Market Reaction to Initial Qualified Audit Opinions in an Emerging Market: Evidence from the Shanghai Stock Exchange

Abstract

This study investigates the valuation effect of modified audit opinions (MAOs) on the emerging Chinese stock market. Here, the term MAO refers to both qualified opinions and unqualified opinions with explanatory note(s). The latter can be considered an alternative form of qualified opinion in China. The institutional setting in China enables us to find compelling evidence in support of the monitoring role of independent auditing as an institution. First, we find a significantly negative association between MAOs and cumulative abnormal returns after controlling for effects of other concurrent announcements. Further, results from a by-year analysis suggest that investors did not reach negative consensus about MAOs' valuation effect until the second year, exhibiting the learning process of a market without prior exposure to MAOs. Second, we do not observe significant differences between market reaction to non-GAAP and GAAP violation related MAOs. Third, no significant difference is found between market reaction to qualified opinions or to unqualified opinions with explanatory note(s).