Negative Press Coverage, Litigation Risk, and Audit Opinions in China

Exploiting a legal regime change in China in 2005 that significantly increased auditors' legal liability, we reexamine why auditors are more likely to issue modified audit opinions (MAOs) to clients who receive negative press coverage before audit report dates. We find that the probability for auditors to issue MAOs is significantly positively associated with negative press coverage during 2001-2009, consistent with findings using the U.S. data. More importantly, we find that such a positive relation does not exist in the low litigation risk period (2001-2004) and is present only in the high litigation risk period (2006-2009). Moreover, we separate negative press coverage into (1) accounting-related and (2) non-accounting negative news reports or (3) first-reported and (4) repeated negative news reports. We find that the probability for auditors to issue MAOs is unrelated to any of these four measures of negative press coverage in the low litigation risk period, and is positively related to accounting-related, non-accounting, and first-reported negative press coverage in the high litigation risk period. Finally, additional analyses on regulatory sanctions in the year after negative press coverage rule out the possibility that the observed no relation between issuing MAOs and negative press coverage in the low litigation risk period is due to slack regulatory sanctions in that period. Taken together, our findings suggest that auditors increase the probability of issuing MAOs to firms receiving negative press coverage to mitigate a perceived increase in litigation risk stemming from negative press coverage in the high litigation risk period