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    The Effect of China’s Weak Institutional Environment on t...
    research summary posted September 15, 2015 by Jennifer M Mueller-Phillips, tagged 05.0 Audit Team Composition, 05.05 Diversity of Skill Sets e.g., Tenure and Experience, 11.0 Audit Quality and Quality Control, 11.07 Attempts to Measure Audit Quality 
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    Title:
    The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits.
    Practical Implications:

    This study suggests that the strength of the institutional environment can significantly influence audit quality, and subsequently financial reporting quality even for global accounting firms with standardized training and auditing procedures.  Furthermore, this study has important implications for the SEC which has voiced concerns about the quality of auditing in China, and the PCAOB which has been barred by the Chinses government from conducting inspections of auditing firms located in mainland China.

    Citation:

    Ke, B., C. S. Lennox, and Q. Xin. 2015. The Effect of China’s Weak Institutional Environment on the Quality of Big 4 Audits. The Accounting Review 90 (4): 1591-1619.

    Keywords:
    Audit quality, Big 4, China
    Purpose of the Study:

    The Big 4 audit firms operate on a global scale and assert that they maintain a uniformly high level of quality around the word by providing their employees standardized training and through the global application of consistent auditing methodologies. However, there is some reason to suspect that the strength of a country’s institutional environment might influence the supply of audit quality such that Big 4 firms provide lower-quality audits in countries with relatively weak institutional environments. Because it is difficult to control for all differences between countries, this can be difficult for researchers to examine empirically. To combat this issue, this study takes advantage of a unique characteristics of Chinese firms.  Hong Kong is seen as having a stronger institutional environment relative to mainland China and firms that are listed on both the mainland exchange and the Hong Kong exchange must prepare and audit two separate sets of financial statements. This allows the authors to better isolate how variability in institutional strength affects audit quality for the clients of Big 4 firms. In particular, the study address the following research objectives:

    • Whether Big 4 firms assign their most experienced audit partners to clients who are listed on both exchanges relative to those only listed on the mainland exchange.  
    • Whether audit quality of cross-listed firms is higher than firms solely listed on the mainland exchange.
    • Whether differences in audit quality between firms that are cross-listed and firms that are only listed on the mainland China exchange lead to differences in financial reporting quality.
    Design/Method/ Approach:

    The authors use data on publicly traded Chinese companies from the years 1995-2012 to examine differences in audit quality, and financial reporting quality for firms cross-listed on both the HK exchange and the mainland China exchange, relative to firms solely listed on the mainland China exchange.  To examine differences in partner experience, the researchers utilize data from a unique dataset supplied by the Chinese Institute of Certified Public Accountants.

    Findings:
    • Partners assigned to cross-listed firms are significantly more experienced than partners assigned to clients that are not cross-listed. This suggests that Big 4 firms may assign auditors based on the strength of the institutional environment such that their more experienced auditors are assigned to stronger institutional environments.
    • Cross-listed firms are associated with higher levels of audit quality relative to firms only listed on the mainland China exchange. This is consistent with the assertion that Big 4 audit firms may provide lower-quality audits in weaker institutional environments.
    • Cross-listed firms are associated with lower levels of financial reporting quality relative to firms only listed on the mainland China exchange. This suggests that the lower level of audit quality provided by Big 4 firms in weaker institutional environments negatively impacts financial reporting quality.
    Category:
    Audit Quality & Quality Control, Audit Team Composition
    Sub-category:
    Attempts to Measure Audit Quality, Diversity of Skill Sets (e.g. Tenure & Experience)