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    Government Ownership, Accounting-Based Regulations, and the...
    research summary posted October 14, 2015 by Jennifer M Mueller-Phillips, tagged 15.0 International Matters 
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    Title:
    Government Ownership, Accounting-Based Regulations, and the Pursuit of Favorable Audit Opinions: Evidence from China.
    Practical Implications:

    The results shed light on the behavior of managers and auditors under the influence of bureaucrats in China. The findings highlight the importance of understanding political and economic institutions when analyzing the reporting behavior of corporate managers and auditors. To understand their reporting behaviors in a transition economy such as China, one must first understand the role and incentive of government and its influence on corporate and accounting affairs. One must also understand the usefulness of securities regulation based on accounting measures. The results suggest that government regulators should be aware of the unintended consequences of basing rights-offering and delisting decisions on accounting earnings that are vulnerable to manager manipulation.

    Citation:

    Chan, K. H., K. Z. Lin, and R. R. Wang. 2012. Government Ownership, Accounting-Based Regulations, and the Pursuit of Favorable Audit Opinions: Evidence from China. Auditing: A Journal of Practice & Theory 31 (4): 47-64.

    Keywords:
    accounting-based regulations, audit opinions, government ownership, institutional environment, local auditors
    Purpose of the Study:

    This paper examines whether local government-controlled companies in China are able to obtain a better opinion from local auditors in an environment where access to new equity and exchange delisting are governed by regulations that are based on accounting earnings. China provides a unique setting in which to examine the strategic interactions of bureaucrats, managers, and auditors. First, financial accounting in China plays a prominent role in enforcing regulations that govern listing, delisting, and additional issuances of corporate securities through rights offering. Specifically, China’s rights-offering and delisting mechanisms attach great importance to the accounting rate of return, similar to debt contracts, bonus schemes, and capital budgeting. When contracts or regulations are accounting-based, corporate managers will have an incentive to manage accounting data to circumvent contractual restrictions. To cover up opportunistic financial reporting, managers are motivated to hire a compliant auditor. Second, local governments in China historically have strong influence over both corporate and accounting affairs. Finally, managerial misbehavior is expected to be prominent in an emerging economy such as China, where the business environment is largely based on relationships, the government protects the companies it owns, and the market mechanisms against opportunistic reporting are immature.

    Design/Method/ Approach:

    After excluding companies with incomplete data, the sample for estimating audit opinions includes 5,268 nonfinancial company-years drawn from the China Securities Markets and Accounting Research and Wind databases from 2001 to 2006.

    Findings:

    The authors find that local state-owned enterprises (SOEs) have a higher marginal propensity to receive a favorable audit report from local auditors when they anticipate raising new equity through a rights issue or when their exchange listing status is at stake. 

    Category:
    International Matters