The Economic Consequence of Voluntary Auditing

A number of Chinese firms voluntarily acquire auditing services for their interim reports, even though the auditing of interim reports is mandatory only for a subset of firms in circumstances that are specified by the state regulators. This unique institutional setting in the Chinese market provides a natural experimental setting to directly investigate why listed firms voluntarily have their financial reports audited, and whether investors place more value on voluntarily audited earnings than on unaudited earnings. Based on a sample of 2,458 semi-annual interim reports released by listed Chinese firms from 1996 to 1999, we find that the choice of voluntary auditing is positively associated with the percentage of tradable shares, profitability, and company size. We also find that the earnings response coefficients of audited firms are higher than those of unaudited firms, especially when the auditing is voluntary. Our findings are consistent with theoretical propositions that managers voluntarily purchase external auditing to enhance the credibility of accounting numbers. This study contributes to the literature, especially on the economic value of voluntary auditing.