AUDITOR-GOVERNMENT ASSOCIATIONS AND AUDITOR INDEPENDENCE IN CHINA

British Accounting Review (2001) 33, 175–189 doi:10.1006/bare.2001.0162, available online at http://www.idealibrary.com on

AUDITOR-GOVERNMENT ASSOCIATIONS AND AUDITOR INDEPENDENCE IN CHINA LLOYD YANG Chinese University of Hong Kong

QINGLIANG TANG University of Western Sydney

ALAN KILGORE Macquarie University

JIANG YI HONG Shanghai University of Finance and Economics Chinese CPA firms were established and initially owned by government bodies. This situation has caused much concern regarding auditor independence in China. A program to disaffiliate CPA firms from their sponsoring body began in 1997, and the purpose of this paper is to investigate whether auditor independence has subsequently improved. We use the number and percentage of non-standard opinions in audit reports as a measure of auditor independence. We found that the number and percentage of non-standard opinions has increased dramatically since 1997. After considering other possible explanations, we attribute the cause for such a change to the disaffiliation program. These results are consistent with the notion that disaffiliated CPA firms face a higher degree of market risk than affiliated firms, and therefore act more independently. Our results thus provide support and justification for the disaffiliation program.  2001 Academic Press

INTRODUCTION Prior research (DeAngleo, 1981a) has defined audit independence as the joint probability that auditors will both find and report misrepresentations The authors wish to thank the participants of the 2000 International Accounting Conference in Niagara Falls and the research seminar of the University of Western Sydney for their comments on earlier drafts of this paper as well as the valuable comments of the two anonymous reviewers. Please address all correspondence to: Qingliang Tang, Locked Bag 1797, PENRITH SOUTH DC NSW 1797, Australia. Tel: 61 2 9685 9465; Fax: 61 2 9685 9339; E-mail: [email protected] Received October 2000; revised and accepted May 2001 0890–8389/01/020175+15 $35.00/0

 2001 Academic Press

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in financial statements. Research findings have suggested that investors and lenders attach importance to audit reports in making investment decisions (Teoh & Wong, 1993; Blackwell et al., 1998). Various studies have examined factors that might influence audit independence, such as low balling (DeAngleo, 1981b; Magee & Tseng, 1990, Calegari et al., 1998; Simon & Frances, 1988; Ettredge & Greenberg, 1990; Lee & Gu, 1998; Dye, 1991, Craswell & Francis, 1999), non-audit services (Parkash & Venable, 1993; Firth, 1997), solicitation (Jeter & Shaw, 1995), and the size of audit firms (DeAngelo, 1981a). Meanwhile, numerous restrictions have been imposed (or proposed) on the activities of auditors (such as the prohibition against holding shares in, or administrative offices at client companies, contingent audit fees, or advertising) in order to maintain independence (Simmnett, 1998; Jeter & Shaw, 1995; Sikka, 1997). One of the objectives of setting accounting and auditing standards, ethical rules, or guidelines is to resolve conflicts (such as improper accounting treatment, presentation, or disclosure) that arise between auditors and clients. Because each conflict situation often involves unique circumstances, the resolution of such conflicts may be influenced by external influences dominant in a particular country. Although there are some general guidelines such as International Statements of Auditing (ISA), the regulation of auditor independence is still operated on a country by country basis. The increasing globalization of capital market and the expansion of large audit firms into truly multinational enterprises indicates that auditor independence is likely to become as sensitive an issue internationally as it is domestically. It is expected that the Chinese accounting profession will soon be one of the largest in the world. The profession is certainly expanding at tremendous speed, and plays an important role in economic reform. However, Chinese auditing operates in a very different environment than that in Western countries (Huang, 1987; Lau & Yang, 1990; Nobes & Parker, 1998). In China the profession is currently under the control of, or strongly influenced by, the government, and situations that cause concern for audit independence in a western country may not be as relevant in China. For example, few Chinese CPA firms provide substantial nonaudit services.1 Conversely, there are issues of independence that arise from unique situations under the current Chinese economic and financial systems. For instance, many foreign investments take the form of joint ventures between foreign investors and state-owned enterprises. Mandatory audits by Chinese CPA firms are required for these foreign investment enterprises. There is a potential conflict of interest in this sort of audit, as the government has an interest in the joint ventures (through ownership of the state enterprise) and government controlled or influenced CPA firms perform such audits. A number of studies address post-reform auditing practice in China (Tang et al., 1999; Lau & Yang, 1990; Huang, 1987; Xiao et al., 2000). In a recent paper, Xiang (1998) indicates that harmonization with International

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Accounting Standards will be difficult in China because local auditors are not perceived as being independent. The present study extends this line of research by investigating whether association with the government impairs auditor independence. Auditor–government relationships are important, particularly in developing countries where governments often dominate professional affairs. Another benefit of this study is that it can offer valuable assistance to China’s regulators as they attempt to develop viable capital markets. China’s potential as one of the world’s largest economies also makes the social welfare implications of such a contribution important. The results of this study should be of interest to investors and creditors, regulators, professionals and academics, and other users of Chinese financial statements and audit reports. The remainder of the paper is organized as follows. The next section describes the current Chinese auditing profession and the issues and problems of auditor independence. The research methodology and hypotheses for the paper are then developed in the third section. The results are then presented and discussed in the following section, and the last section contains a number of concluding remarks. THE CHINESE AUDITING SYSTEM: AN OVERVIEW Prior to 1980, independent auditing practices did not exist under the command economic system of the People’s Republic of China. The demand for such services was the result of economic reform driven by the need to develop a capital market and induce foreign investment. The subsequent reform process created a situation in which state firms were still wholly or partly owned by the government, but managers were offered financial incentives as well as considerable autonomy in decision making. Consequently, China’s large and medium-size industrial and commercial firms are now characterized by extensive managerial autonomy and an effective separation of ownership and control. The financial rewards available to managers are often directly linked to performance, which is usually measured with accounting information. As a result, there is growing evidence that managers manipulate financial information or engage in earnings management (Tang et al., 1999). This increasing separation between ownership and management has led to agency problems when state-owned enterprises seek stock exchange listings. It is well recognized that the demand for external auditing is driven by the extent of separation between owners and firm management (Chow, 1982). Independent auditing in China is now seen as being able to play an important role in alleviating these agency problems. For the first time since 1949, the Chinese Constitution, via the National People’s Congress (1982), now recognizes the need for independent external auditing in the specific context of economic reform.

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The relevant pieces of legislation that regulate audit practices in China are the Auditing Law of 1994 (National People’s Congress of China, 1994) and the CPA Law of 1993 (National People’s Congress of China, 1993). The Auditing Law is mainly concerned with state auditing, and defines the function, objectives, and activities of the state audit office. The CPA Law deals more specifically with professional auditing. Under the current legislation, the Chinese Institute of Certified Public Accountants (CICPA, established in November 1988) is responsible for the regulation of the profession, and membership is compulsory. The Ministry of Finance (MOF) delegates administrative responsibility to the CICPA for registration of CPAs and CPA firms, conducts professional examinations, and administers training programs for CPAs. The CICPA is also responsible for formulating, developing and implementing codes of CPA ethics and auditing standards. Upon approval by the Ministry of Finance, these codes and standards become authoritative documents which are binding on all CPAs. In sum, although the CICPA does not deal directly with clients, its association with the MOF may potentially influence professional independence. Affiliated CPA firms Professional auditing practices were rehabilitated from the situation which pertained in early 1983, when the overwhelming majority of CPA firms2 had been established and sponsored by government bodies or governmentcontrolled institutions.3 The association between accounting firms and their sponsors typically meant that the sponsoring body owned the firm, and staff were included in the personnel of the government unit. Firm operating policy could be influenced or even controlled by the government. Consequently, the market for audit services was highly protected. Sponsoring government units could exert their administrative power to procure clients for the firm, and protect it from market competition. Government ownership of CPA firms took either an industrial or regional form, both of which encouraged protectionism. To give an example of industrial protectionism, a government department may have possessed the necessary authority to require business entities under its control to be audited by CPA firms that it also controlled. Regional protection arose when provincial or local governments demanded that companies located within their administrative territory be audited by local CPA firms. The Chinese Institute of Certified Accountants (CICPA) conducted an investigation in 1997, in which 54% of respondents indicated that their business activities were being interfered with or influenced by government supervisory bodies (CICPA, 1998a). Government control of and influence over CPA firms also protected them from the threat of litigation.

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Disaffiliated CPA firms Following the commencement of the disaffiliation program, more and more firms moved away from their sponsoring bodies. CPA firms must be partnerships if the registered capital is below a certain amount, otherwise they take the form of limited liability firms. The objective of the disaffiliation program is to make the firm financially and operationally independent (CICPA, 1998b; Ministry of Finance, 1999). A disaffiliated CPA firm is supposed to have greater incentive to maintain independence than an affiliated firm. Auditors in an affiliated firm earn salaries from the sponsoring government body, and profits are owned by that body. Additionally, auditors in an affiliated CPA firm are not exposed to personal risk when performing audits, nor do they have the incentive to achieve independence, as they would gain no personal benefit from such activity. If they shirk their duty then they may well face disciplinary action, such as loss of CICPA membership, but such a setback has less effect than on a disaffiliated firm. Partners in disaffiliated firms are held liable for their actions; in limited liability firms, only the partner in charge of the audit has unlimited liability, whilst the other partners are partially protected by limited liability. In both cases partners have greater personal risk, and have more incentive to maintain independence than those in affiliated firms. Table 1 summarizes the main differences between the two types of firms. The present economic reforms and capital market development in China call for independent auditing services. However, due to historical reasons, government–auditor associations seem to be significant obstacles to the profession becoming fully independent. The disaffiliation program was supposedly a crucial step towards such an objective. As there is no research TABLE 1 A comparison of affiliated versus disaffiliated CPA firm Affiliated CPA firms Ownership Legal form Legal status Liability Scope of liability Operation Staff and personnel Profit and benefit

Ownership by sponsoring government entity (parent entity) State-firm, i.e. subordinate to its sponsoring government body May not be a separate legal entity Ultimate liability to parent entity Usually limited liability Under the control of parent entity Parent entity provides key personnel for the firm Return on investment flows to the parent entity

Disaffiliated CPA firms Ownership by partners Partnership or a limited liability firm A separate legal entity Ultimate liability to partners Unlimited liability for a partnership, limited liability for limited liability firm Operations are independent Personnel are disconnected from parent entity Retained within the firm for distribution among partners

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so far to test the underlying assumption that disaffiliated CPA firms are more independent than affiliated firms, the purpose of this study is to provide empirical evidence of disaffiliation, and show whether it actually has enhanced auditor independence. HYPOTHESES AND RESEARCH METHOD The measurement of independence Audit opinions fall into two categories in China: standard unqualified and non-standard opinions. Non-standard opinions include unqualified opinions with explanatory paragraphs, standard qualified opinions, qualified opinions with explanatory paragraphs, disclaimers and adverse opinions.4 All opinions other than standard unqualified category indicate some problem or potential problem with financial statements. This study utilizes nonstandard audit opinions as a measure of auditor independence. If an auditor has an opinion that differs from that of management and mentions this in the audit report, there is prima facie evidence of auditor independence (see DeAngelo, 1981a). Since independence is a state of mind and cannot be observed directly, audit opinions have been used in previous research as a direct or indirect indicator of auditor independence (see Krishnan et al., 1996; Barnes & Huan, 1993; Wines, 1994; Teoh, 1992). Similarly, non-standard opinions are considered as proxies for independence in this study. Note that we treat unqualified audit opinions with explanatory paragraphs as non-standard opinions. This is because the qualitative explanation often provides a crucial and important message regarding company operation and financial situation. This type of opinion has attracted considerable attention in the Chinese media, as it was recently discovered that the explanation usually conveys bad news about the company (Wang, 2000). This is consistent with the observations in the literature, which suggest that auditors may use mitigating qualitative information about the firm, although they are unable to qualify the accounts (see Barnes & Huan, 1993). Hypotheses The disaffiliation program commenced at the end of 1996, and CPA firms were required to be financially and operationally independent before the end of 1998.5 In other words, CPA firms performed audits for the 1997 financial statements of listed companies in 1998 when the disaffiliation program was underway. In 1999, CPA firms that had already been disaffiliated conducted the audit of 1998 financial statements. As disaffiliation took place, auditors faced increased risk in undertaking an audit. This change in the audit environment should have a significant impact on auditor behavior. It is expected that this impact will be observed in the audit reports associated

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with the 1997 and 1998 financial statements. This situation leads to the following hypotheses. H1: There were more non-standard opinions (in both number and percentage) in 1997 audit reports, when the disaffiliation program commenced, than in 1996. H2: There were more non-standard opinions (in both number and percentage) in 1998 audit reports, when the disaffiliation program was completed, than in 1997.

Sample The study utilizes audit reports relating to the annual financial statements for all companies that were listed on the Shanghai and Shenzhen Stock Exchanges from 1993 to 1998.

RESULTS AND DISCUSSION Table 2 summarizes the audit opinions relating to the annual financial statements of listed companies on the Shanghai and Shenzhen Stock Exchanges. This table indicates that there was an obvious increase in the number and percentage of non-standard auditor opinions in 1997 and 1998. In 1996, 9Ð06% of the companies received non-standard opinions. During 1997 this figure increased to 12Ð33% of companies, which was almost as many as the total for the preceding four years. In particular, there was one disclaimer and one adverse opinion (for the first time since stock exchanges commenced operation). Furthermore, in 1998 a total of 844 companies received 152 non-standard opinions (18%). Finally, the number of disclaimers increased from one in 1997 to 14 in 1998. This increase in non-standard opinions from 1996 to 1998 is statistically significant (for the increase from 9Ð06% in 1996 to 12Ð33% in 1997 P<0Ð05, one tailed; for the increase from 12Ð33% in 1997 to 18% in 1998, P <0Ð01, one tailed). These results indicate that both H1 and H2 cannot be rejected (see Figure 1). Moreover, taking 1997 and 1998 as a single post disaffiliation period, the average percentage of non-standard opinions, 15Ð33% (245 companies out of 1598 received non-standard opinions, and some may have received more than one), is much higher than that for the preceding four years (7Ð16%, 95 companies out of 1326 received non-standard opinions) (see Table 2). The difference is also statistically significant (P <0Ð05, one tailed).6 There are a number of possible explanations for such a dramatic increase in non-standard opinions. The purpose of the following discussion is to determine whether the increase is due to increased auditor independence, or other confounding factors.

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TABLE 2 Audit opinions (1993-1998) Year

Standard unqualified opinion No

Nonstandard opinion Unqualified C explanation

% No

1993 1994 1995 1996 1997 1998

182 291 323 530 745 844

178 285 286 482 661 692

97Ð80 97Ð93 88Ð54 90Ð94 87Ð67 82Ð00

3 2 3 25 57 101

%

1Ð65 0Ð69 0Ð93 4Ð72 7Ð56 11Ð97

Qualified Standard qualified

Disclaimer

Qualified C explanation

No

%

No

%

1 4 24 20 16 18

0Ð55 0Ð37 7Ð43 3Ð77 2Ð12 2Ð13

— — 10 3 18 18

— — 3Ð10 0Ð57 2Ð39 2Ð13

Data was obtained from public sources, such as company annual reports. Chinese stock exchanges commenced operation in 1991.

adverse

Total

No

%

No

%

No

%

— — — — 1 14

— — — — 0Ð13 1Ð7

— — — — 1 1

— — — — 0Ð13 0Ð1

4 6 37 48 93 152

2Ð20 2Ð06 11Ð41 9Ð06 12Ð33 18Ð00

L. YANG ET AL.

Total number of listed companies Number

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18% 16% 14% 12% 10% 8% 6% 4% 2%

92

93

94

95* Year

96

97**

98***

Ł

in 1995 new auditing standards were promulgated. in 1997 the disaffiliation program for CPA firms commenced. ŁŁŁ by the end of 1998 CPA firms were disaffiliated. Source: Audit reports from 1993 to 1998 for all companies listed on Shanghai and Shenzhen Stock Exchange. ŁŁ

Figure 1. Percentage of non-standard auditor’s opinions

Foreign influence One possible explanation for the significant increase in non-standard opinions is the potential impact of foreign accounting firms, particularly the Big Five, on Chinese auditing practices. From the early 1980s, China gradually opened its accounting and auditing markets to international accounting firms. Big Five firms were allowed to practice in China in various forms. Firstly, they were allowed to establish representative offices in large cities such as Shanghai, Beijing, and Guangzhou, providing services only to foreign companies. Later they were allowed to form joint ventures with Chinese partners, and were permitted to undertake more accounting and auditing tasks, such as mandatory audits and other services. Finally, they have been permitted to merge with local CPA firms.

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However, we found evidence that international firms and the Big Five did not play a significant role in the increase of non-standard opinions from 1996 to 1998. In both 1997 and 1998 a very small proportion of non-standard opinions, (4 out of 93 in 1997, and 3 out of 152 in 1998) were issued by Big Five firms. The presence of the Big Five might have had a significant impact on auditing in general (Xiao et al., 2000), but foreign influence does not appear to account for the sudden increase in non-standard opinions during the two years under study.7 New auditing standards Another possible explanation for the increase in non-standard opinions is the implementation of new auditing standards. In 1995, the CICPA issued new standards, which were to be made effective from the beginning of January 1996 (CICPA, 1995). These new standards were expected to have a significant impact on audit practice. In particular, it was widely believed that the new standards are consistent with international auditing standards and that their implementation would improve audit independence and quality (DeFond et al., 2000; Xiao et al., 2000). This fact could explain why there was an increase in the number and percentage of non-standard opinions from 1994 to 1995 (from 2Ð06% in 1994 to 11Ð41% in 1995; see Figure 1). However, the implementation of new standards alone does not explain increases in non-standard opinions beyond 1995 (and in particular those after 1997) when the new standards had been in force for a number of years. It is therefore unlikely that the new standards could explain the sudden change in auditor behavior during the period under study. Auditor experience and competence Prior research indicates that auditor competence could be a confounding variable in relation to auditor independence (Barnes & Huan, 1993). Generally speaking, it is possible that auditors in 1997 and 1998 were more experienced than their predecessors. They would have been more likely to detect breaches of accounting and other rules in financial statements. However, auditors gradually accumulate experience and improve their audit skills, and there is no evidence that training programs or projects dramatically improved auditor competence or experience during this period. We are unable, therefore, to consider improved skill or experience as an explanation for the results. Increases in the number of listed companies and corporate activity The number of listed companies increased from 530 in 1996 to 754 in 1997, and further increased to 844 in 1998 (see Table 2). Is the increase in nonstandard opinion merely due to the increased number of listed companies,

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rather than improved auditor independence? Probably not since we use not only the number, but also percentage of non-standard opinions, the quantity factor has been effectively controlled. In fact, new listed companies did not receive more non-standard opinions than old ones. There were 105 IPO companies in 1998, among them 6 received non-standard opinions on their 1998 financial statements. The percentage of 5Ð7% (6/105) for new listed companies receiving non-standard opinions was much lower than the average of 18% for all companies in 1998. It can also be argued that increases in corporate activity are more likely to unearth breaches of accounting and other regulations, and hence increase the number of non-standard opinions. In order to test this proposition we compared 1997 and 1998 sales of companies which received non-standard opinions (excluding newly listed companies in 1998). Our assumption was that an increase in sales indicates an increase in corporate activity. The results of this comparison indicate that for 1997 and 1998, sales were stable for those companies that received non-standard opinions. This result does not allow us to reach a conclusion that the increase in non-standard opinions was due to expanding business activities. The disaffiliation program The disaffiliation program commenced at the end of 1996, and therefore during 1997 Chinese CPA firms were in the process of de-affiliating from their sponsoring bodies. By the end of 1998, nearly all CPA firms that were performing audits of listed companies had been disaffiliated. After disaffiliation, CPA firms were no longer owned by the government and were therefore not subservient to their sponsoring bodies. Disaffiliated firms had the autonomy to determine business strategies and operating policies. At the same time the firms bore all business risks, and faced unlimited or limited liability if they shirked their professional duties. The audit environment also changed, and a growing number of litigation claims were brought against auditors. According to a recent report, lawsuits against auditors have been steadily increasing since 1996 (Li, L, 1998). Therefore, auditors face an environment with increasing audit risk. During the 1980s, users of audit reports did not fully understand the legal and civil liabilities of auditors, who faced no lawsuits. However, the first litigation against an auditor took place in 1996, and since then there has been a dramatic growth in the number of such legal actions (see Figure 2). Apart from litigation, the CPA monitoring body, the Chinese Institute of Certified Public Accountants, and the securities market monitoring body, the Chinese Securities Regulatory Commission, also began to effectively exercise their power to regulate the accounting and auditing market. Consequently more and more auditors have received warnings, fines, had their licenses withdrawn, or been subject to other administrative sanctions (see Figure 3).

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No. of litigation

500 400 300 200 100 1

92

93

94

95 Year

96*

97

98

Ł

the first litigation against auditor and CPA firm took place in 1996. Source: (Chinese) CPA Newsletter, 1998.

No. of sanctions

Figure 2. Incidence of litigation against auditors

500 400 300 200 100

92

93

94

95 Year

96*

97

Ł

administrative sanctions include warnings, fines and withdrawal or suspension of licenses, etc. Source: (Chinese) CPA Newsletter, 1998. Figure 3. Number of administrative sanctionsŁ against auditors

Changes in firm structure and legal form have significantly increased audit risk, and this increased risk should in turn have impacted on auditor behavior and the opinions issued. The disaffiliation program, together with an increase in litigation and administrative sanctions, appears to have contributed significantly to the increase in non-standard opinions in recent years, particularly in 1997 and 1998. The disaffiliation program has exposed auditors to market risk, and audit risk has increased significantly due to increased litigation and the activities of monitoring bodies. Our results are generally consistent with recent surveys concerning the restructuring (disaffiliation) of Chinese CPA firms. For example, a questionnaire survey conducted in late 1998 indicated that 94Ð7% of the

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respondents (CPAs) believed that CPA firms could maintain independence after/or during the process of disaffiliation (Wu, 1999). Additionally during the process of CPA firm restructuring, general public confidence ratings in CPAs increased from 45% in 1996 to 81% in 1998 (Li, S, 1998).

CONCLUSIONS This paper has attempted to explain the sudden and dramatic increase in the number and percentage of non-standard audit opinions issued in 1997 and 1998. We found that this increase is primarily due to the disaffiliation program which has aimed to promote auditor independence. This program has resulted in Chinese CPA firms being exposed to business risk, and having to face unlimited or limited liability if negligent in the performance of their duties. The results further support the notion that audit firm associations with the government can impair auditor independence, and that severing this connection is the first and crucial step towards the creation of a truly independent Chinese auditing profession. NOTES 1. Shortage of qualified auditors appears the main reason for the lack of non-audit services being provided by CPA firms. Although the Chinese accounting profession has been expanding, it is still unable to meet the strong demand for audit related services due to large scale of privatization and corporatization of state owned enterprises and the rapid development of capital markets (Tang et al., 1999). 2. The term ‘CPA firm’ here refers to both accounting and auditing firms. ‘Auditing firms’ refer to those who were sponsored by state audit offices while ‘accounting firms’ refer to those that were sponsored by the Ministry of Finance (or other governmental bodies or government-controlled bodies). 3. Examples of sponsoring bodies include the Departments of Finance and Taxation, or state banks, etc. A sponsoring body may be a government-controlled unit. For example, the Shanghai Da Hua CPA Firm was sponsored by Shanghai University of Finance and Economics which is controlled by the Ministry of Finance. 4. Under Chinese auditing standards, a qualified opinion should be expressed when the financial reports under audit are generally fair, but (1) accounting treatments for some important accounting matters and/or financial statement items are inconsistent with ‘Enterprise Accounting Standards’ or other state financial and accounting regulations, and the auditee has refused to make adjustments; or (2) the auditor is unable to obtain audit evidence due to a scope limitation, or (3) some important accounting policies are not consistently adopted. An adverse opinion should be expressed when there is (1) a serious breach of ‘Enterprise Accounting Standards’ or other state financial and accounting regulations, and the auditee has refused to make adjustments; (2) a serious distortion of financial position and operating results and fund changes, and the auditee has refused to make adjustments. The auditor should decline to express an opinion on the financial reports taken as a whole if he/she is unable to obtain audit evidence due to serious scope limitations and unable to implement necessary audit procedures.

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(Reference: Chapter 5, Detailed Independent Auditing Standards No 7: Audit Report, issued by Ministry of Finance, effective on and from 1 January 1996) 5. In 1998, there were 103 CPA firms who were allowed to perform securities and futures related business and audit listed companies. As a result of the disaffiliation program, 101 firms were disaffiliated from their sponsoring organisations by the end of 1998 (Li, Y, 1999), and two had their license to audit listed companies cancelled due to involvement in audit scandals. 6. The statistical test adopted in this study to compare means is a paired T test. As the direction of the variance is predicted, one-tailed probability is reported. 7. The reasons foreign firms issued fewer non-standard opinions appear to be: (1) foreign firms normally select high quality companies as audit clients; (2) audit fees of foreign firms are much higher than local CPA firms, so only larger and higher quality listed companies can afford, and have incentives to obtain such audit services (Defond et al., 2000), and large high quality companies are also less likely to receive non-standard opinions.

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