Business Strategy, Financial Reporting Violations, and Audit Pricing in an Emerging Market – Evidence from China

Abstract

We examine whether a firm’s business strategy is associated with financial reporting violations and audit fees in an emerging market setting. We follow the typology of Miles and Snow (1978, 2003) that describes a strategy continuum with the innovative ‘prospector’ strategy and the cost-leadership ‘defender’ strategy at the two ends. Using data from China, we find that prospectors are associated with more financial reporting violations and higher audit fees than defenders. Specifically, prospectors are positively associated with the occurrence of inadvertent reporting violations. Further analysis reveals that the increase in audit fees for prospectors is not different among firms exposed to different levels of business risk (proxied by ownership structure, auditor size, and leverage). We conjecture that the associations between business strategy and financial reporting violations and audit fees in China are due to firm financial reporting risks arising from accounting complexity.