PCAOB inspections, auditor reputation, and Chinese reverse merger frauds

Abstract

This paper examines whether Public Accounting Oversight Board (PCAOB) inspections decrease fraud likelihood in the Chinese reverse merger firms’ accounting crisis and whether auditor reputation moderates this relationship. By analyzing Chinese firms listed in the US stock markets through reverse merger (RM) during 2001–2011, we find that PCAOB inspections significantly decrease accounting fraud likelihood for RM firms, especially for auditors with low reputation. But this relationship does not hold for Chinese initial public offering (IPO) firms listed in the US. The reason may be that 84.68% of IPO firms hire Big 4 accounting firms, whose reputation substitutes for PCAOB inspections. Overall, our results indicate that PCAOB inspections help prevent financial frauds, but only for firms hiring non-Big 4 auditors.