Auditors' unqualified opinions on internal controls and accrual quality

Purpose – The purpose of this study is to examine whether auditor's unqualified opinion on internal control (ARIC) is a powerful proxy for the effectiveness of internal control in Chinese context. A rich body of research conducts their designs on an assumption that companies have more effectiveness of internal controls if they disclose ARICs. This study argues that the ARICs are not always reliable, because audit market is well characterized by excessive competition and market supervision is poorer in China compared to developed countries. Design/methodology/approach – The study uses 2008 and 2009 years Chinese listed‐firms data and the Tobit regression to test the relationship between ARIC and accrual quality. The paper employs the Heckman model for self‐selection bias, which are possibly introduced by choice in disclosing ARICs. Findings – The paper finds that firms disclose ARICs do not report lower abnormal accruals relative the non‐ARIC firms, and firms with ARICs issued by dominant auditors show more reliable accruals relative to non‐ARIC firms and firms that disclose ARICs but fail to be issued by dominant auditors. The results are robust to additional accrual quality measure, additional audit quality measure, and the correction of self‐selection bias by using the inverse Millo ratio approach. Originality/value – The results suggest that implementing Chinese‐SOX could be facilitated by improving audit quality.