Auditors’ Role in China: The Joint Effects of Incentive and Regulatory Sanction on Earnings Management Attempts

• In Event: Concurrent Session 1.1: Auditing and Corporate Governance

Abstract

This study investigates Chinese auditors’ role in curtailing or allowing earnings management and the potential moderating effects of regulatory sanction. We focus on Chinese auditors for two reasons: Chinese companies have strong incentives to manage earnings to maintain listing status and also have been historically tied to their auditors. We use a 2X2 experiment, where we manipulate earnings management (low vs. high) and auditor penalty severity (low vs. high). 174 Chinese auditors participated in our study. Results of our experiment suggest that auditors are aware of earnings management attempts and are ready to prevent these attempts. In particular, their readiness is heightened as punishment becomes more severe. Our evidence suggests that in countries with limited investor protection, such as China, auditors will play a meaningful role in curtailing earnings management attempts as long as it has strong regulatory enforcement in place.

Authors

• Ning Du, DePaul University

• Joshua Ronen, New York University

• Jianfang Ye, Shanghai University of Finance and Economics