Auditors’ Organizational Form, Legal Liability, and Reporting Conservatism: Evidence from China*

Abstract

This study uses a unique institutional setting in China to investigate empirically the association between the organizational form of CPA firms (unlimited liability versus limited liability) and the reporting conservatism of auditors. Based on a sample of 5,007 audits of Chinese listed companies from the period of 2000 to 2004, we find that auditors in unlimited liability partnership firms are more likely to issue modified audit opinions than are auditors in limited liability CPA firms. This auditor conservatism stems from distressed firms with going-concern opinions, and we find no statistical evidence that partnerships give more modified opinions for non-distressed firms. In addition, auditors are less likely to issue modified reports after they incorporated the firm in the limited liability form. These analyses support our hypothesis that a limited liability regime induces lower auditor reporting conservatism. Our study contributes to the broader debate on liability reform in the auditing profession.