Audit Failure,Auditor Switching,and Market Reaction

Local accounting firms have achieved initial success with large-scale and internationalization since the CICPA promoted accounting firms to become bigger and stronger in 2007.Among them,Ruihua Certified Public Accountants has become the leader in the local firm and ranked in the top four accounting firms in China for four years.However,from December 2016 to March 2017,Ruihua was repeatedly punished by the CSRC for its audit failure for four times,and the event that were suspended to undertake the new securities business caused a considerable shock to the capital market.Ruihua's series of penalties provide an opportunity for in-depth study of the relationship between the audit market and the capital market in China.Foreign and domestic scholars usually use audit reputation hypothesis and insurance hypothesis to explain the relationship between audit value and market reaction after audit failure.From the Anran event which shocked the world to the scandals of domestic auditors such as events of Yinguangxia and Kelon,the listed companies and auditors have all experienced punishment from the market to a certain extent.However,in the empirical study of the damage to audit reputation,it is difficult to clearly distinguish between reputation mechanisms and insurance functions in explaining market reactions.For domestic audit failures,scholars usually use the market background of low legal litigation risk to test the negative market effect of audit reputation damage based on auditing reputation theory.However,in contrast to the previous background of the audit market system,in the case of Ruihua's four consecutive audit failures,auditors of three incidents were assigned to Ruihua Shenzhen firm.According to the current special general partnership of accounting firms,if the auditor is sued for failure of the audit,the branch will assume unlimited joint and several liability.Therefore,by analyzing the market response of the entire firm and sub-branch's clients before and after the,it will make up for the gap in the research on the audit reputation and insurance mechanism in the domestic capital market.From the perspective of stock market reactions and auditor switching of listed companies,this paper use five administrative penalties of Ruihua to discuss the economic consequences of the loss of auditor reputation in the context of the new system.After empirical research,it was found that:(1)Ruihua's entire client experienced a significant negative stock market reaction before and after the first announcement date of administrative punishment,but the effect of audit reputation damage did not accumulate in the next four incidents.(2)Clients of Shenzhen office generated a significantly negative stock abnormal return after the second penalty announcement date.The market recognized the existence of litigation risks,therefore,the audit insurance mechanism played a certain role in the market;(3)After Ruihua was restored to market access,the lower the earnings quality of customers,the more inclined to voluntarily change the auditor;(4)After Ruihua was restored to market access,investors made a negative market reaction to the behavior of auditor switching,and the later the switching happened,the more significant the negative stock returned.This paper empirically examines the market reaction of Ruihua's audit failures,and further enriches the existing literature on the governance value of audit reputation and insurance mechanism in China's capital market.It is of guiding significance for stakeholders to make investment decisions and for government to improve the regulatory system.