Do auditors change their individual style? Examining the effects of client importance and competition on auditors' influence on earnings comparability in China

• Published date: 01 January 2024
• Author: Wuchun Chi,Kevin Koh,Yanghui Liu,Xiaohai Long
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/ijau.12325

ORIGINAL ARTICLE

Do auditors change their individual style? Examining the

effects of client importance and competition on auditors'

influence on earnings comparability in China

Wuchun Chi

1

| Kevin Koh

2

| Yanghui Liu

3

| Xiaohai Long

4

1

Department of Accounting, College of

Commerce, National Chengchi University,

Taipei City, Taiwan

2

Division of Accounting, Nanyang Business

School, Nanyang Technological University,

Singapore

3

Department of Accounting, School of

Economics and Management, East China

Jiaotong University, Nanchang, China

4

Department of Accounting, School of

Business and Tourism Management, Yunnan

University, Kunming, China

Correspondence

Kevin Koh, Division of Accounting, Nanyang

Business School, Nanyang Technological

University, Singapore.

Email: akohwl@ntu.edu.sg

Funding information

Wuchun Chi acknowledges funding support

from the Taiwan Ministry of Science and

Technology (Project: 107-2410-H-

004-030-MY3). Yanghui Liu and Xiaohai Long

acknowledge funding support from the

National Natural Science Foundation of China

(Project: 71762034).

Individual auditor style implies that two client firms audited by the same individual

auditors are likely to have more comparable earnings than two client firms audited by

different individual auditors within the same audit firm. We investigate whether audi-

tors in China change their individual style to cater to demands of clients that are of

high importance and are located in a competitive audit market. Using a propensity

score match approach, we find evidence of higher earnings comparability between a

pair of client firms audited by the same individual auditors. However, in subsamples

of client firm pairs that are of high importance or are located in a competitive audit

market, we find earnings comparability of client firms audited by the same individual

auditors diminishes. Our findings suggest that due to the influence of economic

bonding in auditor–client relations in China, individual auditors change their style to

cater to client demands.

KEYWORDS

audit market competition, client importance, earnings comparability, individual auditor style

1|INTRODUCTION

Earnings comparability is a desired property of financial statements

by both International Accounting Standards Board and the Financial

Accounting Standards Board. The concept and use of the term earn-

ings comparability differs in the literature.

1

Similar to Francis et al.

(2014), we refer to earnings comparability as the degree of close-

ness between two firms' reported earnings due to the consistency

with which accounting standards are applied across client firms. All

things being equal, client firm pairs in the same industry and fiscal

year are expected to have a similar accruals and earnings structures

because they are likely to be subjected to the same economic

shocks.

Using US data, Francis et al. (2014) find evidence suggesting the

presence of audit firm style increasing the earnings comparability

within a Big 4 auditor's clientele. Similarly, Ege et al. (2020) find client

firms from different countries have more comparable earnings when

audited by local audit firms belonging to the same global audit firm

network. If individual audit partners exercise their own autonomy

consistently when interpreting, implementing, and enforcing the inter-

nal working rules across their client firms, this could lead to individual

auditors displaying a style of their own that is incremental to the audit

firm style that arises from each audit firm's standardized audit meth-

odology. While prior studies (e.g., Gul et al., 2013, among others) find

the individual engagement partners are systematically linked to audit

quality and audit fees, recent studies document that two client firms

audited by the same individual auditors have more comparable earn-

ings than two client firms audited by different individual auditors

within the same audit firm, suggesting the presence of individual audi-

tor style in China (Chen et al., 2020; Jiu et al., 2020; Li et al., 2021; Shi

Received: 3 September 2020 Revised: 26 April 2023 Accepted: 14 June 2023

DOI: 10.1111/ijau.12325

Int J Audit. 2024;28:185–205. wileyonlinelibrary.com/journal/ijau © 2023 John Wiley & Sons Ltd. 185

et al., 2021) and other international settings (Ahn & Sonu, 2021;

Smith, 2022).

2

Motivated by this stream of literature, we examine whether indi-

vidual auditor style in China is affected by auditors' economic depen-

dence on important clients. Theoretically, the impact of economic

bonding to client firms on individual auditor style is unclear. On one

hand, individual auditors have incentives to be independent in order

to avoid any costly litigation and reputational damages arising from

questionable audits of important clients (Reynolds & Francis, 2001).

On the other hand, individual auditors have incentives to give prefer-

ential treatment and report favourably for important clients in order

to retain them (DeAngelo, 1981). In China, the Big 4 audit firms do

not dominate in the same way they do in other developed markets,

resulting in a highly competitive and dispersed audit market (Chan &

Wu, 2011; DeFond et al., 2000). Moreover, China is characterized by

weak legal environment and investor protection (e.g., DeFond

et al., 2000; Lennox & Wu, 2022), which might result in more idiosyn-

cratic partner behaviour than one would expect in countries with

strong institutions that protect investors. Given the significant compe-

tition and relatively weak legal environment that allows for more vari-

ation and discretion in auditors' decision-making, we anticipate

observing a negative impact of economic bonding on individual audi-

tor style in China.

When individual auditors fear losing their clients, they present

and gather information in favour of their clients (Blay, 2005). For such

engagements, the motivated reasoning theory (Kunda, 1990) posits

that individual auditors no longer consistently rely on their usual set

of judgement and decision-making heuristics when applying their

firm's standardized audit methodology. Instead, auditors use the

vagueness of imprecise accounting standards to justify their decisions

and approve reporting decisions that are consistent with their incen-

tives (Hackenbrack & Nelson, 1996). Thus, we hypothesize that the

effects of individual auditor style, as reflected by pairwise earnings

comparability between client firms audited by the same individual

auditors, should diminish when individual audit partners cater to

important client firms' demands and to avoid losing clients in a com-

petitive audit market.

Using financial statements of 2082 listed firms on the Shanghai

and Shenzhen Stock Exchange from 2006 to 2015 to obtain 149 firm

pair observations that are audited by the same set of audit partners,

we find new evidence that earnings comparability between two client

firms audited by the same individual auditors is conditional on client

importance and market competition. After controlling for auditor per-

sonal traits, audit firm's legal structure, and client firm's accounting

flexibility that affect individual auditor style (Chen et al., 2020; Jiu

et al., 2020; Li et al., 2021; Shi et al., 2021), we find diminished earn-

ings comparability in subsamples of auditors with client firms that are

of high importance or are located in a competitive audit market. Our

results indicate that due to the influence of economic bonding in

auditor–client relations in China, individual auditors change their indi-

vidual style to meet clients' expectations.

Our contributions are threefold. First, our study contributes to

the growing body of research that shows higher earnings

comparability for client firms that share common individual auditors.

This phenomenon was initially documented in China by Chen et al.

(2020) and has been observed in other international settings as well

(Ahn & Sonu, 2021; Smith, 2022). Subsequent studies using the

Chinese context have provided additional insights by demonstrating

that individual auditor style is persistent over time (Li et al., 2021)

and is influenced by auditor personal traits such as education and

experience (Jiu et al., 2020; Shi et al., 2021). To the best of our

knowledge, our study is the first to demonstrate that the economic

bonding of auditors to client firms influences individual auditors'

style, resulting in diminished earnings comparability for client firm

pairs that are of high importance or are located in a competitive

audit market. By exploiting the unique context of high competition

and weak investor protection in the Chinese audit market, our study

provides novel insights into whether auditors change their style to

cater to clients' demands.

To mitigate concerns about nonrandom selection of client

firms by audit firms and partners in recent studies on individual

auditor style (Ahn & Sonu, 2021; Chen et al., 2020; Jiu

et al., 2020; Li et al., 2021; Shi et al., 2021; Smith, 2022), we

adopt a propensity score matching (PSM) approach and a one-

to-one matched sample in all our analyses to address issues of

endogeneity and sample skewness. Unlike prior studies, which only

require a common signing auditor in both client firms to classify

the firm pair as having the same auditor (e.g., Chen et al., 2020),

we use a more stringent criterion of requiring both client firms to

have identical audit teams (i.e., the same set of engagement part-

ner and review partner) to minimize the impact of team dynamics

on earnings comparability. Our study corroborates that auditors

exhibit an individual style in enhancing client firms' earnings com-

parability and that recent findings are robust to a more stringent

empirical approach. For a detailed comparison of the contribution

made by our study and the related studies using earnings compara-

bility to identify audit firm and individual auditor style, see

Appendix A.

Second, our study extends the extant literature on how individ-

ual auditors affect audit outcomes.

3

Using the fixed effects method-

ology developed by Bertrand and Schoar (2003), prior studies

(e.g., Gul et al., 2013; Wang et al., 2015) find individual partners dif-

fer systematically in their levels of audit quality and hence conclude

the presence of a fixed individual auditor style. However, there are

studies (Fee et al., 2013; Jarosiewicz & Ross, 2023) raising method-

ology concerns over the use of fixed effects methodology to iden-

tify managerial style.

4

Through examining the consistency with

which accounting standards are applied across client firms by the

same individual partners, we use an alternative empirical approach

to document the presence of individual auditor style that is not

fixed. We illustrate that individual auditors could change their style

to cater to clients that are of high importance or are located in a

competitive audit market.

Third, our findings have significant implications for practitioners,

policymakers, and regulators in understanding earnings quality in

China. Prior studies have provided evidence that the mandatory

186 CHI ET AL.