An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Ferdinand A. Gul
The Hong Kong Polytechnic University

Jeong - Bon Kim
The Hong Kong Polytechnic University

Aini Qiu
The Hong Kong Polytechnic University

Abstract: We investigate whether and how auditor location, a proxy for political connections between local governments and auditors, and the importance of a client relative to an auditor’s client portfolio affects the quality of audits by non-Big 4 auditors in China’s guanxi-based economy. We find that clients of local auditors report a higher level of abnormal non-core earnings and receive modified audit opinions less frequently, compared with clients of non-local auditors. The finding is consistent with the notion that local auditors are more likely to be politically influenced by the local government, and thus provide lower-quality audits than non-local auditors. We also find that in sharp contrast with the U.S. evidence of Big 4 clients, in China, auditors are more economic dependent on important clients than non-local auditors do. Our study provides insights into the role of political economy in affecting financial reporting behavior by using within-country, firm-specific data.

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