Negative Press Coverage, Litigation Risk, and Audit Opinions in China

Abstract

Exploiting a legal regime change in China in 2005 that significantly increased auditors’ civil liability, we reexamine why auditors are more likely to issue modified audit opinions (MAOs) to clients who receive negative press coverage before audit report dates. We find that negative press coverage prior to the audit report date significantly increases the probability for auditors to issue MAOs during 2001-2009, consistent with findings using the U.S. data. More importantly, we find that such a positive relation does not exist in the low litigation risk period (2001-2004) and is present only in the high litigation risk period (2006-2009). Moreover, first-reported negative press coverage and repeated negative press coverage affects audit opinions differently. While neither affects the probability of MAOs in the low litigation risk period, only first-report negative press coverage increases the probability of MAOs in the high litigation risk period. Finally, additional analyses on regulatory sanctions in the year after negative press coverage rule out the possibility that the observed no relation between auditors’ MAOs and negative press coverage in the low litigation risk period is due to slack regulatory sanctions in that period. Taken together, our findings suggest that auditors increase the probability of issuing MAOs to firms receiving negative press coverage to mitigate a perceived increase in litigation risk stemming from negative press coverage in the high litigation risk period.