Auditoria

China Journal of Accounting Research 4 (2011) 135–154

Contents lists available at SciVerse ScienceDirect

China Journal of Accounting Research journal homepage: www.elsevier.com/locate/cjar

Do modified audit opinions have economic consequences? Empirical evidence based on financial constraints q
Zhiwei Lin a,⇑, Yihong Jiang a, Yixuan Xu b a b

School of Accountancy, Shanghai University of Finance and Economics, China School of Accounting and Finance, Shanghai Lixin University of Commerce, China

a r t i c l e

i n f o

a b s t r a c t
We present a framework and empirical evidence to explain why, on average, 11% of listed firms in China received modified audit opinions (MAOs) between 1992 and 2009. We argue that there are two reasons for this phenomenon: strong earnings management incentives lower firms’ financial reporting quality and soft budget constraints weaken the information and governance roles of audit opinions. We find that firms’ financial constraints eased after receiving MAOs, which suggests that MAOs have limited economic consequences. Further analysis shows that this phenomenon predominantly exists in government-controlled firms and firms that receive MAOs for the first time. We also find that MAOs have not influenced financial constraints after 2006. Finally, we find that MAOs did not affect borrowing cash flows from banks until 2005, suggesting that MAOs did not start affecting bank financing until that year. We also find that firms receive more related-party financing after receiving MAOs. Our results indicate that a limited effect on bank financing and increased related-party financing reduce the effect of MAOs on financial constraints. Ó 2011 China Journal of Accounting Research. Founded by Sun Yat-sen University and City University of Hong Kong. Production and hosting by Elsevier B.V. All rights reserved.

Article history: Received 23 April 2010 Accepted 26 April 2011 Available online 27 August 2011 JEL classification: M42 G32 L14 Keywords: Modified