Auditor Switch

1. Title

Major determinant factors of audit switching among A Shares companies listed in the Shanghai&Shenzhen Stock Exchange in China

2. Introduction

With the establishment of Shanghai&Shenzhen stock exchange, China's security market is becoming mature gradually. However, in recent years, the scandal at Enron, and the collapse of Arthur Andersen have drawn public attention to the accuracy of market information. Also, accounting fraud such as"银广夏"event and "华源集团" finance scandal in China led investors doubted the quality of financial statements. Investors and supervisory departments expect that financial statements are free from material misstatement. Whereas, listed companies are willing to reach agreements with accounting firms on accounting policies and accounting methods. Accounting firms, as a third parties, aim to protect investors' interest and refuse collusion behaviors. The conflict of interest intensified contradictions between the accounting firms and listed companies. This contradiction led to the popularity of audit switching in China.

Findings from previous researches indicate that companies decide to switch their incumbent auditors because of factors such as qualified opinions, change of management, dissatisfactions over audit fees, initial public offerings, audit quality, and clients' financial distress. Despite the growing concerns of this issue, few studies in China have examined the main reasons of auditor switching. Based on the special condition of China, some unique factors contribute to auditor switches such as auditor regionalism. This study aims to identify the major determinants of auditor switching among A Shares companies listed in the Shanghai&Shenzhen stock exchange in China. The sample of this study is drawn from the population of domestic officially listed companies in the Shanghai&Shenzhen stock exchange in China from 2007 to 2011, and the financial data is obtained from the CICPA website and companies' annual reports. This research uses ANOVA test and a logistic regression model to test our hypotheses.

The remainder of the paper is organized as follows: section two introduces the problems examined in this study, followed by the prior literature reviews on auditor switching. The objective of this study and the setting of hypotheses are also highlighted in section two. The methodology employed in this study to test the hypotheses will be explained in more details in section three.

In recent years, the scandal at Enron, the collapse of Arthur Andersen, and the enactment of Sarbanes-Oxley Act have brought attention to auditor switching and auditor opinion shopping.

The aim of financial reporting is to provide useful information for the foreseeable users. Auditors play a vital role in monitoring firms' financial reporting processes and providing a reasonable assurance that financial statements are free from material misstatements (Bagherpour, Monroe & Greg, 2010). However, the phenomenon of auditor switching was found to have implications regarding the credibility of financial reporting and the cost of monitoring management activities (Shahnaz, Huson & Annuar, 2008).

2.1 Statement of problems

After hundreds of years' development of western audit practices, the auditing market has become highly centralized. However, in Mainland China, the scale of auditing firms is small and the auditing market is so diverse and fierce that providing high quality auditing service is very difficult. The low-level disorderly competition intensifies the auditor switching. The management can pressure the independent auditor to issue a "clean opinion" by threatening to switch auditors. If the management is dissatisfied with their auditor's opinion on certain technical matters, they may select a new independent auditor to achieve a desired financial reporting (Steven & Dorothy, n.d.).

Based on the unique characteristics of the Chinese auditing market, we intend to investigate how qualified opinions, audit fees, and client financial distress exert effects on auditor switching. We will especially explore the relationship among local governments, listed companies and local audit firms, and analyze how audit regionalism affects auditor switching.

2.2 Literature Review

2.2.1 Qualified Opinion

The qualified opinion of the auditor indicates that the overall financial statements are fairly presented, but the scope of the audit has been materially restricted or applicable accounting standards were not followed in preparing the financial statements. (Arens, Elder & Beasley, 2012).Chow and Rice (1982) examined the influence of qualified opinion on auditor switching and found that firms switch auditors more frequently after receiving qualified opinions. Similarly, Craswell(1988), Citron and Taffler(1992) and Krishnan and Stephens (1996) also supported that qualified opinion has a significant positive effect on auditor switching. However, there is no evidence to further indicate that firms that have received qualified opinions switch to auditors with a history of issuing a lower percentage of qualified opinions (Chow and Rice, 1982). Besides, Craswell(1988) stated that a number of costs imposed on the firm following a qualified opinion are the motivation for managers to do auditor opinion shopping. The cost associated with qualified opinions is an increasing function of the seriousness of the qualification (Whittred, 1980). Consequently, the degree of incentive to switch auditor depends on the seriousness of the qualification.

Furthermore, Davidson, Jiraporn & DaDalt (2006) suggested that companies with qualified opinions are more likely to choose low quality auditors than those companies which also switch but received unqualified opinions. This result is consistent with Whisenant and