 87(5): 1737-1765. DOI:10.2308/accr-50198
Cite this article
Zhu Song, Ke Xiaoli. The Effectiveness of Audit Industry Supervision: Empirical Evidence Based on Firm Strategy Choice after CSRC Administrative Punishment[J]. Journal of Finance and Economics, 2018, 44(3): 56–67.
Previous: The Effect of Local Subsidy Competition on Excess Capacity in China: Empirical Study Based on Propensity Score Matching-DID