Mandatory Internal Control Audits, Audit Adjustments, and Financial Reporting Quality: Evidence from China

• 成果类型: Article
• 署名作者: Lennox, Clive S.; Wu, Xi
• 署名单位: University of Southern California
• 刊物名称: ACCOUNTING REVIEW
• ISSN/ISSBN: 0001-4826
• DOI: 10.2308/TAR-2020-0152
• 发表日期: 2022
• 页码: 341-364
• 关键词: earnings management; COSTS

摘要

This study examines whether audit adjustments are a mechanism that links the effect of mandatory internal control audits (MICAs) on financial reporting quality. We argue that the requirement for auditors to publicly disclose internal control weaknesses exacerbated auditor-client conflicts and that this resulted in auditors being less likely to detect (and correct) misstatements in their clients' pre-audit financial statements. Consistent with this argument, we find significant reductions in audit adjustments following the staggered introduction of MICAs using data from China. We find the reductions in audit adjustments are associated with significant increases in material misstatements following the introduction of MICAs. In contrast, we find that the introduction of MICAs led to a significant reduction in material misstatements among clients that did not experience reductions in audit adjustments. Overall, the two effects offset each other, which explains why financial reporting quality did not improve, on average, following the introduction of MICAs.