Auditor Failure and Market Reactions: Evidence from China

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Zhongtianqin, the largest Chinese auditor in 2000, collapsed in 2001 owing to its audit failure. This study examines how the market reacted to the audit scandal in the Chinese institutional setting. Chinese investors are entitled to recover their investment losses from auditors owing to audit failure. However, civil lawsuits against auditors have not succeeded in the past. Therefore, Chinese auditors do not face the real threat of shareholder litigation. They only have the threat of costly governmental penalties for violating the regulations. Even so, we demonstrate that Chinese audit still contains both assurance and insurance values. Also, the entire market reacted to the scandal. Moreover, we show that investors differentiate audit quality in stock valuation. Finally, companies audited by international auditors suffered less value losses. This study adds to the worldwide literature on auditor failure.