Mandatory Internal Control Auditing and Financial Restatements—Evidence from Chinese-SOX

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  In Roundtable Session: Table 9: Auditing ICFR

Abstract

This paper investigates whether mandatory internal control auditing legislation (Chinese-SOX) can really reduce the possibility of financial restatements in Chinese security market. This regulation which officially takes effect from fiscal year 2012 requires all qualified listed companiesreport their assessments of the design and operating effectiveness of internal controls over financial reporting, together with the external auditors’ opinion on the effectiveness of these controls. Considering the internal control construction standards and detailed requirements to auditors that the regulation emphasized, it is reasonable to expect a policy promoting improvement of internal control quality to reduce financial restatements.
Set all companies listed on the main boards of Shanghai and Shenzhen stock exchange markets (requirement of Chinese-SOX) as the example, we test the effect of mandatory internal control auditingto financial restatement behaviors. The results show that the mandatory internal control auditing by external auditors didnot reduce the possibility of financial restatement which means no obvious evidence of financial reportreliability improvement. Take the unique “dual auditing firms” phenomena in China stock market into account, which means hiring two different audit firms to process financial report audit and internal control audit separately, the results show that this auditing arrangement do really reduce the possibility of the financial restatements.
This study can bring enlightenments for the policy implementation effect analysis and follow-up policy improvements of internal control policies in China, which may also useful to other developing markets. It also supplies inspirationin regulating the company restatement behaviors and improving financial report credibility.

Authors

• Liyan Wang, Peking University

• QIAN XU, Peking University

• Jianguang Zeng, Southwestern University of Finance and Economics