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Executive Integrity, Audit Opinion, and Fraud in Chinese Listed Firms

We examine the influence of auditors on mitigating corporate fraud in China, which is known to have weak legal enforcement, weak investor protection along with tight control of the media and labour unions. We find that firms with executives that have lower integrity, indicated by a greater degree of earnings manipulation, are associated with higher propensity of regulatory enforcement actions against corporate fraud in the subsequent year. We show that this effect is moderated by the issuance of a modified audit opinion report by the auditors. This finding implies that auditors can serve as external governance mechanism to discourage executives with lower integrity in committing fraud. Our results have policy implications for further strengthening auditor independence in emerging countries like China.