Auditor Changes Following a Big 4 Merger with a Local Chinese Firm: A Case Study

Abstract

SUMMARY: This study examines auditor-client relationships following the high-profile merger of a local Chinese audit firm, Da-Hua CPAs, with a Big 4 firm, Ernst & Young, to create EYDH in early 2002. Of the 46 domestically listed clients Da-Hua had at the time of the merger, 30 switched to other audit firms during 2002–04. This large loss of clients could be attributed either anecdotally to a lack of post-merger managerial and cultural congruence, or to a lack of demand for high quality audits. We examine 11 (13) switching clients in 2002 (2004) as early (late) switchers. Although our archival analyses suggest that the switching decisions of early switchers are more likely to be explained by common factors such as changes in client structural characteristics, post-merger client portfolio management, and client-auditor friction over accounting treatments, late switchers do not differ from late non-switchers in terms of these factors. However, we find some time-serial evidence that late switchers follow their audit partners to a local audit firm mainly for greater discretion over financial reporting. Further, semi-structured focused interviews reveal that late switchers found it difficult to adapt to EYDH’s practices which, in their view, were less cooperative and too risk aversive. Overall, the results of our case study are consistent with the notion that clients switch from Big 4 to local firms mainly for more lenient audit treatments.

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