| Author: | Kung, Wai Chiu Marco |
| Title: | Modified audit opinions and auditor switch under the new listing rules regime evidence-based on Hong Kong-listed companies |
| Advisors: | Fung, Mike (AF) |
| Degree: | D.B.A. |
| Year: | 2022 |
| Subject: | Auditing -- China -- Hong Kong Corporations -- Auditing -- Law and legislation -- China -- Hong Kong Hong Kong Polytechnic University -- Dissertations |
| Department: | Faculty of Business |
| Pages: | vi, 143, 3 pages : color illustrations |
| Language: | English |
| Abstract: | Background and motivation: The Stock Exchange of Hong Kong Limited (HKEX) published a Consultation Conclusion to listed issuers (listed companies) with disclaimer or adverse audit opinions on financial statements after a 2-month consultation period carried out in 2018. This Consultation Conclusion empowered HKEX to suspend trading securities of listed companies if preliminary annual results announcements carried the severest modified audit opinions, namely, disclaimer or adverse audit opinions expressed by the incumbent auditor. My observation was triggered from a strong intention of listed companies to make decisions on auditor switch to address disclaimer or adverse audit opinions during the remedial period. Literature: Auditor switch can be generally observed in the form of dismissal, rotation, resignation, or audit tenure. Regardless of the forms of switching, auditor switch behaviors were induced for numerous real-world practice reasons. Findings in academic studies demonstrate many influencing factors of auditor switch based on empirical evidence or analysis involving different markets, countries, selected business sectors, and timing for observations. Some literature explain the auditor switch decision using the opinion shopping theory (Teoh, 1992). However, it seems that no unity model or theory can explain all these behaviors. Nevertheless, auditor switch behavior is more frequent (has higher probability) in firms with qualified opinions instead of expressed clean audit opinions (Chow & Rice, 1982; Gul, Lee, & Lynn, 1992). This idea provides a conceptual groundwork that links auditor switch to classical agency theory (Jensen & Meckling, 2009). Research value: Auditor switch has long been an important study topic in accounting research. A research value arose from the auditor switch literature while exploring some implications from agency theory or other corporate governance considerations, particularly those on modified audit opinions. This study contributes to and enriches literature on auditor switch by discussing the new suspension trading regime and some related implications, such as a 1-year time lag or the moderating effect of some key control variables—a consequence of modified audit opinions. Despite a potential suspension consequence of securities under the newly announced regime, it is vital to understand the change in probability and timing (1-year time lag) of auditor switch to be significantly influenced by different levels of modified audit opinion severity. Purpose: My study analyzes the relationship between modified audit opinions and auditor switch implemented under the new trading suspension regime (regime) based on conceptual groundwork and previous literature. This study also investigates whether and how the new regime has fundamentally changed listed companies' behavior in terms of auditor switch with the interactive effects of various control variables in audit characteristics. Methodology: Using the logistic regression approach, this study evaluates the impact of the new listing rules concerning the trading suspension regime, concluded in May 2019, on the relationship between various levels of modified audit opinion severity given to a firm on one hand and the firm's auditor switch decision on the other. I employ modified audit opinions as a key determinant on auditor switch. The dependent variable is the probability of auditor switch. A dichotomous (binary case) variable indicates whether to switch auditor in the base year. This is an empirical study comprising a sample of 627 observations covered in 302 companies listed on the HKEX, covering the relevant three financial years ending from 2017 to 2019. I categorized all observations according to nine types of modified audit opinions in treatment and control groups. I also coded 3-score scales to indicate the severity level of modified audit opinions concerning the new requirements under the new policy change. The treatment group includes all samples with the severest modified audit opinions, with an assigned level 3 score and subject to trading suspension; other samples have been classified as the control group. Findings: The baseline empirical results show that the auditor switch probability is positively related to modified audit opinions, particularly disclaimer or adverse opinions that are the most severest forms of modified audit opinions. Moreover, the findings reveal a 1-year time lag between the year receiving modified audit opinions and the year of switching auditors. This finding is indeed consistent with the observed real-world phenomenon. Statistical tests for structural breaks suggest that the likelihood of switching auditors in the presence of modified audit opinions has become stronger after implementing the new regime. With obtaining modified audit opinions, the auditee is more likely to switch auditor in the forthcoming financial year after the newly purposed and concluded regime. Therefore, the new regime offsets the 1-year time lag of auditor switch in case a modified audit opinion is given to the firm. The findings also suggest that large and loss-making firms are more sensitive to the regime shift in terms of their probabilities of auditor switch. This study's findings and results also reflect a positive moderating role of the new regime on the relationship between engaging a BIG-N auditor and the probability of auditor switch. However, this result does not capture the situations when shifting results to the succeeding auditor is a BIG-N or non-BIG-N auditor due to limited data availability. In summary, both my design univariate and multivariate test findings and robust results support each of my proposed hypotheses and are consistent with the results of prior literature on auditor switch. Contributions: A large body of research has investigated modified audit opinions as a key determinant of auditor switch. Nevertheless, studies concerning and conducted in the Hong Kong capital market are lacking. Moreover, past research addressing the possible impacts of policy changes on auditor switch is scant. In particular, the relationship between the audit switch and the severity of modified audit opinions and the timing of auditor switch under the new policy regime in Hong Kong is still unclear. This study contributes to the auditor switch literature as well as the accounting and auditing profession in three aspects. First, it enriches the existing literature on auditor switch and opinion shopping incentives with the possible impacts of a significant policy shift. Likewise, my study contributes some new insights or input (pertaining to knowledge gaps in prior studies) resulting from the evidence-based policy change in Hong Kong. To the best of my knowledge, this study is the first to consider the effects of a significant policy (regulatory) regime change on the relationship between auditor switch and modified audit opinions. Second, this study uses the counterfactual impact evaluation method to compare the reaction of auditor switch after the new regime is concluded and executed. It applies the difference in difference (DiD) regression augmented with a varying level of modified audit opinions, allowing firms within the treatment group to react differently to the same intervention. It further examines the impact of various interactions between control variables and the newly imposed regime on auditor switch. This research design makes methodological contributions with regard to counterfactual impact evaluation and the effectiveness of the newly introduced policy. Finally, my study contributes new insight related to practical knowledge benefiting our accounting and audit industries and various practice professions. These practicing professions should also pay more attention to exploring the influence of modified audit opinions on the market and entire listed companies. Similarly, I investigate how this significant policy change affects listed companies' decisions by analyzing policy changes from a scholar's perspective. The results are expected to have important implications on how policy change affects the registered auditing profession, namely public interest entity (PIE) under the Hong Kong Institute of Certified Public Accountants (HKICPA), regulators, and all listed companies in Hong Kong. |
| Rights: | All rights reserved |
| Access: | restricted access |
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| File | Description | Size | Format | |
|---|---|---|---|---|
| 6346.pdf | For All Users (off-campus access for PolyU Staff & Students only) | 1.78 MB | Adobe PDF | View/Open |
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