We examine the implications of social trust for auditor reporting conservatism. Using a sample of listed companies in China, we find that clients located in high-trust regions are less likely to receive a non-clean audit opinion. This negative impact of social trust on auditor reporting conservatism increases when the client’s parent firm operates in a region of higher social trust, suggesting that social trust is contagious from a parent firm to its subsidiaries in a consolidated entity. We provide evidence that (...) the trust contagion is more pronounced for clients with a higher percentage of parent-appointed directors on their boards and clients whose parent firm has fewer subsidiaries. These findings indicate that monitoring and, to a lesser extent, personnel rotation may serve as potential channels of trust contagion. We also find that the impact of trust is more pronounced when the client is located closer to its audit firm, when the client’s parent firm is a state-owned enterprise or holds a higher percentage of the client’s shares, and when the client is associated with greater discretionary accruals. We provide further evidence that it is client rather than auditor trustworthiness that influences auditor reporting conservatism, auditors charge trustworthy clients lower fees, and clients from high-trust regions are less likely to manipulate earnings. Overall, our evidence suggests that social trust alleviates auditor concern about client moral hazard. (shrink)

This study examines the influence of underwriter–auditor relationship on pre-initial public offering earnings management. Using a sample of Chinese to-be-listed firms, we find that a close UAR, as reflected in repeated collaborations between an underwriter and an audit firm in IPOs, is positively associated with pre-IPO earnings management. This association is more pronounced for firms with politically connected auditors/underwriters, firms with less reputable auditors/underwriters, firms located in provinces with weak legal environment, firms to-be-listed on boards with lax listing requirements, and (...) firms whose auditors are with low industry specialization, and legal liability exposures. We provide further evidence that UAR is associated with greater likelihood of irregular activities in post-IPO period and poorer post-IPO financial performance. To the extent that we control for alternative explanations and potential endogeneity, our results suggest that the collusion incentive is likely to drive repeated collaborations between underwriters and auditors in the Chinese IPO market. Our findings provide interesting implications for auditors, investors, and regulators seeking to understand the Chinese IPO market. (shrink)