Do the organization types of audit firms matter to earnings conservatism? Evidence from China

  • Received February 15, 2017;
    Accepted May 4, 2017;
    Published June 6, 2017
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  • Article Info
    Volume 14 2017, Issue #2, pp. 116-127

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This study explores whether legal liability of audit firms is associated with client’s earnings conservatism. In China, audit firms are allowed to choose between legal forms of general partnership (GP) and limited liability corporation (LLC). Because partner auditor is personally liable for all partners’ service in general partnership form, that will provide an incentive for audit partners to monitor each other’s audit quality. Conversely, personal assets of individual partner, under LLC, are no longer available to pay a partnership’s liability, thus reducing the incentives for intrafirm monitoring by partners within an audit firm. Using several different methods for identifying earnings conservatism, this study finds that LLC audit firms are associated with reduced conservatism.

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    • Table 1. Sample selection and distribution of audit firm legal forms
    • Table 2. Descriptive statistics
    • Table 3. Pearson correlations
    • Table 4. Earnings conservatism and organization type: Earnings return model
    • Table 5. Earnings conservatism and organization type: Accrual based model
    • Table 6. Persistence of price-deflated earnings changes and organization type