Audit quality and market pricing of earnings and earnings components in China

Abstract

Purpose – The purpose of this paper is to investigate the effect of audit quality on the market pricing of earnings and earnings components in China. Design/methodology/approach – The paper measures audit quality using three tiers of audit firm designation, namely International Big 4 audit firms, local Top 10 audit firms and, finally, the local second-tier audit firms. Earnings are decomposed into accruals and cash flow components and accruals are further decomposed into discretionary and non-discretionary accruals. Findings – The paper finds that, although earnings and its components are priced positively by the Chinese stock market, Big 4 audit does not provide any incremental benefit to clients in terms of market pricing of clients’ financial numbers. The paper finds a negative impact of local Top10 audit on the pricing of earnings in China. However, the paper finds no incremental effect of local Top 10 audit on the market pricing of earnings components. Originality/value – Although prior research in China has used modified audit opinion as the audit quality matrix, the paper considers market valuation of earnings and earnings components for firms audited by different categories of auditors.