Incentives for Auditor Independence : An Analysis of the Effectiveness of Formal Sanctions in China

This study examines the effectiveness of regulatory sanctions as deterrents to auditors' unethical behavior. Although the effectiveness of formal sanctions is crucial for regulators and policy makers, few empirical studies have addressed the issue. In this paper, we provide empirical evidence on the effectiveness of formal sanctions in improving auditors' independence. We hypothesize that sanctioned auditors who were criticized for failure to detect and report financial statement frauds act more independently and conservatively by issuing more modified audit opinions after being sanctioned. Based on the enforcement releases issued by the China Securities Regulatory Commission, we identified 27 sanctioned auditors and a matched sample of non-sanctioned auditors. We found that in general, sanctioned auditors issued less modified audit opinions than non-sanctioned auditors (control group) but issued more modified audit opinions after the enforcement actions than before. Our findings are important for regulators and policy makers in recognizing their efforts in execution of formal sanctions and in encouraging more stringent and frequent checks on auditors