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Does CEO–Auditor Dialect Connectedness Trigger Audit Opinion Shopping? Evidence from China

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Abstract

Using the original information from the identification cards of CEOs and signing auditors to hand-collect the data on CEO–auditor dialect connectedness (CADC), we examine the effect of CADC on audit opinion shopping (AOS), and further investigate the moderating effect of auditor reputation. Using a sample of Chinese listed firms during the period of 2007–2019, our findings reveal that the likelihood of AOS is significantly higher for firms with CADC than for their counterparts. This finding suggests that CADC impairs auditor independence and triggers AOS. Moreover, the effect of CADC on AOS is less pronounced for BIG10-audited firms than for non-BIG10-audited firms, implying that auditor reputation attenuates the relation between CADC and AOS. Furthermore, the above findings are robust to alternative proxies for CADC and AOS, and our conclusions are still valid after using the Heckman two-stage regressions, the propensity score matching approach, the change model method and the regression discontinuity design to control for the endogeneity issue. Lastly, the impact of CADC on AOS stands only for engagement auditors, but not for review auditors. Overall, our study enriches the existing literature on AOS and auditor independence.

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Notes

  1. Dialect connectedness is different from hometown ties (Du, 2019a). CEO–auditor hometown ties are defined based on whether the CEO and signing auditors were born in the same province, prefecture (prefecture-level city) or county (county-level city). However, CEO–auditor dialect connectedness is identified on the basis of whether the CEO and signing auditors speak the same (branch of) sub-dialect. Clearly, for people from two (or more) adjacent provinces, they may speak the same dialect, suggesting that they have dialect connectedness, but no hometown ties exist between them.

  2. People who share the same dialect may have been born in adjacent regions or even in the same native place and the regional cultural identity can help them find a common ground to form cohesion and deepen interpersonal relationship.

  3. Our study differentiates itself from Du (2019a). Du (2019a) focuses on China's IPO audit market to examine the impact of dialect sharing between the CEO and signing auditors on audit quality. All to-be-listed firms in China's IPO market are issued clean audit opinions without exception (Du, 2019a), so it remains unknown whether CEO–auditor dialect connectedness (CADC) results in successful audit opinion shopping. As a comparison, our study aims at exploring the effect of CADC on audit opinion shopping, a typical behavior that impairs auditor independence.

  4. First, people from the same place have a similar culture, experience, tradition, background, and value orientation (Fisman et al., 2018; Shen et al., 2019), so hometown ties can help to build guanxi in the Chinese society (Chen and Chen, 2004; Shen et al., 2019). However, the fact that two or more individuals were born in the same administrative region (e.g., province) does not necessarily mean cultural identity, and even cultural conflicts may still exist. Second, previous studies define school ties based on the same educational background (Guan et al., 2016), but students who graduated from the same university may have different majors and study at different time periods, and thus it is difficult for individuals to establish social ties when they have no overlap in the same university. Lastly, surname is formed on the basis of genetic relatedness and human migration (Grilli and Allesina, 2017). Chinese people rarely change their surnames and have a strong sense of identity about blood kinship, but the strength of surname ties is affected by the degree of rarity (Du, 2019b). Thus, the interpersonal relation based on surname ties may be relatively weaker.

  5. In 2003, the Regulations on the Mandatory Rotation of Signing Auditors for Securities and Futures Audit Business released by CSRC required that continuous audit services by signing auditors to the clients shall not exceed 5 years. Mandatory auditor rotation does not mean that a firm consciously switches its auditors to engage in opinion shopping.

  6. Up to now, based on the first and second steps, we can judge whether CEO–auditor hometown ties exist. However, to further identify CEO–auditor dialect connectedness, we need further work.

  7. Here are two examples. (1) “445121,” the first 6-digit ID number of a personal identification card, means that one's native place is “Chaoan (county)–Chaozhou (prefecture)–Guangdong (Province). Thus, he (she) speaks Chaoshan branch of sub-dialect of Minnan dialect. (2) If the first 6-digit ID numbers of a CEO and a signing auditor are “610523” and “142723,” then their native places are “Dali (county)–Weinan (prefecture)–Shaanxi (Province)” and “Ruicheng (county)–Yuncheng (prefecture)–Shanxi (Province),” respectively. Clearly, they were born in different provinces, but they speak the same branch of sub-dialect (known as “Jiezhou”; see Fig. 1).

  8. (1) Pinggu District, Jizhou District, and Xinglong County are located in Beijing, Tianjin, and Hebei Province, respectively, but their common branch of sub-dialect is “Jizun.” (2) Kangping County, Lishu County, and Ke'erqin zuoyi zhongqi are located in Liaoning Province, Jilin Province, and Inner Mongolia Autonomous Region, respectively, but their common branch of sub-dialect is “Changjin.” (3) Qijiang District, Lu County, and Xishui County are located in Chongqing, Sichuan Province, and Guizhou Province, respectively, but their common branch of sub-dialect is “Minchi.” In China, it is not rare for people from different administrative regions to speak the same dialect.

  9. In main tests, we also include CEO–auditor school ties (SCHOOL) in Model (2) to provide additional results, which are qualitatively similar to those without school ties.

  10. Untabulated univariate tests reveal that the mean value of AOS is 0.089 (0.130) for firms with CADC and 0.058 (0.079) for firms without CADC when the CEO and signing auditors share (do not share) hometown ties at the province level (HOME_PRO), the difference is significant at the 5% (10%) level with t = 2.09 (t = 1.93). However, the difference in AOS between firms with HOME_PRO and firms without HOME_PRO is insignificant. Above results preliminarily support that the positive impact of CADC on AOS is not qualitatively changed by hometown ties at the province level.

  11. The mean value of SCHOOL is less than 0.101 in Guan et al. (2016) because school ties in our study only focus on the CEO and signing auditors, but Guan et al. (2016) include school ties between auditors and all top executives. We have hand-collected by Wind, CSMAR, CNRDS databases, Baidu search engine, and Sina Finance, but a large number of missing values still exist, resulting in a significant decrease in sample size, consistent with Guan et al. (2016).

  12. The Heckman's two-step method is used to mitigate the sample selection that the data cannot represent the whole sample (Heckman, 1979).

  13. The Shanghai Stock Exchange only requires performance forecast in annual reports, but the Shenzhen Stock Exchange requires performance forecast in both quarterly and annual reports.

  14. Propensity score matching (PSM) approach is not a replacement for the sample selection model (Tucker, 2010). Thus, referring to Bose et al. (2021), Li and Qian (2021) and Su et al. (2020), we use both the Heckman's (1979) two-stage regression procedures and the PSM method in our study.

  15. The method of MSE optimal bandwidth allows different bandwidths on both sides (Calonico et al., 2016).

  16. Referring to Finlay et al. (2013), AR (χ2 = 6.61, p = 0.0101) and Wald (χ2 = 6.49, p = 0.0109) tests suggest that ALT_DIF is not a weak instrumental variable.

  17. The subsample with hometown ties at the prefecture (county) level has 474 (110) observations with CADC = 1 and only 17 (0) observations with CADC = 0.

  18. ZSCORE = 0.012X1 + 0.014X2 + 0.033X3 + 0.006X4 + 0.999X5 (X1 = working capital/total assets, X2 = retained earnings/ total assets, X3 = earnings before interest and taxes/total assets, X4 = market value of equity/book value of total debt, X5 = sales/total assets).

  19. We obtain the data on LPP by analyzing the issue about “What is the interviewee's proficiency in Putonghua?” The answers include five levels: (1) “very fluent”; (2) “fluent with a slight local accent”; (3) “not very fluent”; (4) “understands but does not speak”; and (5) “neither understands nor speaks.” According to the definition of “the ability of speaking Putonghua” from the State Language Work Commission, the first three levels can be defined as speaking Putonghua. Please note that the survey data include 2012 (16,253 observations), 2014 (23,594 observations), and 2016 (21,086 observations), and the data from the Tibet Autonomous Region and Hainan Province are unavailable.

  20. In China, an audit report needs to be signed by at least two auditors. The engagement auditor is responsible for specific work and communicates more audit details with clients' managers (e.g., audit adjustments), but review auditors focus on the compliance of the audit procedures, review the audit evidence and finally form the audit opinion. We distinguish an engagement auditor from a review auditor according to the following criteria: (1) If there is only one partner in the signing auditor team, the partner is identified as the review auditor and the rest is defined as the engagement auditor; (2) If the signing auditor team includes two or more audit partners, the highest position is identified as the review auditor, and the rest is the engagement auditor; (3) If the auditor's position cannot be distinguished, the one with the longest audit experience is defined as the review auditor, and the rest is the engagement auditor (Li et al., 2017).

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Acknowledgements

We appreciate constructive comments from Professor Steven Dellaportas (the section editor), two anonymous reviewers, Quan Zeng, Yingying Chang, Shaojuan Lai, Ying Zhang, Qiao Lin, Yuhui Xie and participants of our presentations at Xiamen University.

Funding

Professor Xingqiang Du acknowledges financial support from National Natural Science Foundation of China (Approval Number NSFC-71790602) and National Social Science Foundation of China (Approval Number 20&ZD111).

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Authors and Affiliations

  1. Center for Accounting Studies of Xiamen University and Accounting Department, School of Management, Xiamen University, No. 422, Siming South Road, Xiamen, 361005, Fujian, China

    Xingqiang Du

  2. Accounting Department, School of Management, Xiamen University, Xiamen, 361005, Fujian, China

    Liang Xiao

  3. Accounting Department, School of Management, Shanghai University, Shanghai, 200444, China

    Yingjie Du

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  1. Xingqiang Du
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Appendix: Variable Definitions

Appendix: Variable Definitions

Variable

Definition

AOS

An indicator for audit opinion shopping, equaling 1 if a firm receives a clean audit opinion and SWITCH equals 1 when the value of DAO is − 0.01 or less, or SWITCH equals 0 when the value of DAO is 0.01 or higher, and 0 otherwise (Chen, Peng, et al., 2016). DAO is estimated from Model (1) and can be defined as the difference between the probability of receiving a modified audit opinion (MAO) under the condition of changing the auditor and not changing the auditor. SWITCH equals 1 if a firm is audited by new auditors compared to the previous year (excluding mandatory changes) at the audit partner level and 0 otherwise

CADC

An indicator for CEO–auditor dialect connectedness, equaling 1 if the CEO and one or more signing auditors (engagement and review auditors) share the same branch of sub-dialect and 0 otherwise (Du, 2019a)

BIG10

An indicator for auditor reputation, equaling 1 if a firm is audited by BIG10 audit firms and 0 otherwise

HOME_PRO

An indicator for hometown ties at the province level, equaling 1 if the CEO and one or more signing auditors (engagement and review auditors) were born in the same province and 0 otherwise

SURNAME

An indicator, equaling 1 if a firm's CEO shares the same surname with one or more signing auditors and 0 otherwise (Du, 2019b)

BLOCK

The shareholding ratio of the largest shareholder

INDR

The ratio of the number of independent directors to the number of board members in a firm

SIZE

Firm size, measured by the natural logarithm of the total assets

LEV

Leverage ratio, computed as the ratio of total liabilities to total assets

ROA

Return on assets, measured as net income divided by total assets

OCF

The ratio of cash flow from operations to total assets

LOSS

An indicator variable that equals 1 if a firm has a negative net profit in the year and 0 otherwise

LISTAGE

A firm's listing age, measured as the natural logarithm of the number of years since a firm's stock has been listed

STATE

An indicator variable that equals 1 if a firm is ultimately controlled by government and 0 otherwise

MKT

Marketization index at the province level (Wang et al., 2017)

SCHOOL

An indicator, equaling 1 if the CEO has a common alma mater with one or more signing auditors and 0 otherwise (Guan et al., 2016)

SWITCH

An indicator, equaling 1 if a firm is audited by new auditors compared to the previous year (excluding mandatory changes) and 0 otherwise

DAO

The original value of audit opinion shopping (Model (1)) (Chen, Peng, et al., 2016), which is defined as the difference between the probability of receiving a MAO under the condition of changing the auditor and not changing the auditor multiplied by 100

CADC_NUM

The number of signing auditors sharing the same branch of sub-dialect with the CEO

CADC_INT

An ordered variable for the intimate degree of CADC, equaling 3, 2, 1, and 0 if a firm's CEO shares the same branch of sub-dialect with signing auditors and all the work is in non-dialectal regions; CEO shares the same branch of sub-dialect with the signing auditors, but only one side works in dialectal regions; CEO shares the same branch of sub-dialect with the auditor and both work in the dialectal regions; CEO and the auditor do not share the same branch of sub-dialect

CADC_GRO

An indicator, equaling 1 if the CEO and one or more signing auditors (engagement and review auditors) share the same sub-dialect and 0 otherwise (Du, 2019a)

DISC

An indicator, equaling 1 if the identification cards of both signing auditors and the CEO are disclosed and 0 otherwise

SE

An indicator, equaling 1 if the firm is listed on the Shenzhen Stock Exchange and 0 otherwise

ANALYST

Analyst coverage, measured as the natural logarithm of (1+ the number of analyst coverage)

INST_SHR

Institutional ownership, measured as the total percentage of shares held by institutional investors

INF_RATE

An indicator, equaling 1 if the stock exchange has the lowest disclosure rating in the last year and 0 otherwise (CNRDS database)

UN_WR

An indicator variable, equaling 1 if a firm's lead underwriter is the top 10 underwriters and 0 otherwise

ALT_DIF

The (smaller) absolute value of the difference in the altitude of birthplaces at the county level between the CEO and signing auditors

HOME_PRE

An indicator for home ties at the prefecture level, equaling 1 if the CEO and signing auditors were born in the same prefecture and 0 otherwise

HOME_COU

An indicator for home ties at the county level, equaling 1 if the CEO and signing auditors were born in the same county (district) and 0 otherwise

NEAR_PRO

An indicator, equaling 1 if the CEO and one or more signing auditors were born in geographically adjacent provinces and 0 otherwise

CADC_ PRO (CADC_ NPRO)

An indicator, equaling 1 if the CEO and one or more signing auditors share the same branch of sub-dialect and have (but do not have) hometown ties at the province level and 0 otherwise

CADC_PRE (CADC_NPRE)

An indicator, equaling 1 if the CEO and one or more signing auditors share the same branch of sub-dialect and have (but do not have) hometown ties at the prefecture level and 0 otherwise

CADC_COU (CADC_ NCOU)

An indicator, equaling 1 if the CEO and one or more signing auditors share the same branch of sub-dialect and have (but do not have) hometown ties at the county or district level and 0 otherwise

CADC_ENG

An indicator, equaling 1 if the CEO and the engagement auditor share the same branch of sub-dialect and 0 otherwise

CADC_REV

An indicator, equaling 1 if the CEO and the review auditor share the same branch of sub-dialect and 0 otherwise

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Du, X., Xiao, L. & Du, Y. Does CEO–Auditor Dialect Connectedness Trigger Audit Opinion Shopping? Evidence from China. J Bus Ethics 184, 391–426 (2023). https://doi.org/10.1007/s10551-022-05126-w

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