Annual Report Queries And Auditors’ Strategic Responses

China has a long history of regulatory inquiry letters as a non-administrative regulatory measure,dating back as far as January 1998 when the Shenzhen Stock Exchange and the Shanghai Stock Exchange issued the "Stock Listing Rules",which required listed companies to respond to stock exchange inquiries in a timely manner,followed by several policy documents issued by the two exchanges.After2014,due to the establishment of the "Information Disclosure Direct" system,inquiry letters and responses began to be publicly disclosed,which provided additional information to investors and an opportunity for this study to explore the strategic response behavior of auditors.In recent years,the exchanges in Shanghai and Shenzhen have been increasing their efforts to "get to the bottom" of regulatory inquiries from listed companies,asking companies with doubtful disclosures to explain,correct or add key information,and requiring auditors and other intermediaries to verify and express clear opinions on the relevant information.Between January 1,2014 and December 31,2021,the Shenzhen Stock Exchange issued 11,714 various inquiry letters concerning 3,392 listed companies,and the structure of the inquiry letters gradually changed from mainly restructuring inquiry letters to periodic report inquiry letters,and the exchange’s supervision of daily information disclosure has been increasing.The increase in the number of inquiries has had an important impact on the decision-making behavior of multiple parties in the capital market: by exerting regulatory pressure on listed companies to regulate their information disclosure behavior,and by issuing regulatory signals to prompt the decision-making behavior of outside investors,thus reducing information asymmetry.In addition,exchange regulatory inquiries also have an impact on the decision-making behavior of auditors,who are information intermediaries in the capital market,as they lead to a restructuring of the contractual relationship between auditors and listed companies.Due to the tightening of the external regulatory environment,the auditor’s decision-making behavior is affected by regulatory inquiries in the process of the game between the auditor and the client,and the equilibrium state of the auditor-client relationship is broken.In this paper,we investigate the auditor’s reaction behavior after receiving the annual report inquiry letter from the exchange,and analyze the change of auditor’s judgment on audit risk and specific response measures after receiving the regulatory inquiry based on the empirical results,and analyze the spillover effect of the annual report inquiry letter from the auditor’s perspective,so as to reflect the regulatory effect of the regulatory inquiry on the auditor’s intermediary role.This paper finds that,in practice,auditors may improve their judgment of future audit risk in response to a regulatory inquiry letter,so that they can develop and implement a more rigorous audit plan to reduce inspection risk,and may reduce regulatory or public pressure by sending a signal of their diligence to the outside world through additional responses to the letter and increasing the amount of information on key future audit matters.In addition,there may be regulatory spillover effects at the audit level from question letter regulation.After a project receives an annual report inquiry letter,the auditor of the questioned company and the auditor of the same branch may increase their review of the remaining unquestioned items,especially those questioned by the exchange,due to the exposure of regulatory focus.This paper also finds that there are still phenomena such as untimely response to inquiry letters,incomplete disclosure,lagging auditor response and lack of attention to inquiry letters,which makes the spillover effect of inquiry letter regulation from auditor’s perspective not obvious and affects the effect of inquiry letter regulation,which provides insights for future inquiry letter policy formulation,i.e.,increasing the intensity of inquiries to intermediaries and improving the importance of inquiry letters to firms.