Interactive Mechanism Between Auditors' Independence And Reputation Based On The Contract Institution

This Research put forward a key point that audit's contractual arrangement guarantees the auditors' independence against outside pressure while the independence reflects their interested tendency to the auditee, and the interactive mechanism between independence and reputation implicates validity of the audit institution. Around this point, an interactive auditor-centered frame based on the contractual arrangement has been constructed which contains four levels as: i) nature and structure of the audit's contracts, ii) executive mechanism of the informal contract, iii) market forces, and iv) government role.The need of audit should attribute to incomplete contracts, and the personal identity of individuals should account for the separation of outside auditing contracts which are composed of two parts as formal and informal ones. The formal contracts between the auditor and identified party are bound by law while the informal ones between the auditor and non-identified party can only be guaranteed by auditors' social responsibility. Auditors cannot be completely independent because they benefit directly from the formal contracts, but the informal ones will be a relief to this defect because they affect auditors' future return. The nature of audit contracts is the result of games played among stakeholders with different powers. The contrast between their powers affects the auditing result through the order stipulated in the contracts. So independence is just a characteristic of auditors' interested tendency to the auditee under the pressure of different stakeholders.Reputation is not only the self-enforcing mechanism of informal contracts, but also the security of auditors' independence. It seems that the auditors' current income is stipulated in the formal contracts, but in fact it originates from auditors' promised independence. It is the same with auditors' future return stipulated in the informal contracts but originated from their essential independence. Auditors earn their reputation from keeping independent which implies current income and future return as well. So they are excited in return to promise independence and to protect it. That is the interactive mechanism between independence and reputation. In this mechanism, market force is to discipline auditors' independence, and to guide different parties to choose auditors collectively. At the same time, Government's role is to promote constructing of a reputation system and to provide judicial relief to impersonal individuals. A stable frame of transaction order can be created then, so that all parties can reap more benefit than what they should pay for themselves.According to the conclusion above mentioned, this research builds a simultaneous equation as recursive implementation and a market reaction model of auditors' reputation. From different aspects, this research gets similar results as follow:(1) Independence which is variable according to the balance of different pressure is affected systematically by the pressure exerted by all parties, such as listed companies, minor stakeholders and market forces. It is the reason why the relationship between auditors and their auditee alters frequently as powerful auditor, powerful auditee or well-matched each other. It is proved that independence is just characteristics of auditors' interested tendency to the auditee under the pressure of different stakeholders' powers.(2) It is proved that reputation can promote auditors to keep their independence actively. There is a need for high-quality audit among high-quality clients. Not only will auditors choose clients, but also clients will choose auditors. That is the incentive which promotes auditors to keep their quality and independence. Though the influence of independence on reputation is certified to be positive, but it is not statistically significant under current condition of government policies in this respect. Information on the alteration in auditors' reputation cannot be passed smoothly to investors so that investors cannot make change to their investment expectation. Conclusions show that investors believe in Big4's quality much more than other audit firms. Perceived audit quality is closed connected to the brand of auditors rather than the improvement in reputation.(3) Value connotations in modified audit opinion are certified which implies an expectation of auditors' quality in investment market. Because of the economic consequence of modified audit opinion, high-quality clients need high-quality audit. It takes the combined efforts of both high-quality audit and the high-quality clients to bring in the high return. But this conclusion is limited to modified audit opinion and is valid no longer to non-modified audit opinion.(4) Market forces take effect through information revealed, and the marketization conduces to accumulation of reputation. The less government intervenes in and the more it coheres with market, the better its supervision takes effect. The power of law is to excite auditors' consciousness of risk so that not only must auditors choose clients but also have to be chosen by clients. The critical reports issued by China Securities Regulatory Commission (CSRC) are widely accepted as a reference of making investment decisions. Those companies punished by CSRC have bad stock price performance due to lack of confidence among investors. Regretfully, information of punishments from CSRC can not be relayed to investors in time so that it has little influence on auditors' reputation.