Role of Audit Quality, Political Connections and Investor Protection on Discretionary Accruals in China

Abstract

The purpose of this paper is to determine the effect of audit quality, political connections and investor protection on discretionary accruals using the modified Jones model as the proxy for discretionary accruals. The top four auditors were used as the proxy for high quality auditors while political connectedness was proxied by percentage of shares owned by the state in a firm (state/non-state owned enterprises). Investor protection was measured by the listing status of a firm whether mainland China or outside. The empirical analyses presented provide support for the proposition that high quality auditors and common law environment regulations mitigate occurrence of discretionary accruals. Additionally, it was observed that politically connected firms have lower discretionary accruals. This study provides a unique focus investor protection and elucidates the effects of listing environment on discretionary accruals by distinguishing between Chinese firms listed in and outside mainland China.

Keywords: Audit Quality, Political Connections, Investor Protection, Discretionary Accruals, China