Does the random inspection reduce audit opinion shopping?

Figures & data

Table 1. Descriptive statistics.

	Column A: Difference in variables before vs. after matching
	Before Matching				After Matching
Variables	Treat = 0	Treat = 1	Diff.	T value	Treat = 0	Treat = 1	Diff.	T value
Size	22.210	22.545	−0.335	−10.70***	22.587	22.555	0.032	0.70
Age	2.832	2.841	−0.009	−1.34	2.854	2.844	0.010	1.00
Lev	0.427	0.465	−0.039	−8.08***	0.466	0.466	0.000	0.02
ROC	0.205	0.108	0.097	4.47***	0.126	0.111	0.015	0.52
CF	0.041	0.040	0.001	0.56	0.042	0.040	0.002	1.06
DIRS	0.101	0.081	0.020	5.52***	0.079	0.081	−0.002	−0.50
LARS	46.818	48.746	−1.928	−5.33***	0.483	0.488	−0.006	−1.13
Big10	0.631	0.556	0.075	7.90***	0.548	0.541	0.007	0.48
RegCap	7.775	8.033	−0.258	−11.10***	7.885	8.034	−0.149	−1.35
History	2.039	2.467	−0.428	−43.18***	2.253	2.462	−0.209	−16.73***
OfficeNum	3.023	3.117	−0.094	−8.20***	3.046	3.116	−0.070	−1.38
	Column B: Descriptive statistics after matching
Variables	N	Mean	S.D.	Min	P25	P50	P75	Max
Switch	4634	0.109	0.312	0.000	0.000	0.000	0.000	1.000
Q	4634	0.030	0.169	0.000	0.000	0.000	0.000	1.000
Check	4634	0.223	0.417	0.000	0.000	0.000	0.000	1.000
Size	4634	22.570	1.532	19.500	21.540	22.310	23.380	27.070
Age	4634	2.849	0.346	1.609	2.708	2.890	3.091	3.434
Lev	4634	0.466	0.217	0.052	0.295	0.456	0.628	0.947
ROC	4634	0.119	0.989	−5.240	0.051	0.118	0.269	4.428
CF	4634	0.041	0.069	−0.203	0.004	0.041	0.081	0.241
DIRS	4634	0.080	0.150	0.000	0.000	0.000	0.078	0.668
LARS	4634	0.485	0.170	0.122	0.360	0.488	0.605	0.891
Big10	4634	0.544	0.498	0.000	0.000	1.000	1.000	1.000

Table 2. The effect of random inspections on audit opinion shopping.

	(1)	(2)	(3)	(4)	(5)	(6)
Dep. Var.: Switch	Lennox (2000) Model		Audit firm FEs		Client FEs
ΔQ	−0.649***	−0.789***	−0.589***	−0.765***	−0.727**	−1.069***
	(−4.15)	(−4.35)	(−3.87)	(−4.42)	(−2.40)	(−3.51)
ΔQ × Check		0.665***		0.813***		1.195***
		(2.84)		(3.29)		(3.74)
Check		−0.002		0.041**		−0.009
		(−0.16)		(2.28)		(−0.45)
Lev	0.077**	0.076**	0.037	0.038	0.020	0.021
	(2.51)	(2.52)	(1.24)	(1.31)	(0.31)	(0.34)
ROC	0.010*	0.010**	0.010*	0.010*	0.015**	0.015**
	(1.93)	(1.99)	(1.87)	(1.93)	(2.06)	(2.06)
CF	−0.065	−0.068	−0.093	−0.095	0.030	0.020
	(−0.84)	(−0.88)	(−1.25)	(−1.28)	(0.27)	(0.18)
DIRS	0.040	0.038	0.063	0.063	0.115	0.167
	(0.91)	(0.87)	(1.46)	(1.47)	(1.12)	(1.62)
LARS	0.030	0.030	0.023	0.022	−0.028	−0.018
	(0.91)	(0.92)	(0.70)	(0.68)	(−0.29)	(−0.19)
Big10	−0.044***	−0.045***	−0.389***	−0.398***	−0.430***	−0.440***
	(−3.99)	(−4.06)	(−5.86)	(−6.31)	(−3.77)	(−4.18)
Fixed Effects	Industry, Year		Industry, Year, Audit Firm		Client, Year, Audit Firm
Adj. R^2	2.7%	2.9%	8.7%	9.1%	24.6%	25.1%
Observations	4634	4634	4634	4634	4634	4634

Table 3. Mechanism tests.

	(1)	(2)	(3)	(4)
	Strengthen the integrated management		Implement internal control requirements
Dep Var: Switch	Headquarters	branches	Abundant manpower	Insufficient manpower
ΔQ	−1.433***	−1.017**	−1.758**	−1.036**
	(−3.33)	(−2.10)	(−2.32)	(−2.51)
ΔQ × Check	0.357	1.733***	0.237	1.533***
	(0.65)	(3.31)	(0.29)	(4.04)
Check	−0.017	−0.033	−0.004	−0.026
	(−0.68)	(−1.04)	(−0.15)	(−0.96)
p-value	0.012		0.081
Controls	Included	Included	Included	Included
Fixed Effects	Client, Year, Audit Firm
Adj. R^2	51.9%	35.9%	50.3%	28.1%
Observations	2295	2339	1477	3157

Table 4. Cross-sectional analyses.

	(1)	(2)	(3)	(4)
Dep Var: Switch	Big 10	Non-Big 10	Not punished	Punished after inspections
ΔQ	−1.229**	−1.253***	−1.478***	−1.433***
	(−2.31)	(−3.30)	(−2.87)	(−2.98)
ΔQ × Check	0.258	1.702***	0.447	1.754***
	(0.45)	(4.68)	(1.15)	(4.36)
Check	0.016	−0.015	0.023	−0.008
	(0.64)	(−0.47)	(0.85)	(−0.23)
p-value	0.009		0.014
Control Variables	Included	Included	Included	Included
Fixed Effects	Client, Year, Audit Firm
Adj. R^2	32.9%	46.3%	34.7%	40.4%
Observations	2521	2113	2814	1820

Table 5. The effect of random inspections on audit quality.

	(1)	(2)	(3)	(4)
	Audit independence		Audit quality
Dep. Var.	Conservative tendencies	Type II error	MAO	Restatement
Check	0.072***	−0.028**	0.021**	−0.048**
	(5.60)	(−2.30)	(2.26)	(−2.01)
Lev	0.039*	0.067**	0.119***	0.048
	(1.71)	(2.24)	(5.76)	(1.20)
ROC	0.000	−0.006	−0.001	−0.013
	(0.10)	(−1.15)	(−0.19)	(−1.61)
CF	−0.136**	−0.195***	−0.225***	−0.270***
	(−2.36)	(−3.40)	(−4.11)	(−2.63)
DIRS	−0.011	−0.052**	0.011	0.023
	(−0.62)	(−2.48)	(0.64)	(0.44)
LARS	−0.038**	−0.045*	−0.049***	−0.037
	(−2.09)	(−1.78)	(−2.92)	(−0.83)
Big10	−0.079	−0.043	−0.057	−0.007
	(−1.58)	(−1.17)	(−1.56)	(−0.11)
Fixed Effects	Industry, Year, Audit Firm
Adj. R^2	5.3%	5.8%	7.3%	7.4%
Observations	4634	4634	4634	4634

Table 6. Dynamic analyses.

	(1)	(2)	(3)
Dep. Var.: Switch	Lennox (2000) Model	Audit firm FEs	Client FEs
ΔQ	−1.147***	−1.085***	−1.451***
	(−3.98)	(−3.83)	(−3.73)
ΔQ × Check[−2]	0.178	0.204	0.115
	(0.42)	(0.49)	(0.24)
ΔQ × Check[−1]	0.571	0.531	0.821
	(1.42)	(1.37)	(1.63)
ΔQ × Check[0]	0.819**	0.885**	1.307***
	(2.25)	(2.41)	(3.03)
ΔQ × Check[1]	0.872**	0.822**	1.175**
	(2.29)	(2.14)	(2.29)
ΔQ × Check[2]	0.882**	0.879**	1.724***
	(2.11)	(2.15)	(3.45)
Control Variables	Included	Included	Included
Fixed Effects	Industry, Year	Industry, Year, Audit Firm	Client, Year, Audit Firm
Adj. R^2	3.0%	9.0%	25.1%
Observations	4634	4634	4634

Table 7. Robustness tests: F. Chen et al. (2016)’s model.

	(1)	(2)	(3)	(4)	(5)	(6)
Dep. Var.: Switch	F. Chen et al. (2016)		+ Audit firm FEs		+ Client FEs
ΔQ	−0.176**	−0.307***	−0.203**	−0.340***	−0.466**	−0.827***
	(−2.20)	(−3.37)	(−2.53)	(−3.73)	(−2.27)	(−3.40)
ΔQ × Check		0.491***		0.511***		0.927***
		(3.01)		(3.14)		(3.46)
Check		−0.003		0.026		−0.002
		(−0.26)		(1.62)		(−0.07)
Control Variables	Included	Included	Included	Included	Included	Included
Fixed Effects	Industry, Year		Industry, Year, Audit Firm		Client, Year, Audit Firm
Adj. R^2	34.6%	34.7%	35.3%	35.6%	37.9%	38.4%
Observations	4634	4634	4634	4634	4634	4634

Table 8. Excludes alternative explanations of capital market stress.

	(1)	(2)	(3)	(4)
Dep. Var.	ΔTurnover	CAR	ΔTurnover	CAR
Treat	−0.001	0.005	0.002	−0.016
	(−0.42)	(0.83)	(0.12)	(−0.70)
Fixed Effects	Industry, Year		Client, Year
Adj. R ^2	9.2%	7.4%	60.7%	81.0%
Observations	838	838	838	838

Table 9. Other robustness tests.

	(1)	(2)	(3)	(4)	(5)	(6)
Dep. Var.: Switch	Exclude clients who have switch firms		Exclude companies inspected by other bodies		Exclude audit firms inspected by dispatched agencies
ΔQ	−0.670**	−1.031***	−1.433***	−1.785***	−0.848**	−1.236***
	(−2.14)	(−3.16)	(−3.28)	(−4.56)	(−2.42)	(−3.35)
ΔQ × Check		1.140***		1.438***		1.291***
		(3.82)		(3.43)		(3.35)
Check		0.013		0.002		−0.024
		(0.76)		(0.08)		(−1.12)
Controls	Included	Included	Included	Included	Included	Included
Fixed Effects	Client, Year, Audit Firm		Client, Year, Audit Firm		Client, Year, Audit Firm
Adj. R ^2	30.4%	31.0%	22.5%	23.0%	31.6%	32.1%
Observations	4426	4426	4151	4151	3718	3718
	(7)	(8)	(9)	(10)	(11)	(12)
Dep. Var.: Switch	Check the effect of random inspection by dispatched agencies		Regression using the Logit model		Control for possible omitted variables
ΔQ	−0.541***	−0.583***	−4.512***	−5.857***	−0.778***	−0.572*
	(−2.90)	(−3.04)	(−4.81)	(−5.61)	(−4.25)	(−1.83)
ΔQ × Check		0.550		7.264***	0.661***	0.723***
		(1.02)		(3.00)	(2.83)	(3.09)
Check		−0.069**		0.550**	−0.003	−0.003
		(−2.30)		(2.49)	(−0.23)	(−0.25)
New variables					Included	Included
ΔQ × New variables					Not Included	Included
Controls	Included	Included	Included	Included	Included	Included
Fixed Effects	Client, Year, Audit Firm		Industry, Year, Audit Firm		Industry, Year
Adj./Pseudo R ^2	27.5%	27.7%	12.6%	13.1%	2.9%	3.0%
Observations	3219	3219	4634	4634	4634	4634

Table 10. When do random inspections work: introduced or implemented?

Dep. Var.: Switch	(1)	(2)	(3)
Column A: The impact of the introduction of the policy on opinion shopping
ΔQ	−2.142***	−2.053***	−1.620***
	(−4.54)	(−5.05)	(−2.79)
ΔQ×Post	0.040	0.004	−0.112
	(0.25)	(0.02)	(−0.52)
Control Variables	Included	Included	Included
Fixed Effects	Industry, Year	Industry, Year, Audit Firm	Client, Year, Audit Firm
Adj. R ^2	5.4%	11.4%	12.7%
Observations	15,778	15,778	15,778
Column B: Impact of random inspections in 2017 and 2018
ΔQ	−0.934**	−0.962**	−1.656***
	(−2.39)	(−2.61)	(−4.56)
ΔQ × Check	0.765*	0.926***	1.543***
	(1.84)	(2.77)	(2.91)
Check	−0.019	−0.009	−0.063**
	(−0.86)	(−0.28)	(−2.33)
Control Variables	Included	Included	Included
Fixed Effects	Industry, Year	Industry, Year, Audit Firm	Client, Year, Audit Firm
Adj. R ^2	3.3%	8.5%	33.1%
Observations	2172	2172	2172

Table A1. Variable definitions.

Variables	Definitions
Switch (S)	A dummy variable that equals 1 if a firm is audited by a new audit firm in year t, and 0 otherwise
Check	A dummy variable that equals 1 for the firms under random inspection in the year after inspection, and 0 otherwise
Q it	A dummy variable that equals 1 if firm i receives a modified audit opinion in year t, and 0 otherwise
Q it-1	A dummy variable that equals 1 if firm i receives a modified audit opinion in year t–1, and 0 otherwise
Size	The logarithm of the total assets of the enterprise
Age	The logarithm of the number of years since its establishment
Lev	Total Liabilities/Total Assets
ROC	EBIT/(net current liabilities + net non-current liabilities – intangible assets – deferred tax assets)
CF	Net cash flow from operating activities/total assets
DIRS	The shareholding ratio of executives
LARS	Total shares held by non-executives with a shareholding ratio of more than 5%
Big10	A dummy variable that equals 1 if a firm is in the top 10 audit firm

Lennox, C. (2000). Do companies successfully engage in opinion-shopping? Evidence from the UK. Journal of Accounting and Economics, 29(3), 321–337. https://doi.org/10.1016/S0165-4101(00)00025-2

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Chen, F., Peng, S., Xue, S., Yang, Z., & Ye, F. (2016). Do audit clients successfully engage in opinion shopping? Partner‐level evidence. Journal of Accounting Research, 54(1), 79–112. https://doi.org/10.1111/1475-679X.12097

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