Abstract
The concern over accounting regulation has resulted in studies of auditor independence and audit quality, as measured by auditor tenure, accounting conservatism, and the type of audit firm the client employs (Big 4 or non-Big 4).In this study, we continue the line of research on conservatism and auditor tenure by examining whether accounting conservatism is related to auditor tenure for Chinese firms. We extend the studies by Jenkins and Velury (2008) and Li (2010) in order to examine Chinese firms that have non-Big 4 auditors, and we investigate whether the association exists for the most important and least important clients of these audit firms. Our findings indicate that least important clients employ more conservative accounting techniques as auditor tenure increases. For the most important clients, there is less conservatism, compared to the least important clients, in the early years of the auditor’s tenure. Our study provides more information about the regulatory issue of mandatory audit firm rotation because our results suggest that mandatory auditor rotation may have an adverse effect on the least important clients of these Chinese audit firms.
Highlights
High-profile corporate failures have raised the issue of balancing management’s and investors’ goal of increased corporate performance with the reliability of companies’ financial statements
In this paper we extend the line of research on conservatism and auditor tenure by examining whether accounting conservatism is related to auditor tenure for publicly-traded Chinese firms
In our study of publicly-traded Chinese companies, we employed models to evaluate the relationship between client importance and auditor tenure, as proxies for audit quality, and accounting conservatism
Summary
High-profile corporate failures have raised the issue of balancing management’s and investors’ goal of increased corporate performance with the reliability of companies’ financial statements. In a study of U.S firms, Jenkins and Velury (2008) have noted the general belief that a high quality audit translates to high earnings quality. The Basu (1997) model measures conservatism by the asymmetric timeliness of reporting bad news relative to good news. By examining this definition of accounting conservatism and its relation to auditor tenure, Jenkins and Velury (2008) documented a positive association between audit quality, as measured by longer auditor tenure, and firms’ earnings quality. Li (2010) noted that for smaller firms or for firms weakly monitored by their auditors, there was a significantly negative association between auditor tenure and conservatism
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