Do auditors favor clients with government favoritism?

Abstract

Governments often grant privileges to particular industries to achieve targeted development, a practice that can be seen as indicative of government favoritism. It is unknown whether auditors take government favoritism into consideration when forming audit opinions. We examine this research question within the context of China, where government favoritism is evident in policies that favor certain industries (GFI) over others (non-GFI). We find that GFI clients are less likely to receive modified audit opinions than non-GFI clients. We then show regulatory support and mitigated going-concern risk as possible explanations for the main result. Auditors exhibit less conservatism (fewer Type I errors) but greater aggressiveness (more Type II errors) when dealing with GFI clients. We also observe that small audit firms acquire regulatory and economic benefits by issuing clean opinions to GFI clients. Overall, this study suggests that government favoritism is critical when auditors form and express their opinions.