مقاله لاتین حسابرسی
ساعت ۱۱:٠٤ ‎ب.ظ روز سه‌شنبه ۳ اردیبهشت ۱۳۸٧  

 

 

Auditing standards, increased accounting

disclosure, and information asymmetry:

Evidence from an emerging market

 

Haiyan Zhou *

 

Department of Accounting and Business Law, College of Business Administration,

The University of Texas - Pan American, United States


 

Abstract

 

The interest in accounting disclosure and audit quality by academics, practitioners,

and regulators heightened following the various financial reporting scandals, and subse-

quent legislative and professional response to these scandals. An important question is

whether the implementation of stricter auditing standards such as those mandated by

the US Sarbanes-Oxley Act would improve the information environment of firms whose

shares are publicly traded. In this paper, I investigate the link between information

asymmetry, measured by bid-ask spread, and increased accounting disclosures following

the adoption of new auditing standards in China-an environment in which disclosure

hitherto was relatively low. I report the following primary results of the statistical anal-

yses. First, information asymmetry cost is substantial in the Chinese order-driven

emerging markets. Second, the firms in the sample experienced significant reductions

in their bid-ask spreads subsequent to the adoption of the new auditing standards.

Third, the reductions in the bid-ask spreads were abrupt and permanent. However,

no significant result is found for firms in the control group with foreign ownership,

whose financial statements were prepared in accordance with international accounting

standards and were audited with international auditing standards. The results have

 

 

*   Tel.: +1 956 381 3334; fax: +1 956 381 2407.

E-mail address: zhaiyan@utpa.edu

 

0278-4254/$ - see front matter   2007 Elsevier Inc. All rights reserved.

doi:10.1016/j.jaccpubpol.2007.08.004

 

 

H. Zhou / Journal of Accounting and Public Policy 26 (2007) 584-620


 

 

585


 

implications for policy makers and regulators in general, and those in emerging markets

in particular.

2007 Elsevier Inc. All rights reserved.

 

Keywords:     Auditing standards; Accounting disclosure; Information asymmetry; Bid-ask spread;

Emerging market (China)

 

 

1. Introduction

 

The interest in accounting disclosure and audit quality by academics, prac-

titioners, and regulators heightened following the various financial reporting

scandals, and subsequent legislative and professional response to these scan-

dals (e.g., ASX Corporate Governance Guide, 2003; Sarbanes-Oxley Act,

2002). An important question that has been on the minds of many is whether

the implementation of stricter auditing standards such as those mandated by

the US Sarbanes-Oxley Act would improve the information environment of

firms whose shares are publicly traded. In this paper, I investigate the link

between information asymmetry, measured by bid-ask spread, and increased

accounting disclosures following the adoption of new auditing standards in

China-an environment in which disclosure hitherto was relatively low.1

Lev (1988)     asserts that accounting regulation should reduce information

asymmetry among investors and increase liquidity in the markets.                          Leuz and

Verrecchia (2000)       argue that increased accounting disclosures should reduce

information asymmetry not only between firms and stockholders but also

among investors.2Currently, most empirical results on the economic link

between increased disclosure and information asymmetry are based on samples

of US firms. However, these firms have a rich information environment, mak-

ing it difficult to observe economic consequences of increased disclosures

(Callahan et al., 1997; Healy and Palepu, 2001; Core, 2001; Leuz and Verrec-

chia, 2000).3An emerging market environment, which is characterized by

 

1   Throughout this paper, I use the term ‘‘increased (accounting) disclosure'' to mean increased

quality and/or quantity of accounting disclosure due to the implementation of the new set of

auditing standards from 1996 to 1999. A similar term is used by Leuz and Verrecchia (2000).

2   This economic link increased disclosure and information asymmetry can be traced back to

Demsetz (1968) theory on security transaction cost, and Bagehot (1971) theory on informed traders

and liquidity traders (see also Copeland and Galai, 1983). Leuz and Verrecchia (2000) extend the

theory on information asymmetry among traders to that between firms and their stockholders. To

attract potential investors in a non-liquid market, a firm has to issue its shares at a discount, which

implies higher cost of capital. A commitment to increased disclosure can reduce the information

asymmetry between the firm and its stockholders, thereby reducing the discount at which the firm's

stocks are sold and lowering its cost of capital.

3      For example, Botosan (1997)               reports that her disclosure index is significantly associated with

the cost of capital only for firms with low analyst following.


 

 

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H. Zhou / Journal of Accounting and Public Policy 26 (2007) 584-620


 

higher level of ex ante information asymmetry, may provide a potentially more

powerful setting for detecting the effects of increased disclosure on market

liquidity (Verrecchia, 2001).

Unlike developed capital markets, accounting disclosures in Chinese capital

markets have been characterized as low in quantity and quality (Xiao et al.,

2004; Abdel-Khalik et al., 1999; Liu and Zhang, 1996). Over the period

1996-1997, accounting regulators and professionals in China implemented a

series of auditing standards, modeled after the International Auditing Stan-

dards. The new auditing standards address a wide range of issues, such as

audits of financial statements, audit evidence, audit reports, fraud and errors,

internal controls, and audit risk.4All domestic auditors are required to comply

with the new standards in the conduct of financial statement audits. In addi-

tion, the Chinese Securities Regulatory Commission (CSRC) and the Chinese

Institute of Certified Public Accountants (CICPA) are required to impose

costly penalties on auditors who fail to comply with the new auditing standards

(DeFond et al., 2000). For example, the Qiongmingyuan scandal in 1996

resulted in the suspension of the CPA firm from practice for six months. Fur-

ther, the Chinese High Court issued Document No. 56 in 1996 emphasizing

auditor's legal liabilities at the national level (Gul et al., 2003).

The intent of the changes in auditing standardization, government enforce-

ment, and litigation environment is to make auditors more independent than

they used to be. If that is so, then disclosure behavior of firms should receive

more supervision and control, yielding significant increases in the quantity

and quality of firms' disclosures and decreases in information asymmetry.

Thus, after adopting these standards, Chinese firms should expect narrower

bid-ask spreads, an economic benefit from increased disclosure suggested by

Lev (1988).

In this paper, I extend prior research in several ways. First, I examine the

role of auditing regulations in reducing information asymmetry. Only few stud-

ies have directly investigated whether audit quality enhances disclosure quality,

reducing both information asymmetry and cost of capital in the US (see Schau-

er, 2003).5A plausible reason for the paucity of research in this area might be

that the rich disclosure environment of US firms limits the incremental impact

 

4      The standards were issued to ‘‘establish authoritative standards for performing independent

audits,'' ‘‘protect the legitimate rights of investors and other interested parties,'' and ‘‘safeguard the

public interests of the society'' (see MOF, 1995, Preface to Independent Auditing Standards, PIAS,

Chapters 1, Section 2). Details are available from          http://www.china-cpa.com/  (accessed on

30.09.2004).

5   Schauer (2003) examines the association between bid-ask spreads of US firms and auditor-type.

With a three-tier classification of audit firms, he finds that the firms audited by Big-Six firms have

lower bid-ask spreads than those audited by non-national firms. However, he finds no difference in

spreads between the firms audited by Big-Six and those audited by national firms. His research does

not address the impact of auditing regulations on market liquidity.


 

 

H. Zhou / Journal of Accounting and Public Policy 26 (2007) 584-620


 

 

587


 

of audit quality on accounting disclosure (Healy and Palepu, 2001). In con-

trast, the disclosure level in the Chinese emerging market is relatively low, thus

audit opinions could convey useful information to the market about the quality

of a firm's accounting information. Empirical studies on Chinese capital mar-

kets have documented links between auditing regulations and audit qualifica-

tions (DeFond et al., 2000), and between audit qualifications and market

return (Gul et al., 2003). I extend this line of research by investigating the

impact of increased auditing regulation on firm's information environment.

Second, most prior studies examine short-term impact of accounting disclo-

sure on information asymmetry (e.g., see Yohn, 1998). As noted by Callahan

et al. (1997), these studies focus only on the short-run information asymmetry

risk faced by dealers and investors rather than the long-run information asym-

metry risk, which is of much concern to policy-makers and regulators.6In this

study, I examine the long-term information asymmetry ‘‘between the informed

and uninformed traders caused by the structural differences in the access to

information'' (Callahan et al., 1997, p. 57).

Finally, the Chinese emerging market implemented a series of auditing stan-

dards within a short period. The incremental effects of increased accounting

disclosure on information asymmetry in such an environment should be much

more significant than in a rich disclosure environment of developed markets

(Verrecchia, 2001). In addition, this study is also the first to explicitly study

economic link between increased accounting disclosures on information asym-

metry in an emerging market.

I compare an experimental group of firms not previously audited under any

auditing standards to a control group of firms previously audited under the

international auditing standards.7I find that the experimental firms' bid-ask

spreads declined significantly subsequent to the adoption of the new auditing

standards (controlling for other known bid-ask spreads determinants). Fur-

ther, time-series intervention analyses suggest that the experimental group's

spread reductions are significant and permanent. I find no significant decline

in control group's bid-ask spread.

 

 

 

 

 

 

6      While dealers are concerned with the short-run risk in trading with informed traders,

accounting policy-makers and regulators are interested in the long-run effects of disclosure on

information asymmetry and market liquidity. The key distinction is short-term information

asymmetry that is resolved by a periodic disclosure versus information asymmetry that persists. I

owe a sincere gratitude to one of the anonymous reviewers for pointing out this issue.

7      Prior to the adoption of the new auditing standards, financial statements of Chinese firms,

except for those with foreign ownership, were audited with a set of auditing guidelines that were

suggestive and have no legal enforceability (DeFond et al., 2000).


 

 

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H. Zhou / Journal of Accounting and Public Policy 26 (2007) 584-620


 

The results of this paper have implications for policy-makers and regulators,

and in particular, those in emerging economies. Policy-makers and regulators

usually state that high quality accounting and/or auditing standards ‘‘result in

greater investor confidence, which improves liquidity, reduces capital cost, and

makes market prices possible'' (Levitt, 1998, p. 81). A good effort on account-

ing/auditing policy-making and regulation should help the emerging economies

improve information environment and market liquidity. The results suggest

that auditing standards enhance disclosure quality, and that regulators in

emerging economies should focus on auditing regulations to enhance audit

quality in addition to their efforts to improve corporate accounting disclosure.8

The remainder of the paper is organized as follows. Section 2 presents the

motivations for the study and the institutional settings of the Chinese emerging

market. Overviews of prior research and hypothesis development are presented

in Section 3. Section 4 describes the research design, and Section 5 presents the

empirical results. The final section concludes the paper and discusses the impli-

cations of the results.

 

 

2. Institutional background of Chinese stock markets and disclosure practice

 

The rapid development of the Chinese stock exchanges stimulated the regu-

lation of corporate disclosure practices because investors cannot make rational

investment decisions without reliably prepared financial statements, which

have been audited using generally accepted auditing standards. Since the estab-

lishment of securities markets in China in early 1990s, the number of publicly

listed firms increased from 14 in 1991 to 1069 in December 2000 (Sami and

Zhou, 2004). Along with the rapid growth in the stock markets, the demand

for accounting disclosure by investors also dramatically increased. To stan-

dardize corporate disclosure practices, two important documents were issued

in 1992 - the Accounting System for Companies with Listed Shares and Account-

ing Standard for Business Enterprises - General. The issuance of these docu-

ments was the first step by Chinese policy-makers to bring the country's

 

 

 

 

8   In addition, evidence of the relationship between increased accounting disclosures and bid-ask

spreads from an order-driven market has implications for the recent move to implement an order-

driven mechanism in quote-driven markets, such as the NASDAQ and the London Stock

Exchanges (Brockman and Chung, 1999; Schwartz and Weber, 1997). Complementing the

literature on order-driven markets, the results reported in this paper suggest that information

asymmetry exists in such markets and that increased accounting disclosure helps to reduce bid-ask

spreads, as in quote-driven markets. Thus, a possible implication of my findings is that regulators

who want to implement an order-driven mechanism may find that traders behave in the same

manner as market-makers when they are confronted with a different information asymmetry risk.


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