Regulation Risk and Auditors’ Reporting Conservatism: Evidence from Chinese Comment Letters

Abstract

We study how auditors respond to regulatory risk that arises when their clients receive comment letters from Chinese stock exchanges. Our results show that auditors are more likely to issue modified or conservative—but not excessively conservative—audit opinions to the recipients of comment letters. This reporting conservatism is especially pronounced when comment letters contain more questions, when more comment letters are issued, when the auditors must give opinions on some specific issues, or when there are more auditor-involved issues in comment letters. Comment letters have been issued in China since 2013 but were not disclosed until 2015. There is no significant difference for the impact of comment letters on auditors’ conservatism between pre- and post-disclosure periods. Further, auditor size has no significant effect on the impact of comment letters in post-disclosure periods. We interpret our results as supporting the regulation risk hypothesis.