Do Audit Clients Successfully Engage in Opinion Shopping? Partner‐Level Evidence

• Author: FENG CHEN,FEITENG YE,SHUANG XUE,ZHIFENG YANG,SONGLAN PENG
• DOI: http://doi.org/10.1111/1475-679X.12097
• Date: 01 March 2016
• Published date: 01 March 2016

DOI: 10.1111/1475-679X.12097

Journal of Accounting Research

Vol. 54 No. 1 March 2016

Printed in U.S.A.

Do Audit Clients Successfully

Engage in Opinion Shopping?

Partner-Level Evidence

FENG CHEN,

∗SONGLAN PENG,

†SHUANG XUE,

‡

ZHIFENG YANG,

§AND FEITENG YE



Received 22 August 2014; accepted 26 August 2015

ABSTRACT

This study investigates whether companies engage in audit opinion shopping

activities by exerting influence over an audit firm’s decision to switch the en-

gagement partner (“partner-level opinion shopping”) in the Chinese setting,

where the identities of engagement partners are publicly disclosed. Adopting

the empirical framework developed by Lennox [2000], we show evidence that

∗University of Toronto and University of Missouri-Columbia; †York University; ‡Shanghai

University of Finance and Economics; §City University of Hong Kong; Shanghai Lixin Uni-

versity of Commerce.

Accepted by Philip Berger. Weappreciate the helpful comments and suggestions from an

anonymous referee, Sudipta Basu, Jian Cao, Chih-Ying Chen, Donghua Chen, Yingwen Guo,

Carl Hollingsworth, Mingyi Hung, Qiliang Liu, Wally Smieliauskas, Minlei Ye, Ping Zhang,

and the participants of the 2014 AAA Auditing Section midyear meeting, the 2014 AAA Inter-

national Section midyear meeting, the 2014 AAA annual meeting, the 2014 CAAA annual

meeting, the 2014 JCAE annual symposium, the 4th (2014) joint symposium of City Uni-

versity of Hong Kong, National Taiwan University, and Shanghai University of Finance and

Economics, and the workshops at Huazhong University of Science and Technology, Nanjing

University, McGill University, and Sun Yat-Sen University. Feng Chen acknowledges financial

support from the Social Sciences and Humanities Research Council of Canada. Shuang Xue

acknowledges financial support from the National Science Foundation of China (Project No.

71172143 and Project No. 71572102). Zhifeng Yang acknowledges a research grant from the

Research Grants Council of the Hong Kong Special Administration Region, China (Project

No. 196413). Feiteng Ye acknowledges financial support from the National Science Founda-

tion of China (Project No. 71502107) and the Humanities and Social Science Foundation of

the Ministry of Education of China (Project No. 13YJC790183).

79

Copyright C, University of Chicago on behalf of the Accounting Research Center,2015

80 F.CHEN ET AL.

companies successfully engage in partner-level opinion shopping. Further,

partner-level opinion shopping is more likely to be successful if a company

is economically important to an audit firm, and it is less likely to be success-

ful if the audit firm is formed as a partnership rather than a corporation.

We also find that companies successfully engaging in partner-level opinion

shopping exhibit significantly lower earnings quality. Finally, we directly com-

pare audit records between incoming and outgoing partners and find that,

for companies that successfully improve audit opinions after partner switch-

ing, incoming partners have a significantly higher propensity to issue clean

opinions than their outgoing counterparts.

JEL codes: M40; M41; M42

Keywords: opinion shopping; partner switch; audit quality; individual

auditor

1. Introduction

Opinion shopping refers to the practice by which audit clients seek alterna-

tive auditors willing to give a clean audit opinion when the incumbent audi-

tor is likely to issue an unclean opinion. Existing studies examine whether

companies successfully engage in opinion shopping through switching au-

dit firms, using data from such countries as China, the United Kingdom,

and the United States (e.g., Chow and Rice [1982], Krishnan [1994],

DeFond, Wong, and Li [2000], Lennox [2000], Chan, Lin, and Mo [2006]).

In this study, we examine evidence of switching audit partners within the

same firm rather than switching to another firm for clean audit opinions,

which we term “partner-level opinion shopping.”

Anecdotal evidence suggests that managers may successfully pressure au-

dit firms to remove nonacquiescent audit partners. As a notable exam-

ple, Carl Bass, a Houston-based member of Arthur Andersen’s Professional

Standards Group (PSG),1was removed from the Enron account under pres-

sure from Enron management because he questioned some of Enron’s

accounting practices (Raghavan [2002]). Regulators have also noted the

possibility of partner-level opinion shopping. For example, in its propos-

als to require disclosure of the engagement partner’s name, the Public

Company Accounting Oversight Board (PCAOB) claims that such disclo-

sure can “provide a basis for analysts, investors, and others to ask a com-

pany’s management whether last year’s engagement partner is continuing

on the engagement and, if not, why not” (PCAOB [2013], p. 13), and it

might “promote auditor independence by discouraging audit clients from

inappropriately pressuring the firm to remove an engagement partner”

(PCAOB [2011], p. 9). The PCAOB even suggests that an audit firm file

1PSG is a small group of Arthur Andersen’s most experienced and technically astute part-

ners. It defined Andersen’s positions on hundreds of complicated accounting issues (Alexan-

der et al. [2002]).

PARTNER-LEVEL OPINION SHOPPING 81

a special report “when it replaces an engagement partner for reasons other

than mandatory rotation to provide an explanation of the reasons for the

change” (PCAOB [2011], p. 18). These statements suggest that partner-

level opinion shopping has become a regulatory concern and the regula-

tors believe that this practice may be more prevalent if the names of en-

gagement partners are not publicly disclosed. However, to our best knowl-

edge, there is virtually no empirical evidence on the existence and extent

of partner-level opinion shopping.

We attempt to fill this gap in the auditing literature by testing whether

companies successfully engage in partner-level opinion shopping using

data from China. Engagement partners in China are required to sign the

audit report, which enables us to identify partner switches before partners

reach their mandatory rotation limit. China provides a powerful setting

to investigate the issues of partner-level opinion shopping for the follow-

ing reasons. First, the Chinese capital market is characterized by weak in-

vestor protection and ineffective enforcement of laws (Allen, Qian, and

Qian [2005]). Further, the fierce competition for audit business among

audit firms in China offers bargaining power to audit clients, while the liti-

gation risk faced by auditors is relatively low (Wang, Wong, and Xia [2008],

He, Pittman, and Rui [2013], Yang [2013], Ke, Lennox, and Xin [2015]).

Because of the low costs of audit failure, audit firms in China may be more

tolerant of partner-level opinion shopping. Second, Chinese audit firms

generally have weak quality control mechanisms in place; thus, achieving

consistent audit quality across different audit partners of the same firm is

difficult (e.g., Gao [2012]). Gul, Wu, and Yang [2013] show that audit part-

ners in China exhibit significant variation in audit quality. The presence of

audit partners with heterogeneous audit quality within the same audit firm

makes it possible for companies to improve audit opinions through press-

ing the audit firm to replace relatively conservative partners, that is, part-

ners who have a relatively low propensity to issue clean opinions, with less

conservative partners of the same firm. Therefore, we expect that partner-

level opinion shopping is likely to exist in the Chinese market. However,

assigning specific audit partners to particular engagements is ultimately de-

termined by the audit firm. An audit firm may not always agree to replace

the engagement partner when disputes arise between the incumbent part-

ner and client management. Even if the audit firm agrees to replace the

incumbent partner, it may not necessarily assign a new engagement part-

ner with characteristics preferred by the client. Hence, whether companies

successfully engage in partner-level opinion shopping is an empirical issue.

Our sample consists of 11,919 observations from 1998 to 2012. We follow

the “what if” research framework of Lennox [2000] to determine whether

companies successfully engage in partner-level opinion shopping. Specifi-

cally, we use an audit reporting model to determine a company’sprobability

of receiving a modified audit opinion (MAO) with and without a partner

switch, respectively. The difference in the probabilities between the switch

and no-switch scenarios is defined as the opinion shopping variable. If a