Do auditors consider alleged bribery when accepting clients? Evidence from Chinese non-state-owned enterprises

Abstract

This study examines the relationship between firm-level alleged bribery and audit-related decisions for Chinese non-state-owned enterprises (NSOE). Using a sample of listed NSOEs in 2010–2016, we find that alleged bribery is negatively correlated with the probability of being accepted by top-tier auditors and is positively correlated with audit fees. These findings suggest that top-tier auditors are more reluctant to accept corrupt firms and also charge higher audit fees. Also, we find that the negative correlation between alleged bribery and the probability of being accepted by top-tier auditors is strengthened after an anti-corruption campaign launched by the Chinese government in 2013 and/or after the crackdown of provincial-level officials, and is more pronounced in less developed regions. Finally, we find that alleged bribery is positively associated with the level of earnings management, implying that alleged bribery likely increases irregularities in financial statements.

Keywords:

• alleged bribery
• auditors’ client acceptance
• audit fees
• non-state-owned enterprises (NSOE)
• earnings management

Acknowledgements

We appreciate helpful guidance and constructive comments from two anonymous reviewers, Xiao Xiao (Discussant), Liansheng Wu (Guest Editor), Jason Xiao (Guest Editor), and Mark Clatworthy (Editor), as well as participants at the 2018 Accounting and Business Research Conference on Auditing at Peking University, Beijing, China. We also thank Zhiming Ma, Theresa Hammond, and Michael Werner for comments and suggestions.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 We follow Zeng et al. (2016) in calling the unexplainable component of ETC ‘alleged bribery’. Alleged bribery captures an abnormal level of ETC after excluding normal business costs. The limitation of this measurement is that it can be a mixture of costs of illegal bribery, managerial perks, and normal socialising. Therefore, we use the word ‘alleged’ which typically refers to a claim of wrongdoings without proof, and the term ‘alleged bribery’ fits what we measure in that an abnormal level of ETC suggests a higher probability of bribery but does not necessarily indicate that bribery has happened.

2 For example, guidance for auditing pharmaceutical companies issued by Ernst & Young recommends not only assessing the validity of the business activities and associated receipts, but also evaluating the adequacy of the expense bases relative to staff salaries, customer rebates, customer development, activity budgets, third party projects, and signed contracts. (https://xueqiu.com/8300851176/132625210 in Chinese).

3 We focus on NSOEs because they usually have tight financing constraints, and thus need reputable audit firms to provide outside investors with a greater degree of assurance. Also, excluding Chinese state-owned enterprises (SOE) from the sample helps us separate the ownership effect and better understand auditors’ acceptance of NSOE clients. Wang et al. (2008) have examined auditor choices of SOEs.

4 The Big8 have been catching up with the Big4 since 2013. For example, Ruihua China, a new firm created by the merger of RSM China and Crowe Horwath China has surpassed both KPMG and E&Y in annual rankings issued by the CICPA since 2013. Lixin China (BDO’s Chinese affiliate) surpassed KPMG in 2013 and surpassed both KPMG and E&Y in 2014. (http://www.cicpa.org.cn/news/201405/W020140530620129219579.pdf) Furthermore, in terms of audit revenue, the Big4’s growth rate has slumped since 2008, while the Big8 have grown quickly at a rate of approximately 20% (http://www.chinaaccountingblog.com/weblog/bad-news-for-the-big-four.html).

5 For example, investors might not be compensated, even though a court has ruled in their favor against a company and its auditors (He et al. 2017).

6 We use a different method because survey-based data might be prone to respondent bias (Zeng et al. 2016).

7 Following Li and Zhao (2015), we include expenses in the following categories, i.e. travel expenses (Chai Lv Jiao Tong Fei Yong), entertainment expenses (Ye Wu Zhao Dai Fei Yong), meeting expenses (Hui Yi Fei Yong), clerical expenses (Ban Gong Fei Yong), and social expenses (Jiao Ji Ying Chou Fei Yong).

8 The PC is a legislative body, and the CPPCC is a political advisory body.