Relation between Auditors’ Risk-Preparedness and Audit Adjustments: Evidence from Professional Risk Fund and Professional Indemnity Insurance

• In Event: Managing and Responding to Risk

Abstract

Using proprietary information about Chinese audit firms’ Professional Risk Fund (PRF) and Professional Indemnity Insurance (PII), and audit adjustments data for publicly traded clients, we examine whether and how audit firms’ PRF and PII relate to audit adjustments. Using the probability and magnitude of making audit adjustments to clients’ profits, we find that audit firms’ PRF and PII have opposite effects on audit adjustments. In particular, audit firms with larger PRF provisions exhibit higher audit adjustments, whereas audit firms that hold more PII exhibit lower audit adjustments. Our findings are robust to multiple approaches for addressing potential endogeneity, including using a changes model, a fixed-effects model, and a difference-in-differences specification. The results call into question the use of one-size-fits-all regulations regarding specific risk-shielding methods.

Authors

• Yingwen Deng, Renmin University of China

• Gerald Lobo, University of Houston

• Cyndia Wang, The University of British Columbia

• Min Zhang, Renmin University of China

• Jie Xue, Ministry of Finance of China