Adoption of Anglo-American Models of Corporate Governance and Financial Reporting in China 9781783508976, 9781783508983

Citation preview

ADOPTION OF ANGLO-AMERICAN MODELS OF CORPORATE GOVERNANCE AND FINANCIAL REPORTING IN CHINA

STUDIES IN MANAGERIAL AND FINANCIAL ACCOUNTING Series Editor: Marc J. Epstein Recent Volumes: Volume 12:

Performance Measurement and Management Control: A Compendium of Research

Volume 13:

Information Asymmetry: A Unifying Concept for Financial and Managerial Accounting Theories

Volume 14:

Performance Measurement and Management Control: Superior Organization Performance

Volume 15:

A Comparative Study of Professional Accountants’ Judgements

Volume 16:

Performance Measurement and Management Control: Improving Organizations and Society

Volume 17:

Non-Financial Performance Measurement And Management Practices In Manufacturing Firms: A Comparative International Analysis

Volume 18:

Performance Measurement and Management Control: Measuring and Rewarding Performance

Volume 19:

Managerial Attitudes Toward a Stakeholder Prominence within a Southeast Asia Context

Volume 20:

Performance Measurement and Management Control: Innovative Concepts and Practices

Volume 21:

Reputation Building, Website Disclosure and the Case of Intellectual Capital

Volume 22:

Achieving Global Convergence of Financial Reporting Standards: Implications from the South Pacific Region

Volume 23:

Globalization and Contextual Factors in Accounting: The Case of Germany

Volume 24:

An Organizational Learning Approach to Process Innovations: The Extent and Scope of Diffusion and Adoption in Management Accounting Systems

Volume 25:

Performance Measurement and Management Control: Global Issues

Volume 26:

Accounting and Control for Sustainability

Volume 27:

Intellectual Capital and Public Sector Performance

Volume 28:

Performance Measurement and Management Control: Behavioral Implications and Human Actions

STUDIES IN MANAGERIAL AND FINANCIAL ACCOUNTING VOLUME 29

ADOPTION OF ANGLO-AMERICAN MODELS OF CORPORATE GOVERNANCE AND FINANCIAL REPORTING IN CHINA BY

HUIYING WU University of Western Sydney, Sydney, Australia

CHRIS PATEL Macquarie University, Sydney, Australia

United Kingdom North America India Malaysia China

Japan

Emerald Group Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2015 Copyright r 2015 Emerald Group Publishing Limited Reprints and permissions service Contact: [email protected] No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-78350-898-3 ISSN: 1479-3512 (Series)

ISOQAR certified Management System, awarded to Emerald for adherence to Environmental standard ISO 14001:2004. Certificate Number 1985 ISO 14001

CONTENTS LIST OF TABLES AND FIGURES

ix

LIST OF ABBREVIATIONS

xi

ABSTRACT

xiii

1. INTRODUCTION 1.1. 1.2. 1.3. 1.4. 1.5. 1.6. 1.7. 1.8.

1 1 4 7 9 10 12 14 15

Introduction Motivation Significance of the Topic Associated Issues Theoretical Framework Research Design Aim and Objectives Chapter Outline

2. GLOBAL CONVERGENCE AND CORPORATE GOVERNANCE RELATED FINANCIAL REPORTING ISSUES 2.1. 2.2. 2.3. 2.4. 2.5.

Introduction Convergence of Corporate Governance and Accounting Definition of Corporate Governance Corporate Governance Related Financial Reporting Issues Concluding Remarks

3. THE DEVELOPMENT OF ACCOUNTING THOUGHT AND PRACTICES IN CHINA 3.1. 3.2. 3.3.

Introduction Traditional Chinese Accounting Accounting Under a Centrally Planned Economy

v

17 18 19 27 29 51 55 56 57 63

vi

CONTENTS

3.4. 3.5.

Accounting Under a Market-Oriented Economy Concluding Remarks

4. AN INTEGRATED INSTITUTIONAL PERSPECTIVE 4.1. 4.2. 4.3. 4.4.

Introduction Institutional Theory Proposed Framework Concluding Remarks

5. RESEARCH DESIGN 5.1. 5.2. 5.3. 5.4. 5.5.

Introduction Research Methodology Data Collection Data Analysis Concluding Remarks

6. THE CORPORATE GOVERNANCE AND ACCOUNTING ENVIRONMENT IN CHINA 6.1. 6.2. 6.3. 6.4. 6.5. 6.6.

Introduction Background International Influences Domestic Institutional Influences Accounting Infrastructure Concluding Remarks

7. CORPORATE GOVERNANCE-RELATED FINANCIAL REPORTING ISSUES IN CHINA: EMPIRICAL EVIDENCE 7.1. 7.2. 7.3. 7.4. 7.5. 7.6. 7.7. 7.8.

Introduction Independent Directors Audit Committees Auditor Independence Corporate Code of Conduct Adoption of IFRS Measures for Improvement Concluding Remarks

8. SUMMARY AND CONCLUSION 8.1. 8.2.

Introduction Summary of the Study

65 69 73 74 74 77 94 97 97 98 103 109 113 117 118 118 120 123 147 160

167 168 168 180 186 192 193 196 198 201 201 202

vii

Contents

8.3. 8.4. 8.5. 8.6.

Findings Contribution Implications Limitations and Suggestions for Future Research

203 211 213 214

APPENDIX: INTERVIEW GUIDE

217

Adoption of Anglo-American Models of Corporate Governance and Financial Reporting in China Interview Guide Chinese Version

217 224

REFERENCES

229

LIST OF TABLES AND FIGURES TABLES Chapter 2

Table 2.1 General Characteristics of Insider and Outsider Systems. . . . . . . . . . . . . . . . Table 2.2 General Characteristics of Global Corporate Governance Systems. . . . . . . . . . . . . . Table 2.3 Studies of the Relationship between Audit Committee and Financial Reporting Quality. . . . . . . . . . . . . . . . . . . . .

21 24 35

Chapter 5

Table 5.1 Determination of an Interpretive Methodology. . . . . . . . . . . . . . . . . . 102 Table 5.2 Profile of Interviewees. . . . . . . . . . . . . . 108 Table 5.3 Coding of Data. . . . . . . . . . . . . . . . . 111

Chapter 6

Table 6.1 Share Classifications in China’s Stock Market. . . . . . . . . . . . . . . . . . . . . 133 Table 6.2 A Comparison of the Number of Professional Accountants in China and Anglo-American Countries. . . . . . . . . . . . . . . . . . . . 159

FIGURES Chapter 4

Chapter 6

Fig. 4.1 Framework to Examine the Adoption of Anglo-American Models of Corporate Governance and Financial Reporting in China. . . . . . . . . . . . . . . . . . . . .

78

Fig. 6.1 Accounting Regulatory Framework in China. . . . . . . . . . . . . . . . . . . . .

158

ix

LIST OF ABBREVIATIONS APESB ASBE ASX CalPERS CICPA CLERP CPA CSRC EU FRC GAAP GDP IAS IASB IASC IFAC IFRS IOSCO IPO MOF NYSE OECD QFII RMB SOE UK US USD WTO

Accounting Professional and Ethical Standards Board Accounting Standards for Business Enterprises Australian Securities Exchange California Public Employees’ Retirement System Chinese Institute of Certified Public Accountants Corporate Law Economic Reform Program Certified public accountant China Securities Regulatory Commission European Union Financial Reporting Council Generally accepted accounting principles Gross domestic product International Accounting Standards International Accounting Standards Board International Accounting Standards Committee International Federation of Accountants International Financial Reporting Standards International Organization of Securities Commissions Initial public offering Ministry of Finance New York Stock Exchange Organisation for Economic Co-operation and Development Qualified Foreign Institutional Investors Renminbi (Chinese currency) State-owned enterprise United Kingdom United States US dollar World Trade Organization

xi

ABSTRACT In the context of globalization, national economies have become increasingly interdependent, and internationally acceptable corporate governance and accounting practices are diffused across different jurisdictions. This monograph critically examines how globalization has affected the adoption of Anglo-American models of corporate governance and financial reporting in China, the largest transitional economy. More specifically, it examines whether measures taken by the Chinese government, including the adoption of the International Financial Reporting Standards, the introduction of independent directors and audit committees, and the strengthening of auditor independence, are likely to improve the quality of financial reporting of Chinese listed companies. The following research question is addressed: What issues are involved in adopting Anglo-American models of corporate governance and financial reporting in China? In contrast to a significant number of prior studies that have focused largely on quantifiable and narrowly focused theoretical approaches, this monograph adopts a holistic perspective. A comprehensive theoretical framework based on institutional theory, which incorporates international influences, domestic influences, and intraorganizational dynamics, was developed to provide richer insights into the issues under investigation. This monograph provides a holistic examination of convergence with internationally acceptable corporate governance and accounting principles and standards in China by taking into account the influence of political, legal, economic, social, cultural, and historical factors on corporate governance and accounting practices. The contextual analysis reveals deeper and sharper insights into the convergence process as well as potential challenges and issues associated with the implementation of internationally acceptable principles and standards in a transitional economy. The findings of this monograph suggest that the current institutional environment in China does not yet fully support AngloAmerican practices. The implementation of internationally acceptable principles and standards is largely symbolic rather than instrumental. This monograph shows how contradictory institutional pressures shape the process and outcome of loose coupling between regulations and actual

xiii

xiv

ABSTRACT

operations, which are intertwined with organizations’ conflicts of interest and power dependence within China’s institutional setting. Policy makers, researchers of corporate governance and accounting, accountants, and those who set standards for corporate governance and accounting are likely to benefit from this monograph, which shows the importance of contextual factors in the convergence process. Convergence is a complex and dynamic sociopolitical process that requires a critical examination of the contextual environments of countries and intraorganizational dynamics to evaluate effectiveness and issues arising from such a process.

CHAPTER 1 INTRODUCTION

ABSTRACT Forces of globalization have driven international convergence in corporate governance and accounting considerably over the past few decades. Nevertheless, despite the global trend, convergence of corporate governance and financial reporting remains a subject of debate. This research monograph critically examines whether China’s convergence with Anglo-American corporate governance principles and the International Financial Reporting Standards (IFRS) is likely to produce the expected outcomes of improving the transparency and comparability of accounting information in Chinese firms. In this chapter, we discuss the motivation for and the significance of the study; describe the issues associated with the adoption of internationally acceptable standards and principles in China; explain the theoretical framework used to inform the study and research methodology; and present the aim and objectives of the monograph. Keywords: Overview; motivation; theoretical framework; methodology; aim and objectives

1.1. INTRODUCTION This research monograph critically examines whether China’s convergence with Anglo-American corporate governance principles and the International Financial Reporting Standards (IFRS) is likely to produce the expected outcomes of improving the transparency and comparability of accounting information in Chinese firms.1 In particular, it reveals issues

1

2

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

arising from the importation of internationally acceptable governance mechanisms and accounting standards, using an integrated institutional perspective that incorporates institutional shapers and intraorganizational dynamics. Adopting a holistic approach, this monograph shows how corporate governance and accounting practices are shaped by the interaction between (1) intraorganizational dynamics comprising power dependence and conflicts of interest among key organizational players and (2) a varied range of external institutional influences, including political, economic, legal, cultural, and historical factors. As a result, the implementation of internationally acceptable principles and standards is essentially symbolic rather than instrumental, and regulations concerning the adoption of Anglo-American models of corporate governance and financial reporting have become largely separate from actual operations. The forces of globalization have driven international convergence in corporate governance and accounting considerably over the past few decades. Growing relationships in international trade and transnational business relationships have resulted in a need for internationally comparable business practices and standards (Solomon, 2010). As a result, a number of important initiatives have been launched with the aim of standardizing corporate governance at a global level, including the OECD Principles of Corporate Governance by the Organisation for Economic Co-operation and Development (OECD, 1999, 2004), the Global Principles of Corporate Governance by the California Public Employees’ Retirement System (CalPERS, 1999), and the Guidance on Good Practices in Corporate Governance Disclosure by the United Nations Conference on Trade and Development (United Nations Conference on Trade and Development, 2006). In addition, the International Accounting Standards Board (IASB) has developed a comprehensive set of internationally acceptable standards for financial reporting, IFRS, for global use. These global convergence initiatives suggest that companies all over the world are increasingly adopting common solutions for corporate governance problems. Nevertheless, despite the global trend of convergence, convergence of corporate governance and financial reporting remains a subject of debate. Some argue that variations among countries in governance practice are determined by differences in culture, politics, legal systems, values, business financial arrangements, and ownership structure (Gregory, 2006; Matoussi & Jardak, 2012). Governance convergence does not take place out of context, and the imposition of new standards may not result in the intended policy or performance outcomes (Yoshikawa & Rasheed, 2009). Governance may be converging in form rather than substance, with

Introduction

3

little impact on corporate behaviors (Khanna, Kogan, & Palepu, 2006; Yoshikawa & Rasheed, 2009). Thus, regardless of the standardization of governance principles in the context of globalization, corporate practices across regions vary because of different institutionalized local forces that shape those practices (Balachandran, Dossi, & Van Der Stede, 2010; Denis & McConnell, 2003; Larcker & Tayan, 2011; Yoshikawa & Rasheed, 2009). Following China’s integration into the global economy with the initiation of reform and open-door policies in the 1980s, the Chinese government has endeavored to improve corporate governance and financial reporting. Specifically, the corporate governance system has been reformed by emulating the Anglo-American model (Lau, Fan, Young, & Wu, 2007; Miles, 2006; Tam, 2002). For example, the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies and the Code of Corporate Governance for Listed Companies in China were promulgated by the China Securities Regulatory Commission (CSRC) in 2001 and 2002, respectively.2 Among other things, these regulations emphasize introducing independent directors, establishing audit committees, maintaining auditor independence, and improving the disclosure of information. Furthermore, the new Accounting Standards for Business Enterprises (ASBE), issued by the Ministry of Finance (MOF) in 2006 and first applied to listed companies in January 2007, is largely based on IFRS. The purpose of this monograph is to examine the issues involved in achieving the expected objectives of adopting Anglo-American models of corporate governance and financial reporting in China. These objectives are stated in broad and vague terms in official documents. For example, the CSRC (2001) states that the objective of the Code of Corporate Governance for Listed Companies in China is to “promote the establishment and improvement of modern enterprise system by listed companies, to standardize the operation of listed companies and to bring forward the healthy development of the securities market.” According to the MOF (2006), the objective of the new ASBE is “to standardize accounting recognition, measurement and reporting of enterprises, and to ensure quality of accounting information.” For the purpose of the current study, the expected objective of adopting Anglo-American models of corporate governance and financial reporting is defined as improving the accountability of organizational players, including company managers, independent directors, and auditors, and eventually improving the quality of financial reporting. The remainder of the chapter is organized as follows. Section 1.2 discusses the motivation for the study. The significance of the topic is outlined

4

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

in Section 1.3. Section 1.4 describes the issues associated with the adoption of internationally acceptable standards and principles in China. Section 1.5 explains the theoretical framework used to inform the study. Section 1.6 explains research methodology, including the research methods, data collection, and data analysis. The aim and objectives of the study are presented in Section 1.7. Finally, Section 1.8 provides a chapter outline of the monograph.

1.2. MOTIVATION This monograph is motivated by two factors. First, this study seeks to examine empirically the current situation regarding convergence with internationally acceptable principles and standards in China. Second, it seeks to overcome two limitations of the existing literature, namely, (1) the lack of examination of institutional influences on corporate governance and financial reporting practices and (2) the execution of those practices.

1.2.1. Providing Empirical Evidence of Convergence in China The importance of corporate governance and financial reporting and the interrelation between them have attracted increasing attention from researchers. Research has documented that financial reporting plays an important role in corporate governance (e.g., Armstrong, Guay, & Weber, 2010; Bushman, Indjejikian, & Smith, 1996; DeAngelo, 1988; Palepu, 1986; Sweeney, 1994; Wallace, 1997) and that corporate governance arrangements in turn have a direct impact on financial reporting (e.g., Agrawal & Chadha, 2005; Beasley, Carcello, Hermanson, & Lapides, 2000; Bowen, Rajgopal, & Venkatachalam, 2008; Francis, Schipper, & Vincent, 2005; Koh, Laplante, & Tong, 2007). Although such studies have provided useful insights, the majority have been conducted in Anglo-American countries; studies focusing on countries in which capital markets are less sophisticated and governance mechanisms are still evolving are limited (Goodwin & Seow, 2000). Furthermore, previous studies examining corporate governance-related financial reporting issues have generated mixed results. For example, some studies show a negative relation between audit committee independence and earnings management in the US market (Abbott, Parker, & Peters, 2004; Bedard,

Introduction

5

Chtourou, & Courteau, 2004; Klein, 2002; Xie, Davidson, & DaDalt, 2003), whereas others find that the independence of audit committees has no significant impact on the quality of reported earnings (Agrawal & Chadha, 2005; Lin, Li, & Yang, 2006). These mixed results suggest that there is no uniform pattern in the relation between corporate governance mechanisms and financial reporting quality. Richer insights are required to understand financial reporting issues related to corporate governance. Moreover, a number of high-profile corporate failures and accounting scandals, such as Enron, WorldCom, and Tyco International in the United States and HIH and One Tel in Australia, have raised serious concerns about the effectiveness of corporate governance mechanisms in general (Rezaee, 2005). Given the problems experienced in Anglo-American countries, in which relatively mature economic and legal systems could be expected to ensure good corporate governance, it is likely that countries that lack an essential supportive infrastructure could encounter greater problems (see also Shi, 2005). The mixed findings, coupled with the accounting scandals in Anglo-American countries, highlight the importance of studying the effectiveness of AngloAmerican ideas in emerging markets. The adopting of Anglo-American models of corporate governance and financial reporting has long been debated in China. The major concern is whether these imported principles are likely to function properly in China’s context (e.g., Chen, 2005; Miles, 2006). China is a transitional economy undergoing significant institutional changes. Although the effective implementation of internationally acceptable principles in this changing environment is a major challenge facing the Chinese government, this issue receives scant investigation. In addition, given China’s increasing importance on the global stage, international stakeholders, including foreign investors and various international organizations such as the OECD and IASB, are likely to be interested in the current situation regarding convergence in China. Therefore, the primary motivation of this study is to provide empirical evidence regarding the execution of internationally acceptable principles and standards in China.

1.2.2. Overcoming Two Limitations in the Existing Literature This monograph seeks to overcome two main limitations of the existing literature on corporate governance and financial reporting practices. The first limitation is the lack of attention paid to the influences of the institutional environment on these practices. The second limitation is

6

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

the limited number of studies that have examined the execution of these practices. 1.2.2.1. Examining the Influences of the Institutional Environment on Corporate Governance and Financial Reporting Practices Corporate governance and accounting are increasingly viewed as social and institutional practices rather than merely technical ones, and these practices interact with the institutional context (Chizema & Buck, 2006; Hopwood, 2000; Irvine, 2008; Yoshikawa, Tsui-Auch, & McGuire, 2007). These practices impact not just organizational performance but also society as a whole. Turley and Zaman (2004) call for future studies to consider the organizational and institutional contexts in which corporate governance occurs. Furthermore, as a social and institutional practice, accounting also needs to be examined in its wider economic and social setting to enrich understanding of accounting practices and changes (Burchell, Clubb, Hopwood, Hughes, & Nahapiet, 1980; Hopwood & Miller, 1994; Potter, 2005). The existing literature on corporate governance-related financial reporting issues has largely neglected the impact of the institutional environment on the issues under examination. This monograph examines institutional influences on the adoption and implementation of internationally acceptable principles and standards in China. 1.2.2.2. Examining the Execution of Corporate Governance and Financial Reporting Practices A review of the literature on corporate governance and financial reporting shows that previous studies have mainly relied on a quantitative research methodology (see also Leblanc & Schwartz, 2007). Although such studies shed light on the association between governance mechanisms and the quality of financial reporting, they are unable to examine the dynamic nature of corporate governance and accounting practices and the interactions among those practices and their institutional environment. Leblanc and Schwartz (2007) call for further studies adopting an in-depth, qualitative research approach to provide insights into the application of corporate governance mechanisms. Using a qualitative research methodology, and through interviews with selected key individuals who are directly involved in corporate governance and accounting, including company management, independent directors, auditors, and academics, this monograph provides empirical evidence of

7

Introduction

the process and outcome of adopting internationally acceptable principles and standards in China. In short, motivated by the limited number of empirical studies conducted in developing and emerging economies, and the lack of attention to institutional influences on corporate governance and financial reporting practices and to the dynamic nature of those practices, this study seeks to fill the gaps in the literature.

1.3. SIGNIFICANCE OF THE TOPIC This monograph is significant for at least two reasons. First, corporate governance and financial reporting increasingly affect national economies and people’s daily lives. Second, China exerts a growing influence on the global economy, and this increases the importance of issues associated with corporate governance and accounting practices there.

1.3.1. Corporate Governance and Financial Reporting There is an enhanced awareness of the importance of corporate governance and financial reporting across the world. The OECD points out that in today’s economies, interest in corporate governance goes beyond that of shareholders in the performance of individual companies. As companies play a pivotal role in our economies and we rely increasingly on private sector institutions to manage personal savings and secure retirement incomes, good corporate governance is important to broad and growing segments of the population. (OECD, 2004, p. 3)

The growing influence of the business sector also adds importance to the quality of financial reporting, as the objective of financial statements is to provide information to a variety of users for making decisions (IASB, 2010). The importance of good corporate governance and its responsibility for the integrity of financial reporting is formally established by international organizations and various national authorities in the form of corporate governance principles or guidelines (see ASX, 2010; FRC, 2008; NYSE, 2011; OECD, 2004). For example, the OECD states that “the corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the

8

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

financial situation, performance, ownership, and governance of the company” (OECD, 2004, p. 22). Good corporate governance safeguards the integrity of financial reporting (ASX, 2010) and promotes confidence in corporate reporting (FRC, 2008). In the context of globalization, national economies have become increasingly interdependent, and practices are diffused across different jurisdictions. International harmonization of accounting standards has gained momentum, and more than 120 nations and reporting jurisdictions permit or require IFRS for domestically listed companies.3 Corporate governance practices across borders are converging toward the Anglo-American model (Hansmann & Kraakman, 2000; D. Reed, 2002). The key issue arising from the wide diffusion of Anglo-American ideas is how effectively they apply to different institutional environments and to transitional economies in particular. 1.3.2. Corporate Governance and Financial Reporting Reforms in China Following the implementation of its economic and open-door policies of the 1980s, China has become an important player on the global stage. Its accession to the World Trade Organization (WTO) in December 2001 signaled China’s further integration into the global economy. The 2008 Olympic Games in Beijing provided an opportunity not only for international and local firms to expand their business but also for the Chinese government to adopt more open policies to facilitate China’s interaction with the rest of the world. He Zhenliang, International Olympic Committee Executive Board member and former vice-president of the China Olympic Committee, asserted the following: The 2008 Olympic Games will serve as a catalyst for furthering reform and the liberalization process in China. Coupled with the far-reaching impact of China’s accession to the World Trade Organization, China’s economy will become more closely linked internationally. (Hong, Wu, & Xiong, 2005, p. 520)

China’s importance in the world economy has increased along with its rapid economic growth. Being the world’s largest and fastest growing transitional economy (Allen, Qian, & Qian, 2005; Lin & Liu, 2009), China averaged 9.67% growth in its gross domestic product (GDP) from 1978 to 2006 while the world economy was growing at about 3.3% on average (Xinhua, 2007). It reported a nominal GDP of RMB 39.80 trillion (USD 6.0 trillion) and a foreign exchange reserve of USD 2.8 trillion in 2010,4 overtaking Japan as the second largest economy in the world (Bloomberg News, 2010).

9

Introduction

Because of its impressive economic performance China has become increasingly attractive to foreign investors. China has enjoyed the largest portion of foreign direct investment flowing to developing countries for 14 successive years; by the end of 2006, 590,000 foreign firms (Xinhua, 2007) and 450 international firms listed in the 500 Top World Companies (Ezzamel & Xiao, 2007) had invested in China. China received a total of USD 1.05 trillion in direct foreign investment from 1979 to 2010.5 However, poor corporate governance and financial reporting are becoming major obstacles to China’s further growth. Because of the poor performance of state-owned enterprises (SOEs), corporate governance was identified by the Chinese government as the core element of enterprise reform in the Fourth Plenum of the Chinese Communist Party’s 15th Central Committee held in September 1999. Furthermore, a broad range of commitments under the WTO accession opened up the Chinese market at a higher level, exposing Chinese companies to global competition and increasing the urgency of the need to tackle corporate governance issues (Tenev, Zhang, & Brefort, 2002). In addition, widespread accounting manipulation has caused great concern about the quality of financial reporting (Jun Lin & Chen, 2005). Financial fraud is much more common in China than in the United States, and approximately 15% of listed companies have a record of practicing it (Zhang & Ma, 2005). High-profile corporate scandals such as Yin Guang Xia, Lantian, and Zhengzhou Baiwen all involved the falsification of financial statements (Hu, Tam, & Tan, 2010). The MOF recently uncovered financial frauds that involved a number of listed firms, including Tianhai, Liuyan Huapao, and Hangtian Tongxing (China Securities Journal, 2007). The large scale of corporate fraud and accounting manipulation severely undermines investor confidence and hinders the development of China’s business sector, which adds to the importance of examining corporate governance and accounting reforms in China.

1.4. ASSOCIATED ISSUES Corporate governance and financial reporting are largely shaped by the institutional environment. Chinese companies operate in an institutional setting different from that of Anglo-American countries. For example, whereas principal agent conflicts are at the center of governance issues within Anglo-American countries because of highly dispersed ownership

10

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

structures and the associated separation of ownership and control (Jensen & Meckling, 1976), the more severe corporate governance challenge in China is principal principal conflicts that result from concentrated ownership and controlling shareholders’ expropriation of minority interests (Luo, Wan, & Cai, 2012; Su, Xu, & Phan, 2008; Zou, Wong, Shum, Xiong, & Yan, 2008). China’s political system is characterized by single-party leadership. Although progress has been made in withdrawing from the corporate sector, the Chinese government still has considerable influence over corporations largely because of its multiple roles as regulator and shareholder (Liu, 2006). Specifically, the government remains in control of key resources as a regulatory agency (Li, Meng, Wang, & Zhou, 2008) and persistently intervenes in corporate operations as a controlling shareholder (Lau et al., 2007; Liu & Sun, 2005). Confucian philosophy, which emphasizes harmony and stability, has a considerable impact on Chinese society (Lin & Ho, 2009). Guanxi, a convention of informal social communication, influences all parties involved in company operations (Wong, 2010). China’s legal system is underdeveloped and provides little support to shareholders, and to small shareholders in particular (Wang & Chen, 2008; Zou et al., 2008). The accounting infrastructure in China is also unique, as the accounting profession is still young and the government is heavily involved in accounting-related matters (Yee, 2009). Such local institutional embeddedness and politics may hinder efforts at governance convergence (Yoshikawa & Rasheed, 2009) and make comparisons between the accounting figures of companies in China and those in Anglo-American countries impossible, even though both countries may profess to follow similar accounting standards (Ball, Robin, & Wu, 2003; Cuijpers & Buijink, 2005). Thus, although the Chinese government has the power to introduce AngloAmerican models of corporate governance and financial reporting by way of regulations, it is debatable whether the imported principles are actually applied by organizational players and achieve their expected objectives in the Chinese setting.

1.5. THEORETICAL FRAMEWORK An integrated institutional perspective is used to examine issues of interest to the current study. Institutional theory seeks to offer institutional explanations for the processes by which structures, including schemas, rules, norms, and routines, become established as authoritative guidelines for

Introduction

11

social behavior (Scott, 2004). According to institutional theory, the emergence, diffusion, adoption, adaption, and decline of certain patterns of behavior among organizational or community members are to a large extent influenced by societal expectations, which are in turn shaped by the social, political, and economic environment (DiMaggio & Powell, 1983; Meyer & Rowan, 1977; Powell, 1991). Therefore, from an institutional perspective, corporate governance and financial reporting practices are institutional arrangements of organizations justified not only by the efficiency of those practices but also by the legitimacy granted them by society. A growing number of studies that have used institutional theory to explain corporate governance and accounting changes have generated fruitful insights. Institutional theory has been used to examine, for example, innovation and change in corporate governance in France (Lee & Yoo, 2008), Germany (Chizema & Buck, 2006), and Japan (Yoshikawa et al., 2007). It is also considered the most informative perspective from which to study corporate governance in emerging economies (Hoskisson, Eden, Lau, & Wright, 2000; Lau et al., 2007; Peng, Lu, Shenkar, & Wang, 2001; Wright, Filatotchev, Hoskisson, & Peng, 2005). Furthermore, institutional theory has been used to explain the adoption of international accounting standards across different countries, for example, in Bangladesh (Mir & Rahaman, 2005) and the United Arab Emirates (Irvine, 2008). To examine the complex nature of corporate governance and accounting changes, this study adopts a holistic approach, which can “identify and illuminate the multi-dimensional character of the institutional context, the different levels at which power is exercised, and the means through which change impacts on organizational processes” (Burns & Scapens, 2000, p. 23). Drawing on the concepts developed in existing institutional theories, in particular those related to neo-institutionalism (Greenwood & Hinings, 1996), an institutional framework was developed to use as an interpretive framework in this monograph. This framework is discussed in detail in Chapter 4 and shown in Fig. 4.1. The framework comprises international influences, domestic influences, and intraorganizational dynamics. In the context of economic globalization, international actors play an increasingly important role in China due to China’s increasing integration into the global economy. Thus, an examination of international influences is useful to provide an understanding of the adoption of Anglo-American models of corporate governance and financial reporting in China. However, the implementation of internationally acceptable practices is largely shaped by the local environment including (Irvine, 2008). An examination of domestic influences

12

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

the political, economic, legal, and cultural systems; the equity market; and the accounting infrastructure in China is essential to this study because Chinese companies operate in an environment considerably different from that of Anglo-American countries. In addition, this framework incorporates intraorganizational dynamics to gain an understanding of organizational actions. Although the Chinese government has been able to impose Anglo-American ideas by way of regulation, it is Chinese companies that interpret and practice the imported concepts. The execution and effectiveness of the new rules is ultimately determined by organizational response. Also in this monograph, the notions of conflict of interest, power dependence, and loose coupling are introduced to explain the interaction and response of organizational players.

1.6. RESEARCH DESIGN Consistent with the theoretical framework, an interpretive methodology was used because of its strengths for examining research context, interactive processes, and meanings that are not measurable by statistical data. Such an interpretive methodology is also consistent with the ontological and epistemological positions of the authors, who believe that knowledge about corporate governance and financial reporting practices is socially and experientially constructed. Data triangulation, which refers to the use of multiple sources of data, was used in this study. It enabled the same phenomenon to be examined from multiple perspectives, which were then used to mutually validate the findings (Leedy & Ormrod, 2001); allowed the researcher to capture a holistic and contextual understanding of the events under investigation (Denzin, 2009); reduced the bias of both the researcher and respondents; and enhanced the interpretability and trustworthiness of the data (Robson, 2002). This study used two main data sources, namely, interviews with selected key individuals and surveys of publicly available documents. Semistructured interviews were conducted with selected key individuals directly involved in corporate governance and financial reporting in China (see the interview guide in Appendix). The use of semistructured interviews ensured that the same basic questions were covered with each respondent while allowing the interviewer some freedom to pursue new insights (Fontana & Frey, 2003). It also allowed the researcher to effectively ask probing questions to elicit further insights into any unsolicited statements

Introduction

13

that were made or any response to a specific question, reducing threats to the validity and reliability of the data (McKinnon, 1988). There were four categories of interviewees: company managers, independent directors, auditors, and academics. Multiple groups of people can provide both a comprehensive picture of the phenomenon under examination and a variety of perspectives on that phenomenon (McKinnon, 1988). Also, these interviews helped the researcher gather useful and relevant information within a short time frame (Perera, 2005). The interviewees were selected mainly on the basis of their demonstrated knowledge and expertise. All selected participants had more than 5 years of experience in the relevant fields and held senior positions in their institutions. A total of 42 persons were initially identified as suitable interviewees through searching websites of listed companies, universities, and government agencies. The first author contacted these persons by phone or email. Of these, 23 interviewees participated in the study: seven company managers, seven independent directors, five auditors, and four academics. For the purpose of this study it is important to seek out the views of government agencies, as corporate governance and financial reporting have been heavily driven by the government. However, because of difficulties approaching the appropriate government officials, it was not possible to obtain these insights. All interviewees signed an information statement and consent form that formally assured the interviews of confidentiality. The interviews were conducted in Chinese by the first author and ranged from 40 minutes to 2 hours. Fifteen interviews were tape-recorded with the participants’ permission, and notes were taken on the remaining eight. Chinese versions of the transcripts were mailed to the interviewees for verification purposes, and any ambiguities were clarified. All Chinese transcripts were translated into English by an experienced translator with considerable knowledge of the business and accounting fields. In addition, the translator’s work was thoroughly reviewed by the first author. A pilot study was undertaken before the field study to assess the appropriateness of the interview questions, as suggested by Robson (2002). The pilot study comprised four stages and started with pilot testing of the interview questions among three academics at one Australian university who are knowledgeable about corporate governance and financial reporting. The refined questions were tested among four accountants who work in accounting firms or companies in Australia. The third step involved three Chinese participants who currently work in Chinese listed companies. The final step was to gain feedback from supervisors of the research project. Refinements were made following these stages.

14

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

A document survey was selected as a method of data collection because of its low cost, ease of access, and ability to provide both information unavailable in spoken form and historical insight (Hodder, 1994). Sources of public documents used in the current study included corporate governance guidelines and accounting regulations issued by government agencies, government reports, reports issued by supranational organizations such as the OECD and the WTO, rating agencies’ reports, official statistics data, relevant content on firms’ websites, and media and analysts’ reports. In addition, the existing literature on corporate governance and financial reporting issues in China was also surveyed. Furthermore, a set of data analysis procedures was developed to increase the rigor and validity of the data analysis. As this study is informed by an interpretive theoretical framework, six constructs (also referred to as basic codes; see Table 5.3) related to organizational changes were identified. Then procedures suggested by a number of prior studies were largely followed, including identifying open codes, collapsing open codes into core codes, and developing concepts. Given the nature of the study, the data analysis process was largely completed manually, as suggested by the prior literature (Lye, Perera, & Rahman, 2006; Parker & Roffey, 1997; Taylor & Bogdan, 1998).

1.7. AIM AND OBJECTIVES The aim of this monograph is to examine whether the adoption of AngloAmerican models is likely to improve corporate governance and financial reporting in China. The research question is as follows: What issues are involved in adopting Anglo-American models of corporate governance and financial reporting in China? To achieve this aim, this study has the following objectives: • To identify specific corporate governance issues directly associated with financial reporting and examine their impact on the quality of financial reporting • To develop a holistic and comprehensive theoretical framework • To explore the corporate governance and accounting environment in China • To examine the main features of stock exchanges and listed companies in China

15

Introduction

• To discuss pressures at both international and domestic levels that caused China to adopt Anglo-American models of corporate governance and financial reporting • To provide empirical evidence of the issues associated with the implementation of those imported ideas • To evaluate the effectiveness of such implementation

1.8. CHAPTER OUTLINE The remainder of the monograph is organized as follows. Chapter 2 examines corporate governance-related financial reporting issues in the context of globalization. It starts with a discussion of the global trend of convergence in corporate governance and accounting. Then it reviews various definitions of corporate governance and develops the definition of corporate governance used in the current study. After that, various principles of corporate governance are examined to identify a number of elements of corporate governance considered to be directly related to financial reporting. The theoretical and methodological contributions and limitations of relevant studies that focus on corporate governance-related financial reporting issues are also evaluated. The chapter concludes by explaining how, in view of the existing gaps in the literature, this monograph contributes to the literature on global convergence in corporate governance and accounting. Chapter 3 examines the development of accounting thought and practices in China with the purpose of illustrating its relevance to current accounting policies and practices. Chapter 4 develops the theoretical framework used to inform the study, which is based largely on neo-institutional theory. Chapter 5 explains the research design. This chapter provides reasons for selecting a qualitative research methodology. In addition, data collection and analysis methods, and the strategies used to enhance the reliability and validity of the findings, are explained. Chapter 6 examines the corporate governance and accounting environment in China. More specifically, informed by the institutional theoretical framework developed in Chapter 4, this chapter examines both international and domestic institutional factors.

16

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Chapter 7 analyzes and discusses the empirical results of the study. The discussion is organized under the following themes: independent director, audit committee, auditor independence, corporate code of conduct, adoption of IFRS, and measures for improvement. Chapter 8 concludes the monograph. This chapter summarizes the findings and contributions of the study, acknowledges the limitations of the study, and provides suggestions for further research.

NOTES 1. The term Anglo-American is used for the group of countries that includes the United States, the United Kingdom, Canada, Australia, and New Zealand (Alexander & Archer, 2000). 2. The CSRC regulates China’s securities markets with the aim of maintaining a fair and efficient market (http://www.csrc.gov.cn/pub/newsite/). 3. http://www.iasplus.com/en/resources/ifrs-topics/use-of-ifrs, accessed on September 7, 2013. 4. Statistical Communique´ of the People’s Republic of China in 2010, available at http://www.stats.gov.cn 5. China Statistical Yearbook 2007, China Statistics Press; Statistical Communique´ of the People’s Republic of China in 2007, Statistical Communique´ of the People’s Republic of China in 2008, Statistical Communique´ of the People’s Republic of China in 2009, and Statistical Communique´ of the People’s Republic of China in 2010, available at http://www.stats.gov.cn

CHAPTER 2 GLOBAL CONVERGENCE AND CORPORATE GOVERNANCE RELATED FINANCIAL REPORTING ISSUES

ABSTRACT This chapter examines corporate governance related financial reporting issues in the context of globalization. Over the past few decades, the process of globalization has substantially altered the fields of corporate governance and accounting. More specifically, Anglo-American models of corporate governance and financial reporting have received increasing momentum in emerging economies, including China. However, a review of relevant studies suggests that there is limited research examining the implementation of Anglo-American concepts in various countries regardless of their growing acceptance. This monograph extends the existing literature by comprehensively investigating the adoption of internationally acceptable principles and standards in China, the largest transitional economy that has different institutional context from Anglo-American countries. In addition, the review has a number of implications for developing the theoretical framework, and determining the research methodology for the monograph. Keywords: Global convergence; corporate governance related financial reporting issues; literature review

17

18

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

2.1. INTRODUCTION The global trend of convergence in corporate governance and accounting has gained increasing momentum in the past few decades. Corporate governance historically varies across countries because of local differences in culture and political, economic, and legal systems (Aggarwal, Erel, Stulz, & Williamson, 2010; Coffee, 2000; Doidge, Andrew Karolyi, & Stulz, 2007). Indeed, a number of studies have documented systematic variations in corporate practices across regions by classifying corporate governance models into, for example, insider and outsider models (Franks & Mayer, 1997; Short, Keasey, Hull, & Wright, 1998) and Anglo-American, communitarian, and emerging market systems (Choi, Raman, Usoltseva, & Lee, 1999; Epstein, 2012). Recently, an increasing number of studies have noted a global process of convergence toward the Anglo-American corporate governance system, such as in European countries (Goergen, Martynova, & Renneboog, 2005) and in transitional economies, including Bangladesh (Siddiqui, 2010; Uddin & Choudhury, 2008), Russia (Buck, 2003; Judge & Naoumova, 2004), and India (A. M. Reed, 2002). In addition, International Financial Reporting Standards (IFRS), largely based on an Anglo-American perspective (Botzem & Quack, 2009), has been claimed as a comprehensive set of internationally acceptable standards for financial reporting and been permitted or required by many jurisdictions across world. Nevertheless, despite the increasing popularity of Anglo-American ideas across the world and in emerging economies in particular, a review of prior studies that examined corporate governance related financial reporting issues reveals scant efforts devoted to examining the implementation of Anglo-American models in a non-AngloAmerican context and, more important, a clear lack of attention to local institutional forces that shape the implementation process and outcomes. The relationship between corporate governance and financial reporting is increasingly being recognized as an important subject for research in accounting. Researchers have documented a variety of roles of accounting in various corporate governance practices, such as takeovers, shareholder litigation, and managerial compensation plans (Bushman & Smith, 2001). On the other hand, an increasing number of studies have examined the effect of corporate governance mechanisms on the quality of financial reporting. The research focus of this monograph is the impact of implementing Anglo-American models of corporate governance and financial reporting in China. The Organisation for Economic Co-operation and Development (OECD) Principles of Corporate Governance state that the corporate

Corporate Governance Related Financial Reporting Issues

19

governance framework should ensure timely and accurate disclosure on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company (OECD, 2004). In Australia the Principles of Good Corporate Governance and Best Practice Recommendations require a company to safeguard integrity in financial reporting and make timely and balanced disclosure of all material matters concerning the company (ASX, 2010). Thus, improving the quality of financial reporting is a key goal of good corporate governance. Focusing on governance effects of Anglo-American corporate governance elements, this chapter critically evaluates theoretical and methodological limitations of prior research in relation to corporate governance related financial reporting issues in order to inform and guide the research design of this monograph. The chapter is organized as follows. Section 2.2 outlines global corporate governance systems and discusses the global trend of convergence in corporate governance and financial reporting. Section 2.3 examines the definitions of corporate governance used in the literature. Section 2.4 reviews studies investigating corporate governance related financial reporting issues under the following titles, namely, independent director, audit committee, auditor independence and corporate code of conduct. The final Section 2.5 concludes the chapter with some concluding remarks.

2.2. CONVERGENCE OF CORPORATE GOVERNANCE AND ACCOUNTING 2.2.1. Global Corporate Governance Systems Corporate governance traditionally varies across countries. The global variations in governance practices are largely determined by country characteristics, such as legal protections for investor protections (Aggarwal et al., 2010; Doidge et al., 2007), norms and culture (Coffee, 2000), and level of economic and financial development (Doidge et al., 2007). Researchers have attempted to classify corporate governance systems (Choi et al., 1999; Cuervo, 2002; Epstein, 2012; Franks & Mayer, 1997; Kaplan, 1997; La Porta, Lopez-De-Silanes, & Shleifer, 1999; Letza, Sun, & Kirkbride, 2004; Lo´pez de Silanes, La Porta, Shleifer, & Vishny, 1998; Nobes, 1998). One well-known traditional way of classifying corporate government systems is the insider/outsider model, which is based mainly on

20

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

business structure and finance (Franks & Mayer, 1997; Short et al., 1998). In outsider systems, also known as market-based systems, although most large firms are mainly financed by external shareholders such as financial institutions and individual shareholders, the control of those firms essentially rests with managers (Short et al., 1998). The separation of ownership and control gives rise to agency problems and results in significant costs to both management and shareholders (Jensen & Meckling, 1976; Sundaram & Inkpen, 2004). Shareholders tend to be short-term oriented and prefer an exit strategy to voice their opinion. Further, because these external shareholders are not involved in the day-to-day management of the company, they do not have access to the company’s detailed management accounting information. Such shareholders heavily rely on financial accounting information to assist them in their investment decisions. Given the significance of outsider financing, financial accounting in outsider systems has historically developed with a primary aim of providing fair and balanced information to external shareholders (Nobes, 1998). Outsider systems of corporate governance tend to have common law systems, which provide strong investor protection. Traditionally, the United Kingdom, the United States, Australia, and New Zealand have been characterized in this category. In contrast, in insider systems, publicly listed companies are controlled by a small number of large shareholders, who may be founding family members, other companies through cross-shareholdings and pyramidal ownership structures, the government, or banks. Insider systems are also known as relationship-based systems because of the important role played by the relationship between companies and their influential shareholders in corporate governance. While the close ties between controlling owners and managers are likely to reduce agency problems, the highly concentrated ownership structures can bring about a number of issues, such as opaque financial reporting, dominant stakeholders’ abuse of power and misuse of corporate funds, and other expropriation of minority interest behaviors. Further, since these dominant players, including family owners, the government, and banks, have access to detailed internal management accounting information of the company, the demand for financial statements to provide information to aid decision making is relatively low. As a result, different from the primary role of providing fair and balanced information in outsider systems, financial accounting in insider systems has developed to fulfill roles such as the provision of information for tax purposes. Insider systems of corporate governance tend to have Roman law systems, which provide weak investor protection. Japan, Germany and most European countries, and many East Asian countries have been

Corporate Governance Related Financial Reporting Issues

Table 2.1.

21

General Characteristics of Insider and Outsider Systems.

Insider System • Firms owned predominantly by insider shareholders who also wield control over management • System characterized by little separation of ownership and control such that agency problems are rare • Hostile takeover activity is rare • Concentration of ownership in a small group of shareholders (founding family members, structure, state ownership) • Excessive control by a small group of “insider” shareholders • Wealth transfer from minority shareholders to majority shareholders • Weak investor protection in company law • Potential for abuse of power by majority shareholders • Majority shareholders tend to have more voice in their investee companies

Outsider System • Large firms controlled by managers but owned predominantly by outside shareholders • System characterized by separation of ownership and control, which engenders significant agency problems • Frequent hostile takeovers acting as a disciplining mechanism on company management • Dispersed ownership • Moderate control by a large range of shareholders • No transfer of wealth from minority shareholders to majority shareholders • Strong investor protection in company law • Potential for shareholder democracy • Shareholding characterized more by exit than by voice

Source: Adapted from Solomon (2010).

characterized traditionally in this category. Table 2.1 summarizes the typical characteristics associated with insider and outsider corporate governance systems. Another increasingly accepted framework in the literature classifies corporate government systems into the Anglo-American system, communitarian system, and emerging market system (Choi et al., 1999; Epstein, 2012). The Anglo-American system of corporate governance refers to a range of commonly used corporate governance mechanisms that have been developed in the United States, the United Kingdom, Australia, New Zealand, Canada, and South Africa because of the similarities in their legal structures and cultures (Epstein, 2012). In these countries, the primary objective of corporate governance is the maximization of shareholder value (Letza et al., 2004; Sundaram & Inkpen, 2004). Accordingly, their legal systems provide investors with legal protection from expropriation by managers, including protection of minority rights and legal prohibitions against managerial self-dealing (Shleifer & Vishny, 1997). Companies in this system have dispersed ownership structures (Jensen & Meckling, 1976), and

22

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

a large share of corporate ownership is traded on public exchanges such as the New York Stock Exchange (NYSE) and London Stock Exchange (Kakabadse, Tsvetkov, Uldatsov, & Kakabadse, 2009). Thus, corporate governance practices are heavily influenced by well-developed financial markets because these exchanges often set their own requirements for corporate governance. In the Anglo-American system, corporate boards are usually accorded the responsibilities of overseeing and evaluating the performance of senior managers and the corporation (Epstein & Roy, 2005, 2007). As a result, boards are often primarily composed of independent directors with no financial interest in the firm (ASX, 2010; Choi et al., 1999; NYSE, 2011). In addition, the Anglo-American system heavily emphasizes transparency and disclosure in corporate governance, including financial reporting, corporate strategy, and board performance (Larcker & Tayan, 2011). The communitarian corporate governance system has been practiced in much of continental Europe and in Japan (Epstein, 2012). Originating in the Romano-Germanic civil law codes (Glendon, Gordon, & Osakwe, 1994), the civil law legal system largely relies on statutes and codes to regulate corporate governance (Matoussi & Jardak, 2012). Compared to common law legal codes in Anglo-American countries, countries with civil law legal codes have developed fewer laws to protect shareholder rights. Instead, corporate governance is largely shaped by the relationships between firms and a wide range of stakeholders. Indeed, while the AngloAmerican governance system can be classified as a shareholder-oriented model, the communitarian system adopts a stakeholder-centric approach to governance (Larcker & Tayan, 2011). In the communitarian system, corporate operations are influenced by a varied range of stakeholders, including lending partners, suppliers, customers, employees, and members of society, because of the frequent interaction among companies and these stakeholders (Cadbury, 2006). In Germany and Japan, for example, firms and banks often cross-invest in their suppliers and customers, creating conglomerates of corporations (Larcker & Tayan, 2011). As a result, corporate governance is embedded in the multidimensional relationships between corporations and their stakeholders. Such relationships play an important role in conducting business transactions (Choi et al., 1999) and the monitoring and implementation of disciplinary procedures (Kaplan, 1997). Further, stakeholders have considerable influence on the supervisory board.1 For example, at least half of the supervisory board in Germany is required to be employee representatives (Larcker & Tayan, 2011). The emerging market corporate governance system refers to corporate governance practices that evolve in emerging economies such as China,

Corporate Governance Related Financial Reporting Issues

23

Brazil, India, Mexico, Russia, and much of Eastern Europe.2 Because of considerable differences in legal traditions, language, and culture in these countries (Black, De Carvalho, & Gorga, 2012), there is significant uncertainty and dynamism as to how corporate governance will likely evolve (Choi et al., 1999; D. Reed, 2002). Nevertheless, a number of noticeable patterns have emerged over time. First, corporate governance in emerging markets tends to be stakeholder centric, with dominant family or state ownership and considerable state participation in the economy (Epstein, 2012). For example, almost 45% of the equity value of all Indian companies is owned by company insiders and their families (Larcker & Tayan, 2011). The Chinese government still highly regulates equity markets and prohibits many companies from trading their shares on exchanges for political reasons (Larcker & Tayan, 2011). Further, the emerging market system features a lack of credible legal protections for shareholders (Shleifer & Vishny, 1997), a low level of disclosure and transparency (Larcker & Tayan, 2011), and the coexistence of the two-tier board structure of communitarian countries and the unitary board structure of the Anglo-American system (Kakabadse, Kakabadse, & Yang, 2009). Table 2.2 compares and contrasts general characteristics found in Anglo-American, communitarian, and emerging market corporate governance systems.

2.2.2. Global Convergence in Corporate Governance and Accounting The past few decades have seen a trend of corporate governance and accounting convergence in the context of globalization. Because of growing international trade and transnational business relationships, the development of internationally comparable business practices and standards has become increasingly necessary. The need for a global convergence in corporate governance is determined by a range of forces associated with expanding international investment, increasing foreign subsidiaries, and integration of the international capital markets. Indeed, although there has not been a single set of internationally acceptable corporate governance standards, recent years have observed a trend of global convergence in corporate governance largely driven by companies’ demand for financing across international capital markets (Solomon, 2010). A number of significant initiatives have been launched with an aim of standardizing corporate governance at a global level. The OECD has developed one of the most important international corporate governance codes of practice, namely, the OECD Principles of Corporate Governance

24

Examples of countries General characteristics

General Characteristics of Global Corporate Governance Systems. Anglo-American

Communitarian

Emerging Market

US, UK, Australia, Canada, South Africa • Shareholder centric • Market centered • Unitary board structure • Boards primarily composed of nonexecutive directors (and independent directors) • Common law legal system • High levels of disclosure and more rules on disclosure • Large pay incentives for managers, including pay for performance

Japan, Germany, Belgium, Scandinavia • Stakeholder centric • Bank centered • Two-tier board structure (supervisory and management) • Labor, founding family, and banks are common members-interlocking common • Civil law legal system • Moderate levels of disclosure • Moderate pay incentives

China, Eastern Europe, India, Brazil, Mexico, Russia • Stakeholder centric • Government/family centered • Board structure varies • Few independent board members • Relatively weak legal systems • Low levels of disclosure • Smaller pay incentives

Source: Adapted from Epstein (2012).

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Table 2.2.

Corporate Governance Related Financial Reporting Issues

25

(OECD, 1999, 2004). Embracing a broad perspective, the OECD describes corporate governance as a system that “deals with the rights and responsibilities of a company’s management, its board, shareholders and various stakeholders.”3 While recognizing there is no single model of good corporate governance, OECD governance principles attempt to identify some common elements that underlie good corporate governance by covering issues such as rights and equitable treatment of shareholders, the role of stakeholders, disclosure and transparency of financial information and governance matters, and responsibilities of corporate boards. Over time, the OECD Principles of Corporate Governance have gained worldwide recognition as an international benchmark for sound corporate governance and have been used by both OECD and non-OECD countries (Jesover & Kirkpatrick, 2005). Countries have used OECD governance principles as a reference point for self-assessment and for developing their own codes of best practice in corporate governance (Solomon, 2010). Another significant initiative to a global convergence in corporate governance was taken by CalPERS in the United States, one of the most proactive institutional investors in the world. CalPERS issued the Global Principles of Corporate Governance in 1999, setting a global benchmark for minimum standards to which all markets throughout the world should strive (CalPERS, 1999). The Guidance on Good Practices in Corporate Governance Disclosure by the United Nations Conference on Trade and Development represents the United Nations’ effort at harmonizing corporate governance globally (United Nations Conference on Trade and Development, 2006). Within the European Union (EU), while it has traditionally been considered inadvisable by the EU force member states to harmonize corporate governance as a result of regulation (Solomon, 2010), the European Commission issued a green paper on the EU corporate governance framework for public consultation in 2011. The green paper contains three chapters, namely, boards, shareholders, and the comply-orexplain principle.4 A growing body of research has documented that there is a global trend toward homogeneity of national systems of corporate governance, with noticeable movements toward greater transparency, shareholder empowerment, and director oversight in the Anglo-American style of corporate governance, in not only developed economies but also transitional and developing economies (Cuervo, 2002). Goergen et al. (2005) contend that a process of convergence toward the Anglo-American corporate governance system has been started in Europe by investigating the recent reforms of takeover regulation in 30 European countries. Hackethal, Schmidt, and

26

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Tyrell (2005) maintain that the German corporate governance system has shifted to a capital market-based Anglo-American model. The adoption of or convergence toward Anglo-American models has also been found in transitional and developing economies such as Bangladesh (Siddiqui, 2010; Uddin & Choudhury, 2008), Russia (Buck, 2003; Judge & Naoumova, 2004), and India (A. M. Reed, 2002). Furthermore, over the last three decades, the forces of globalization have also substantially altered the discipline of accounting (Heidhues & Patel, 2012). The global accounting convergence that aims at improving accounting quality and comparability has been largely driven by increasing international economic and political interdependence, growing multinational companies, and integrating international capital markets (Gallhofer, Haslam, & Kamla, 2011; Lehman, 2005; Rezaee, Smith, & Szendi, 2010). The establishment of the International Accounting Standards Committee (IASC), the predecessor of the International Accounting Standards Board (IASB), in 1973 is generally considered to be the first global milestone in the process of international accounting convergence (Heidhues & Patel, 2012). Founded by the accountancy bodies in 10 countries (Australia, Canada, France, Germany, Ireland, Japan, Mexico, The Netherlands, the United Kingdom, and the United States) with a broad objective of formulating international accounting standards, the IASC issued a series of standards that are referred to as International Accounting Standards (IAS). The International Organization of Securities Commissions (IOSCO) endorsed IASC’s efforts in 2000, recommending to national securities regulators the adoption of IAS by foreign issuers for cross-listing purposes (Doupnik & Perera, 2011). In 2001, the IASB replaced IASC to take charge of developing accounting standards that are referred as IFRS. To this end, the IASB formed four specific objectives, namely (1) to develop, in the public interest, a single set of high-quality, understandable, enforceable, and globally accepted financial reporting standards based on clearly articulated principles; (2) to promote the use and rigorous application of those standards; (3) to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings; and (4) to promote and facilitate the adoption of IFRS through the convergence of national accounting standards and IFRS (Heidhues & Patel, 2012). Fueled by strengthened legitimacy, the IASB has gained increasing momentum over the past decade. IFRS has been viewed as a comprehensive set of internationally acceptable standards for financial reporting and are permitted or required by 128 jurisdictions.5 More important, IFRS is largely based on accounting practices in

Corporate Governance Related Financial Reporting Issues

27

Anglo-American countries, and the international accounting standardsetting process has been controlled by the Anglo-American accounting and audit industry (Botzem & Quack, 2009; Chua & Taylor, 2008). Nevertheless, regardless of the increasing acceptance and wide diffusion of Anglo-American ideas, the convergence of corporate governance and financial reporting remains controversial and is still a subject of debate.

2.3. DEFINITION OF CORPORATE GOVERNANCE The definition of corporate governance and its implications for companies have been the subject of extensive research, debate, and comment over the last few decades. The focus of the debate is whether the responsibility of a company is owed solely to shareholders or to broader categories of stakeholders. A narrow view of corporate governance emphasizes shareholder value maximization. According to this view, shareholders provide funds to companies, and as the owners of companies their interests should be the paramount concern. For example, Friedman (2009) argues that the sole responsibility of a business is to use its resources to engage in activities designed to maximize profit for its shareholders. Profit maximization is the primary driver of corporations (Berle, 2004). Shleifer and Vishny (1997) assert that corporate governance deals with the ways in which suppliers of financing to corporations assure themselves of getting a return on their investment given the agency problem of the separation of management and finance. The following definitions reflect a shareholder perspective. The Australian Treasury’s Corporate Law and Economic Reform Program initiative (CLERP, 1997) states that corporate governance is the term used to describe the rules and practices put in place within a company to manage information and economic incentive problems inherent in the separation of ownership from control in large enterprises. It deals with how, and to what extent, the interest of various agents involved in the company are reconciled and what checks and incentives are put in place to ensure that managers maximize the value of the investment made by shareholders. (p. 62)

The UK Cadbury Report (Cadbury, 1992) provides the following definition: Corporate governance is the system by which companies are directed and controlled … (p. 14). The issue for corporate governance is how to strengthen the accountability of boards of directors to shareholders. (p. 47)

28

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

The UK Financial Reporting Council (FRC, 2008) defines the purpose of good corporate governance as [contributing] to better company performance by helping a board discharge its duties in the best interests of shareholders; if it is ignored, the consequence may well be vulnerability or poor performance. Good governance should facilitate efficient, effective and entrepreneurial management that can deliver shareholder value over the longer term. (p. 1)

However, the growth in power of corporations and their increasing impact on various stakeholders and society as a whole have raised awareness of the interests of other stakeholders. Freeman (2010) defines stakeholders as entities and interests that are involved, either voluntarily or involuntarily, in the operations of the firm. Companies operate within the society and have a variety of impacts on different stakeholder groups. If companies focus only on shareholder value, the broader society could suffer in terms of poor working conditions, inferior products, exploitation of the environment, pollution, and so on (Du Plessis, Hargovan, & Bagaric, 2011). Freeman (2010) argues that the central challenge of running a business is to create a satisfactory balance of interests among its diverse constituencies. The interdependencies among the firm, its employees, customers, investors, communities, and constituencies are vital to the survival and success of the firm (Post, Preston, & Sauter-Sachs, 2002). As a result, stakeholder theorists argue that managers should make decisions so as to take account of the interests of all the stakeholders in a firm (Freeman, 2010; Post et al., 2002). While the above discussion implies somewhat of a contradiction between shareholder and stakeholder approaches, some argue that the two approaches are not mutually exclusive and thus attempt to reconcile them. For example, Jensen (2002) points out the importance of good relations with a variety of stakeholders in maximizing the long-term market value of an organization. Further, in acknowledging the existence of competing stakeholders’ interests, he argues that such competing interests should be chosen by the criterion of market value maximization. The alignment of the interests of shareholders and stakeholders is also addressed by the OECD, which stresses that the ultimate success of a corporation results from the contributions of a range of stakeholders, so it is to a corporation’s longterm benefit to recognize the interests of its various stakeholders (OECD, 2004). The following definitions take into account the interests of stakeholders. For example, the OECD (2004) defines corporate governance as a set of relationships between a company’s management, its board, its shareholders and other stakeholders. Corporate governance also provides the structure through which

Corporate Governance Related Financial Reporting Issues

29

the objectives of the company are set, and the means of attaining those objectives and monitoring performance are determined. Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and its shareholders and should facilitate effective monitoring. (p. 11)

The Australian Securities Exchange (ASX, 2010) states that corporate governance is the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations … (p. 3). Effective corporate governance structures encourage companies to create value, through entrepreneurialism, innovation, development and exploration, and provide accountability and control systems commensurate with the risks involved … (p. 3). Companies should not only comply with their legal obligations, but should also consider the reasonable expectations of their stakeholders including: shareholders, employees, customers, suppliers, creditors, consumers and the broader community in which they operate. (p. 21)

There is no universally accepted definition of corporate governance encompassing all aspects emphasized by these various definitions. It is clear that contemporary corporate governance has moved away from its traditional shareholder-oriented perspective toward a broader stakeholderoriented one because of the increasingly important role of stakeholders in a corporation’s ongoing existence and long-term prosperity and the increasing interaction between the corporate sector and society. Nevertheless, by analyzing the definitions used by the OECD (2004) and ASX (2010) it can be seen that the underlying concepts are consistent, to some extent, with those promoted by Jensen (2002). While stakeholder interests are recognized, the major concern of corporate governance is still located within value creation for the firm and its shareholders. A good corporate governance structure provides incentives for the board and management to act in the interest of shareholders, encourages them to improve profitability, and imposes proper accountability and control systems on corporate operations.

2.4. CORPORATE GOVERNANCE RELATED FINANCIAL REPORTING ISSUES The purpose of this section is twofold. First, it identifies internationally recognized corporate governance elements that are considered directly related to financial reporting. Second, it reviews studies examining corporate governance related financial reporting issues. The remainder of

30

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

the section is organized under the following headings, namely, independent directors, audit committee, auditor independence, and corporate code of conduct.

2.4.1. Independent Directors It is essential that the board of directors be able to make objective judgments in order to exercise its duties of monitoring managerial performance and ensuring the integrity of the company’s financial reporting. Independent directors can considerably contribute to the decision making of the board of directors by bringing an objective view. As a result, a number of reports recommend assigning independent directors to boards by recognizing the boards’ responsibilities for financial reporting and the importance of independent directors in this regard (Bosch, 1995; Cadbury, 1992; Hilmer, 1998). In addition, the role of independent directors is also acknowledged by various codes of corporate governance. The OECD (2004) emphasizes a board’s independence from both managers and controlling shareholders and calls for a sufficient number of independent directors to be assigned. A balance of executive directors and independent directors is stressed in the revised Combined Code on Corporate Governance in the United Kingdom (FRC, 2008). A majority of independent directors is recommended by both the NYSE (2011) and the Australian Securities Exchange (ASX, 2010). To ensure independent directors’ ability to exercise independent judgment, Anglo-American countries clearly define independent directors and state independence requirements. For example, in Australia, ASX (2010) defines an independent director as a nonexecutive director who is not a member of management and who is free of any business or other relationship that could materially interfere with or could reasonably be perceived to materially interfere with the independent exercise of his or her judgment. It also lists relationships that may affect independent status, including ownership, employment, and commercial relationships (ASX, 2010). In the United States, NYSE (2011) states that no director qualifies as “independent” unless the board of directors affirmatively determines that the director has no material relationship with the listed company (either directly or as a partner, shareholder, or officer of an organization that has a relationship with the company). In addition, it sets strict bright-line tests to assess a director’s independence, including commercial, familial, and employment aspects (NYSE, 2011).

Corporate Governance Related Financial Reporting Issues

31

It has been a regulatory requirement for Chinese listed companies to introduce independent directors to boards of directors since the issuance of the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies in 2001 and the Code of Corporate Governance for Listed Companies in China in 2002. According to the CSRC (2001), independent directors of a listed company are directors who hold no positions in the company other than the position of director and who maintain no relations with the company and its major shareholder that might prevent them from making a judgment independently. In addition, the CSRC (2001) requires that independent directors meet the “independent requirements,” which are similar to those of Anglo-American countries and deal with issues of employment, ownership, and business relationships. It is worth noting that the Chinese government is less rigorous in maintaining the number of independent directors on boards than are the regulatory authorities in Australia and the United States, which require that they be in the majority. For example, the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies states that by June 2002, at least two members of a board of directors shall be independent, and independent directors shall constitute at least one third of a board by June 2003. Independent directors are expected to help improve the credibility of financial reporting by providing additional objective and independent reviews. Most research findings suggest that the introduction of independent directors in general, and more particularly financially sophisticated independent directors, onto boards is effective in constraining discretionary reporting behavior. For example, in US markets Klein (2002) finds a negative relation between board independence and abnormal accruals. Xie, Davidson, and DaDalt (2003) document that board independence reduces the likelihood of earnings management. Agrawal and Chadha (2005) find that the probability of earnings restatement is related not to the independence of boards but to the financial expertise of independent directors, suggesting that securing the independence of boards is of itself insufficient to properly monitor financial reporting process. In the Australian context, Koh, Laplante, and Tong (2007) suggest that board independence helps curb income-increasing abnormal accruals. Further, independent directors are likely to contribute to the quality of financial reporting by preventing various fraudulent activities. Farber (2005) examines a sample of 87 firms identified by the SEC as fraudulently manipulating their financial statements and finds that fraudulent firms have lower percentages of outside board members relative to a control sample.

32

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Similarly, Uzun, Szewczyk, and Varma (2004) investigate US corporate fraud in the period 1978 20016 and document that the likelihood of corporate wrongdoing decreases along with an increase in the number of independent directors on boards. In contrast, some studies report a nonsignificant association between independent directors and earnings management. For example, in the Malaysian context, Rahman and Ali (2006) find no significant relationship between earnings management and board independence. A possible reason is the board of directors’ relative lack of knowledge in a company’s affairs and consequent management dominance over board matters. Osma and Noguer (2007) investigate the association between earnings management and board composition in Spanish companies and find that the role in curbing earnings manipulation is mainly played by institutional directors instead of independent directors. A possible explanation offered by the authors is that the deeply rooted differences in the legal and institutional environments from Anglo-American countries may contribute to the effectiveness of independent directors in the Spanish setting. However, they fail to provide an adequate examination of the institutional environment in Spain and its impact on the function of independent directors in their study. Following the introduction of independent directors in China, researchers have been seeking to ascertain whether this adoption has led to improved corporate accounting and accountability. Firth, Fung, and Rui (2007b) investigate the relation between corporate governance and financial reporting in Chinese listed companies during the period 1998 2003. Their results show that firms that have a higher proportion of independent directors have greater earnings informativeness, and independent directors are negatively associated with the magnitude of absolute discretionary accruals. Using a sample of the 300 largest listed companies, Xiao, Yang, and Chow (2004b) examine the factors behind Chinese listed companies’ voluntary adoption of Internet-based financial reporting as well as the extent of disclosure and find that, among others, independent directors influence Internet disclosure. Lo, Wong, and Firth (2010) investigate the governance role of constraining management’s opportunistic behaviors (in the form of transfer pricing manipulations). They find that firms with a board that has a higher percentage of independent directors are less likely to engage in transfer pricing manipulations. Chen, Firth, Gao, and Rui (2006) examine the effect of boardroom characteristics on corporate financial fraud based on data derived from the enforcement actions of the CSRC. They document a negative association between the proportion of outside directors

Corporate Governance Related Financial Reporting Issues

33

and the incidence of fraud, suggesting that increasing the proportion of outsiders on boards is an effective way to reduce fraud. In contrast, Chen and Cheng (2007) investigate the effectiveness of reformed corporate governance, including introducing independent directors, on the harmonization of Chinese accounting practices in a sample of 104 companies issuing B shares between 1999 and 2003. Their findings reveal that the reformed corporate governance has not made a significant contribution toward this harmonization, and corporate governance as an important means of facilitating accounting harmonization has yet to be effective. In short, while prior studies have documented the importance of independent directors in constraining discretional reporting behaviors and preventing fraudulent activities in Anglo-American countries such as the United States and Australia, the effectiveness of independent directors in other countries, including China, is largely unclear and has not received due attention from researchers. Further, although some researchers (e.g., Osma & Noguer, 2007; Rahman & Ali, 2006) have suspected that unique features of local institutional environments may contribute to the function of independent directors, they have not explored the issues in depth. Moreover, most studies rely heavily on a quantitative methodology to ascertain the statistical relation between independent directors and financial reporting.

2.4.2. Audit Committee As an audit committee can be a more efficient mechanism than a full board of directors for focusing on particular issues relevant to the integrity of a company’s financial reporting, it is recommended that such a committee be established to take charge of accounting and auditing affairs. For example, the UK Revised Combined Code on Corporate Governance (FRC, 2008) states that an audit committee is charged with reporting-related responsibilities such as monitoring and reviewing the integrity of financial reporting, internal financial controls, internal audit functions, and the independence of external auditors. In accordance with the New York Stock Exchange Corporate Governance Standards audit committees are particularly charged with financial reporting affairs, with the board maintaining ultimate responsibilities, including the integrity of the company’s financial statements, the independent auditor’s qualifications and independence, the performance of the company’s internal audit function and independent

34

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

auditors, and other reporting-related affairs (NYSE, 2011). In Australia the Corporate Governance Principles and Recommendations recommends that the board establish an audit committee, focusing particularly on issues associated with the quality of financial reporting and the independence of external auditors (ASX, 2010). In order to maintain the independence of audit committees, a majority of independent directors is suggested by the Bosch Report (Bosch, 1995), the Hilmer Report (Hilmer, 1998), and the Australian Securities Exchange (ASX, 2010), while each member being independent is required by the Cadbury Report (Cadbury, 1992), the NYSE (2011), and the Sarbanes Oxley Act (United States Congress, 2002). Further, the technical expertise of audit committees is also emphasized. For example, both the NYSE (2011) and the Australian Securities Exchange (ASX, 2010) suggest that at least one member of the audit committee have accounting or related financial management expertise. In accordance with the Sarbanes Oxley Act, a company must disclose whether the audit committee includes at least one member who is a financial expert or its reasons for not including one. Chinese listed companies are required to establish an audit committee in accordance with the Code of Corporate Governance for Listed Companies in China (CSRC, 2002). The committee should be chaired by an independent director, and independent directors should constitute the majority of the committee. In addition, at least one independent director from the audit committee should be an accounting professional. The main duties of the audit committee include recommending the engagement of the external auditor, overseeing the interaction between the internal auditor and external auditor, inspecting the company’s financial reports, and monitoring the company’s internal control system (CSRC, 2002). Generally, audit committees in China have similar requirements for their composition and duties to those of their Anglo-American counterparts. 2.4.2.1. Audit Committee and Financial Reporting Quality A considerable number of studies have examined the association between audit committees and financial reporting (see Table 2.3 for studies reviewed in this regard).7 While earnings management is frequently used as a proxy for financial reporting quality, other issues such as accounting fraud and qualified audit report offer different perspectives for evaluating reporting quality. With regard to audit committees, most studies focus on such aspects as the presence of an audit committee and particular audit committee characteristics (e.g., composition, expertise, meetings).

Studies of the Relationship between Audit Committee and Financial Reporting Quality.

Dependent Variable: Proxy of Reporting Quality Accounting fraud

Earnings management

Audit qualification

Studies

Independent Variables Related to Audit Committees Existence Meetings

Crutchley et al. (2007) Uzun et al. (2004) Farber (2005) Lin et al. (2006) Klein (2002) Xie et al. (2003) Bedard et al. (2004) Agrawal and Chadha (2005) Abbott et al. (2004) Yang and Krishnan (2005) Piot and Janin (2007) Rahman and Ali (2006) Koh et al. (2007) Kent et al. (2010) Peasnell et al. (2005) Carcello and Neal (2000) Pucheta-Martı´ nez and De Fuentes (2007)

−SR

−SR −SR NSR −SR

Independence −SR −SR −SR NSR −SR −SR −SR NSR

−SR

−SR

NSR −SR −SR

NSR NSR −SR −SR

−SR

NSR +SRa NSR

NSR

−SR (error or noncompliance) NSR (uncertainties and scope limitation)

Country

Expertise

−SR NSR −SR −SR −SR −SR −SR NSR

US US corporate fraud US US US US US US US US quarterly earnings France income-increase Malaysia Australia Australia UK US financially distressed firms Spain

Corporate Governance Related Financial Reporting Issues

Table 2.3.

Notes: +SR: positive significant relationship, −SR: negative significant relationship, NSR: no significant relationship. a Usually −SR indicates audit committees are effective in improving the financial reporting quality. However, in the study of Carcello and Neal (2000), +SR indicates positive impact of audit committees on financial reporting quality.

35

36

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Committee Presence. Whether the presence of an audit committee can improve the quality of financial reporting is a basic question with regard to the effectiveness of audit committees. Interestingly, although the practice of establishing an audit committee has been followed for nearly two decades and is widely accepted by academics, regulators, investors, and the business sector, recent studies still document inconsistent results (see also Turley & Zaman, 2004). Uzun et al. (2004) find that the presence of an audit committee is associated with a lower likelihood of corporate fraud in the US setting. In the French context, Piot and Janin (2007) indicate that the presence of an audit committee prevents income-increasing earnings management. In contrast, the existence of an audit committee is found to have no association with the likelihood of receiving a qualified audit report in the Spanish context (Pucheta-Martı´ nez & De Fuentes, 2007) or with the extent of earnings management in the UK setting (Peasnell, Pope, & Young, 2005). Committee Composition. Independence is the most emphasized attribute of audit committees. An increasing number of studies examine the role of audit committee independence in preventing earnings management. Most research has been conducted in the US markets and has produced mixed results (see Abbott, Parker, & Peters, 2004; Agrawal & Chadha, 2005; Bedard, Chtourou, & Courteau, 2004; Klein, 2002; Lin, Li, & Yang, 2006; Xie et al., 2003; Yang & Krishnan, 2005). A number of studies have documented a negative relationship between audit committee independence and earnings management (Abbott et al., 2004; Bedard et al., 2004; Klein, 2002; Xie et al., 2003), suggesting that improving audit committee independence is effective in improving financial reporting quality. However, Klein (2002) indicates that maintaining a wholly independent audit committee may not be necessary, as no significant association could be found between earnings management and the more stringent requirement of 100% audit committee independence. In contrast, the findings of Bedard et al. (2004) support the requirement in the Sarbanes Oxley Act that all members of audit committees be independent. On the other hand, Lin et al. (2006) focus on fiscal year 2000 only and find that the independence of audit committees has no significant impact on the quality of reported earnings. Consistent with this finding, Agrawal and Chadha (2005) find that audit committee independence is unrelated to the probability of a company restating earnings. Results are also mixed in other contexts. Piot and Janin (2007) find that in France the independence of audit committees makes no difference with regard to earnings management activities. They further explain that

Corporate Governance Related Financial Reporting Issues

37

the collective board responsibility for financial reporting quality may hamper the monitoring incentive of outside directors. Similarly, the relationship between the independence of audit committees and earnings management is found to be nonsignificant in Malaysia (Rahman & Ali, 2006). However, in the Australian setting, it is found that independent audit committees are important governance attributes for financial reporting (Kent, Routledge, & Stewart, 2010; Koh et al., 2007). In addition to earnings management, accounting fraud and audit qualification are also used as proxies for reporting quality to examine the association between audit committee independence and the quality of financial reporting. Consistent results are reported in the US markets. Uzun et al. (2004) find that the likelihood of corporate fraud decreases along with the increased number of independent directors on audit committees. Accounting fraud is more likely associated with firms with fewer outsiders on their audit committees (Crutchley et al., 2007; Farber, 2005). Carcello and Neal (2000) investigate the association between the composition of financially distressed firms’ audit committees and the likelihood of receiving going-concern reports. The results indicate that, for firms experiencing financial difficulties, the greater the percentage of independent directors on the audit committee, the higher the probability the auditor will issue a going-concern report, suggesting that maintaining audit committee independence is essential to protecting auditor independence and hence financial reporting quality. In the Spanish context, Pucheta-Martı´ nez and De Fuentes (2007) examine the relationship between the likelihood that a company will receive a qualified audit report and the existence and characteristics of the audit committee.8 The results indicate that an independent audit committee reduces the likelihood of receiving an error or noncompliance qualification, suggesting the effectiveness of increasing the number of independent members on audit committees. However, an audit committee’s composition has no relation with the likelihood of disclosure of uncertainties and scope limitations, suggesting that introducing independent directors onto audit committees is ineffective in this regard. Committee Expertise. Expertise in finance, accounting, and governance is another important attribute of audit committees, as the major responsibility of an audit committee is overseeing financial reporting and the audit process and safeguarding the quality of financial reporting. In the US markets the majority of studies have found that audit committee expertise benefits accounting quality. For example, Xie et al. (2003) find that audit

38

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

committee members with corporate or financial backgrounds are associated with firms that have smaller discretionary current accruals. The probability of restatement is lower in companies whose audit committees have financial expertise (Abbott et al., 2004; Agrawal & Chadha, 2005; Bedard et al., 2004). Instead of annual earnings numbers, Yang and Krishnan (2005) focus on quarterly earnings management and document that quarterly earnings management is lower for firms whose audit committee directors have greater financial expertise. In the context of accounting fraud, Farber (2005) finds fraud firms have fewer financial experts on the audit committee compared to matched control firms. In contrast, in the Malaysian setting audit committee expertise is found to have no significant impact on the quality of reported earnings (Rahman & Ali, 2006). Committee Meetings. Active audit committees that meet often are expected to “perform their duties in a more responsible manner than committees that meet seldom or never” (Pucheta-Martı´ nez & De Fuentes, 2007, p. 1398). In the US markets, while audit committee meeting frequency is found to be negatively associated with the level of discretionary accruals (Xie et al., 2003) and the occurrence of restatement of annual results (Abbott et al., 2004), Lin et al. (2006) indicate no significant relationship between audit committee meetings and earnings management. In the Malaysian setting, Rahman and Ali (2006) are also unable to find any relationship between financial reporting and audit committee meetings. However, a significant relationship between accrual quality and audit committee meetings is found in the Australian setting (Kent et al., 2010; Koh et al., 2007). In other areas, including fraud and audit reports, results also vary. Farber (2005) finds that financial fraud firms have fewer audit committee meetings, while Uzun et al. (2004) document that the relationship between meeting frequency and incidence of corporate fraud is not statistically significant. In the Spanish context, Pucheta-Martı´ nez and De Fuentes (2007) report that the meeting frequency of audit committees is not significantly associated with audit reports. 2.4.2.2. Auditor Independence and Internal Control Audit committees are also charged with strengthening auditor independence and monitoring internal control systems. As auditor independence and internal control have a direct impact on reporting quality, an examination of audit committees’ effects from these two perspectives enriches the understanding of their function of improving financial reporting quality.

Corporate Governance Related Financial Reporting Issues

39

DeZoort and Salterio (2001) adopt an experimental approach and find that greater independent director experience and greater audit knowledge are associated with higher audit committee member support for an auditor who advocated a “substance over form” approach in a dispute with client management. Audit committees with greater independence and greater governance expertise are more likely to protect external auditors from dismissal following the issuance of an unfavorable report (Carcello & Neal, 2003). With regard to their role in internal control, Zhang, Zhou, and Zhou (2007) document that firms with audit committees that have less financial expertise are more likely to be associated with internal control weaknesses. Independent audit committees and audit committees with financial expertise are less likely to be associated with the incidence of internal control problems (Krishnan, 2005). 2.4.2.3. Audit Committee Process A few studies focus on the audit committee process, intending to better understand audit committees’ activities. Beasley, Carcello, Hermanson, and Neal (2009) provide insights into the audit committee oversight process obtained through in-depth interviews of 42 individuals actively serving on audit committees of US public companies. In addition to evidence of ceremonial action, they also find that many audit committee members strive to provide substantive monitoring of financial reporting. Moreover, they find that many responses vary with personal and company characteristics, with particularly notable differences related to audit committee members’ accounting expertise and time of appointment to the audit committee. The research results suggest that the operation process of audit committee is dynamic and that contextual factors should be taken into account to understand the audit committee function. Gendron and Bedard (2006), by conducting interviews in three Canadian public corporations, examine the process by which meanings of audit committee effectiveness are socially constructed within the small group of people who attend audit committee meetings. The results indicate that attendees’ reflective acts upon processes and activities surrounding audit committee meetings play a key role in configuring meanings of effectiveness. Moreover, the attendees’ degree of confidence in the diverse areas in which the audit committee is involved varies significantly in time and space. Adopting a case study approach, Turley and Zaman (2007) seek to investigate the conditions and processes affecting the operation and potential effectiveness of audit committees in a major UK company, with particular focus on the interaction among the audit committee, individuals from

40

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

financial reporting and internal audit functions, and the external auditors. They find that informal networks between audit committee participants condition the impact of the audit committee and that the most significant effects of the audit committee on governance outcomes occur outside the formal structures and processes. Lin, Xiao, and Tang (2008) use questionnaire surveys to investigate the perceptions of the roles and responsibilities of audit committees in the current business environment in China from the perspectives of investors/ creditors, independent directors (audit committee members), company officers, and auditors. The results show that various groups of stakeholders have generally accepted the ceremonial roles and responsibilities of audit committees in terms of improving corporate governance structure and raising the image of good corporate governance. However, more concrete audit committee oversight roles and responsibilities for improving internal control, rules compliance, sound financial reporting, and auditing processes have not been fully recognized at present, particularly by company management and independent directors. In addition, the results reveal that actual audit committee operations in practice are ineffective, although the majority of Chinese listed companies have set up audit committees. In particular, most audit committees in Chinese listed companies held no or few meetings with a very short meeting duration during a year are rarely involved in the decisions of appointing auditors or determining audit fees, and maintain little contact with internal and external auditors. The factors identified as contributing to ineffective audit committee operations include the constraints of the two-tier board system, the poor qualifications of audit committee members and their insufficient commitment, and the lack of clear and stringent legal requirements on audit committee responsibilities or obligations. However, the authors did not examine these factors in depth. Several studies that have investigated the effectiveness of audit committees in China have produced mixed results. For example, Lo et al. (2010) find that audit committees with financial experts are effective in constraining management’s opportunistic behaviors. By investigating companies issuing B shares that are required to prepare two sets of financial reports under the Chinese generally accepted accounting principles (GAAP) and IFRS, Chen and Zhang (2010) document that audit committees effectively control firms’ application of accounting standards, thus playing a significant role in reducing the earnings differences under the two frameworks. In contrast, in another study that focuses on the same issue, Chen and Cheng (2007) reveal that audit committees are not effective in promoting the convergence of Chinese accounting practices.

Corporate Governance Related Financial Reporting Issues

41

In short, the studies reviewed above largely rely on archival data and attempt to identify the relationship between audit committee characteristics and expected functions, including safeguarding financial report quality, enhancing auditor independence, and monitoring internal control. While these quantitative studies contribute to the extant literature, the contribution is limited because they rarely provide adequate insights into the functioning process of audit committees. Several studies have used a qualitative approach, seeking to unpack the black box of the audit committee process. Their contribution is also limited because of the lack of a comprehensive examination of the contextual environments that largely shape the operation of audit committees.

2.4.3. Auditor Independence Independence is one of the fundamental ethical principles established by professional accounting organizations (e.g., APESB, 2010; IFAC, 2006). The International Federation of Accountants (IFAC) adopts a conceptual approach to auditor independence. In accordance with the IFAC Code of Ethics for Professional Accountants, an auditor should maintain both independence of mind and independence in appearance (IFAC, 2006). These two aspects are defined as follows: Independence of mind the state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgment, allowing an individual to act with integrity, and exercise objectivity and professional skepticism. Independence in appearance the avoidance of facts and circumstances that are so significant a reasonable and informed third party, having knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm’s, or a member of the assurance team’s, integrity, objectivity or professional skepticism had been compromised. (APESB, 2010)

Auditor independence, the cornerstone underpinning the value of audits, is commonly emphasized. For example, the OECD (2004) recommends that an annual audit be conducted by an independent, competent, and qualified auditor in order to add credibility to financial reporting quality by ensuring a fair presentation of the financial statements of a company. In order to enhance auditor independence, it has been suggested that audit committees be charged with recommending and appointing external auditors and overseeing auditor independence and overall interactions with external auditors (ASX, 2010; OECD, 2004). This practice enhances auditor

42

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

independence, as it suggests that external auditors should be accountable to shareholders rather than corporate managers. The importance of auditor independence is reflected in the fact that independence issues are increasingly addressed from a legal perspective. High-profile corporate collapses such as Enron, WorldCom, and HIH illustrate the severe consequences associated with the lack of auditor independence. As a result, auditor independence has been reinforced through legislation in many countries, including the United States and Australia. In the United States, the Sarbanes Oxley Act dramatically affects the accounting profession and provides more stringent independence requirements and more severe penalties for breaches than ever before. Among other things, it greatly restricts the ability of auditors to provide nonaudit services and mandates disclosure of nonaudit services and audit partner rotation. Further, the role of audit committees is considerably strengthened. For example, the Sarbanes Oxley Act stipulates that audit committees be directly responsible for the appointment, compensation, and oversight of the work of auditors. All auditing services and nonaudit services must be approved by audit committees, and auditors must make timely reports to them. In Australia, the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (also known as CLERP 9) was introduced with the main focus on auditor independence. Some of the most significant changes stipulated in the CLERP 9 include additional disclosure in the directors’ report regarding the auditor and the audit, general and specific auditor independence requirements, auditor rotation, and disclosure of nonaudit services. The Chinese government launched the disaffiliation program to sever the relationship between accounting firms and government agencies during 1997 1998 (discussed in detail in Chapter 6). The Chinese Institute of Certified Public Accountants (CICPA) issued the Code of Ethics for Certified Public Accountants in 1997, which establishes fundamental principles of professional ethics for accountants. The Guideline of Ethics for Certified Public Accountants issued in 2002 provides detailed guidelines for complying with the Code of Ethics.9 Listed companies are required to establish audit committees to take charge of accounting and auditing-related affairs in accordance with the Code of Corporate Governance for Listed Companies in China (CSRC, 2002). Nevertheless, while it has been widely recognized that maintaining auditor independence is the cornerstone of improving the quality of financial reporting, there is controversy over what factors actually affect auditor

Corporate Governance Related Financial Reporting Issues

43

independence. Most debate on this issue focuses on whether restrictions placed on such aspects as nonaudit services and auditor tenure can safeguard audit independence. Proponents argue that such restrictions might reduce potential threats to actual and perceived auditor independence resulting from the closeness in the auditor client relationship (Basioudis, Papakonstantinou, & Geiger, 2008; Dee, Lulseged, & Nowlin, 2006). In contrast, opponents insist that the provision of nonaudit services to the same client and longer tenure enable auditors to gain in-depth knowledge about their clients and thus improve audit quality (Chen, Lin, & Lin, 2008; Jenkins & Velury, 2008). In addition, auditor rotation imposes additional costs associated with periodically introducing a new auditor, including potential inefficiency and ineffectiveness (Bedard, Deis, Curtis, & Jenkins, 2008). Researchers have employed archival, experimental, and survey approaches to examine these issues, with most of the available evidence being accumulated based on publicly listed companies in the United States. Taking a different perspective, a number of studies discuss the local construction of auditor independence in context where the concept of auditor independence is imported from Anglo-American countries. The findings indicate that the meaning of auditor independence is historically and culturally constructed (e.g., Hudaib & Haniffa, 2009; MacLullich & Sucher, 2005; Sucher & Kosmala-MacLullich, 2004). The following sections review the literature on nonaudit services, auditor rotation, and the construction of auditor independence, respectively. 2.4.3.1. Nonaudit Services Studies examining the impact of nonaudit services on audit independence report mixed results. Some studies find evidence that the provision of nonaudit services has a detrimental impact on auditor independence and audit quality. For example, Dee et al. (2006) find that for S&P 500 firms, higher proportions of nonaudit fees are associated with higher income-increasing accruals. Financially distressed companies with higher nonaudit fees are less likely to receive a going-concern modified audit opinion in the United Kingdom (Basioudis et al., 2008). By surveying internal and external auditors, Felix, Gramling, and Maletta (2005) document that external auditors with a significant provision of nonaudit services are more likely to be affected by client pressure and less concerned about internal audit quality and coordination with internal auditors. Davis and Hollie (2008) find that nonaudit fees impair perceived auditor independence even when auditors are in fact independent. In New Zealand context, Hay, Knechel, and

44

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Li (2006) report a potential loss in perceived independence, while no evidence is found that the level of nonaudit fees impairs actual auditor independence. Gul, Jaggi, and Krishnan (2007) investigate the joint effects of auditor tenure and nonaudit fees and find that high nonaudit fees have a negative impact on auditor independence when audit tenure is short and client firm size is small. Some studies find no evidence suggesting that the provision of nonaudit services undermines auditor independence. For example, Ashbaugh, LaFond, and Mayhew (2003) show that auditors do not compromise their independence as a result of providing relatively more nonaudit services, measured in terms of the ratio of nonaudit fees to total fees and the sum of audit and nonaudit fees in the US setting. Ruddock, Taylor, and Taylor (2006) suggest that the provision of nonaudit services is not associated with reduced news-based conservatism in Australian listed companies.10 Iyer and Rama (2004) survey 124 certified public accountants (CPAs) in industry employed as chief executive officers, chief financial officers, controllers, or treasurers and find that the purchase of nonaudit services is not related to clients’ perceptions about their ability to persuade the auditor. Instead of focusing solely on nonaudit fees, some researchers examine both audit and nonaudit fees in order to present a more comprehensive understanding. Khurana and Raman (2006) find that both nonaudit and total (audit and nonaudit) fees are perceived to compromise auditor independence and hence undermine the financial reporting credibility of a Big 5 audit in the US setting. Also in US markets Srinidhi and Gul (2007) find that while nonaudit fees reduce accrual quality because of economic bonding, audit fees result in higher accrual quality.11 Consistent with Srinidhi and Gul (2007), Basioudis et al. (2008) document a significant positive relation between audit fees and a going-concern modified audit opinion for financially distressed UK companies, also suggesting a positive impact of audit fees on audit quality. Kinney, Palmrose, and Scholz (2004) investigate the impact of various types of nonaudit services on earnings management and find that the impact of nonaudit services differs in various types of services.12 Cahan, Emanuel, Hay, and Wong (2008) use longitudinal measures (for the period 1995 2001) of nonaudit fees to test the relation between nonaudit fees and auditor independence in New Zealand firms. They find that while discretionary accruals are not individually associated with nonaudit fee growth rates, the length of time of provision of nonaudit service, or client importance measured by nonaudit fees, they are positively and significantly related to the combination of the three factors.

Corporate Governance Related Financial Reporting Issues

45

Rather than focusing on the amount of fees and fee ratios, Lai (2009) examines financially distressed US firms receiving a going-concern modified audit opinion before and after the audit fees and nonaudit fees disclosure requirement introduced in 2000 by the Securities and Exchange Commission. The results show that financially distressed firms are more likely to be issued a going-concern opinion after the disclosure requirement relative to the period before the disclosure requirement, hence providing evidence implying that disclosure of audit fees and nonaudit fees is associated with enhanced auditor independence. Joe and Vandervelde (2007) use an experimental approach to investigate whether knowledge gained from providing nonaudit service can be transferred to enhance audit effectiveness when the same auditor performs both audit and nonaudit tasks and when the auditor only reviews the nonaudit work papers prepared by different auditors in the same audit firm or in a different firm. The results show higher risk assessments when auditors perform both nonaudit and audit tasks, implying a more effective audit strategy in response to higher assessed risk and thus improved audit quality. However, in terms of fraud risk, auditors performing both audit and nonaudit tasks are less professionally skeptical, as evidenced by less fraud risk factors identified, than when a different audit firm provides the nonaudit service. Further, the results suggest that knowledge transfer is only achieved when both audit and nonaudit tasks are performed by the same auditor. In addition, while reporting the benefits of knowledge transfer in audit effectiveness, Joe and Vandervelde (2007) also acknowledge the costs associated with the perception of a loss in objectivity. 2.4.3.2. Auditor Rotation Auditor rotation can occur at both partner and firm levels. While mandatory partner rotation has been adopted in some countries, such as the United States, the United Kingdom, and Australia, audit firm rotation is still subject to heated debate. The following discussion focuses on audit partner rotation. Most current archival studies examining the relation between auditor tenure and audit quality do not document evidence in support of auditor rotation. Carcello and Nagy (2004) find that fraudulent financial reporting is more likely to occur in the first 3 years of the auditor client relationship, and there is no evidence to support that fraudulent financial reporting is more likely given a long auditor tenure. Similarly, Gul et al. (2007) find a positive association between nonaudit fees and positive discretionary current accruals for firms with a short auditor tenure of no more than 3 years,

46

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

suggesting that nonaudit fees may impair auditor independence in cases of short, as opposed to long, auditor tenure. Chen et al. (2008) report that absolute discretionary accruals decrease significantly with both audit partner tenure and audit firm tenure in Taiwanese companies, indicating that neither audit partner rotation nor audit firm rotation improves earnings quality. A positive association has been found between conservatism in reported earnings and auditor tenure, suggesting mandating auditor rotation may have an adverse effect on conservatism in reported earnings (Jenkins & Velury, 2008). Manry, Mock, and Turner (2008) find that auditor partner tenure does not affect audit quality for large clients and shorter tenure small clients. For small clients with a partner tenure of greater than 7 years, they even find audit partner tenure to be significantly and negatively associated with estimated discretionary accruals, suggesting that increased partner tenure benefits audit quality. Blouin, Grein, and Rountree (2007) examine former Arthur Andersen clients and fail to reveal significant financial reporting quality improvements for companies with extreme discretionary accruals that had severed ties with Andersen, indicating some ineffectiveness of mandatory auditor rotation. Carey and Simnett (2006) report mixed results in the Australian setting. They find long-tenure auditors have a lower propensity to issue a going-concern opinion for distressed companies and some evidence of just beating earnings benchmarks. They find no evidence of an association between long audit tenure and abnormal working capital accruals. Studies considering independence in appearance also produced mixed results. Using a sample of former Arthur Andersen clients, Kealey, Lee, and Stein (2007) find that audit fees charged by the successor auditor vary positively with the length of the prior auditor’s tenure, indicating that successor auditors perceived a higher risk from new clients having a longer tenure with their previous auditor. From an investor perspective, Boone, Khurana, and Raman (2008) document a nonlinear relation between audit firm tenure and perceived audit quality. In the early stages of tenure, increased tenure is perceived to improve audit quality. However, as the period of tenure increases, possibly to 13 years and beyond, increased tenure is perceived to have a negative impact on audit quality. Ghosh and Moon (2005) find that earnings coefficients are greater for companies with longer tenure auditors, suggesting that market participants, such as investors and information intermediaries, consider such companies’ earnings to be more useful. Adopting a client perspective, Iyer and Rama (2004) show that respondents (chief executive officers, chief financial officers, controllers, or treasurers) from companies with short auditor tenures are more likely to

Corporate Governance Related Financial Reporting Issues

47

consider that they could persuade the auditor in auditor client disputes based on the survey data. These results are not consistent with concerns expressed by legislators and others that long auditor tenure will adversely affect audit quality. 2.4.3.3. Construction of Auditor Independence A number of studies have documented the influence of local context in the construction of auditor independence. For example, Sucher and KosmalaMacLullich (2004) find the understanding and realization of auditor independence is shaped by the unstable market and immature legal framework in the Czech Republic. MacLullich and Sucher (2005) argue that the concept of auditor independence in Poland is influenced by the accounting traditions (e.g., accounting’s administrative function) under the centrally planned economy. In Saudi Arabia, Hudaib and Haniffa (2009) indicate that Islamic teachings have a considerable impact on the meaning of auditor independence. These studies provide insights into the practice of auditor independence within contexts different from Anglo-American countries, indicating the importance of taking into account local socioeconomic and cultural influence. The findings reveal that without the recognition that there are differences in local culture and accounting traditions, it is unlikely that substantial rationalization of auditor independence will be achieved even though the form of audit procedures is followed (Hudaib & Haniffa, 2009; MacLullich & Sucher, 2005; Sucher & Kosmala-MacLullich, 2004). However, these studies do not provide adequate discussion of local context. In China, researchers have largely focused on ascertaining audit quality difference between local accounting firms and international accounting firms. For example, Chen and Cheng (2007) investigate the effectiveness of improving audit quality by merging local Chinese CPA firms with the Big 4 firms on the harmonization of Chinese accounting practices. Their findings reveal that the measure of improving audit quality is not effective in promoting harmonization. Chen et al. (2006) show that there is no significant difference in deterring corporate financial fraud between prestige auditors (based on size and then Big 5) and other auditors. In contrast, Xiao et al. (2004b) find that auditor type (based on size and then Big 5) does influence Chinese listed companies’ Internet disclosure in terms of the voluntary adoption of Internet-based financial reporting, as well as the extent of the disclosure. In short, the meaning and operation of auditor independence have been subjected to extensive research. As discussed previously, IFAC adopts a conceptual approach to define auditor independence and emphasize both

48

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

actual independence and perceived independence (IFAC, 2006). However, the majority studies adopt a narrow view to examine auditor independence issues by largely relying on a quantitative methodology to ascertain the relationship between various factors, including nonaudit services and auditor rotation, and auditor independence. Such studies provide limited insights because the meaning and operation of auditor independence cannot be measured by statistical relationships. As indicated by studies that investigate local constructions of auditor independence, how the concept of auditor independence is interpreted and practiced needs to be examined from a historical and cultural perspective (Hudaib & Haniffa, 2009; MacLullich & Sucher, 2005; Sucher & Kosmala-MacLullich, 2004). This view is particularly relevant to China because the Chinese accounting profession has developed in a different setting from Anglo-American countries (discussed in detail in Chapter 6).

2.4.4. Corporate Code of Conduct Management integrity is closely related to the quality of financial reporting. A corporate code of conduct encourages high ethical standards, facilitates company directors and senior managers in fulfilling their responsibility, and makes the company credible and trustworthy. The OECD (2004) recommends developing company codes of conduct that serve as a standard for conduct by both the board and key executives when exercising judgment in dealing with varying and often conflicting constituencies. Company codes of conduct also help the board oversee the internal control systems by encouraging the reporting of unethical behaviors that might also compromise the integrity of financial statements. The ASX in Australia states that a code of conduct is an effective way to guide the behavior of directors and key executives and suggests that companies establish such a code to clarify the standards of ethical behavior required of directors and key executives (ASX, 2010). In the United States, the NYSE requires that listed companies adopt and disclose a code of business conduct and ethics for directors, officers, and employees in order to help foster a culture of honesty and accountability (NYSE, 2003). The Sarbanes Oxley Act requires a company to adopt a code of ethics specifically for senior financial officers. The above discussion indicates that encouraging ethical behaviors is an important part of corporate governance and adopting a corporate code of conduct is an effective way to apply high ethical standards. Further,

Corporate Governance Related Financial Reporting Issues

49

corporate codes of conduct primarily concerning senior management’s ethics are essential and useful in promoting high ethical standards for directors and key executives, who in turn set the tone at the top within organizations (Treadway, 1987). The Code of Corporate Governance for Listed Companies in China does not explicitly state the ethical requirements of the board, management, and employees, nor does it require the establishment of a corporate code of conduct. The absence of an ethical component in this code likely indicates that ethical issues have not obtained due attention in China. A corporate code of conduct is expected to have a positive impact on the outcome of financial reporting by providing moral guidance to employees. Bosch (1993) emphasizes that a code of ethics can encourage employees to adhere to ethical principles throughout the organization. The practice of corporate ethics helps incorporate ethical standards into the culture of an organization (AICD/KPMG, 1998). A growing number of corporations worldwide are developing and implementing codes of conduct. Kaptein (2004) reports that 52.5% of the 200 largest corporations in the world have ethical codes. However, the presence of a code of ethics does not of itself ensure that the rules will be willingly followed (see also Allmon & Grant, 1990), which is partly evidenced by the mixed results generated by empirical studies. Somers (2001) surveys 613 management accountants in the United States and compares those working in organizations with and without a code, respectively. The results indicate that organizations promoting ethical behavior are less likely to be associated with wrongdoing and have higher levels of employee commitment. In contrast, McKendall, DeMarr, and Jones-Rikkers (2002) analyze data from a survey sent to 315 companies in the United States and find no evidence that codes of conduct help reduce legal violations. As Graves (1924, p. 59) states: The code of ethics is not a cure-all, and it possesses no magic powers by which it can change moral darkness into light, but it is an effective instrument which now contributes much, and which, with proper use, can be made to contribute much more, to the cause of truth and honor in business relationships.

Similarly, Schwartz (2001, p. 260) points out that “codes of ethics can be an important first step towards the objective of encouraging legal and ethical behavior. Codes, however, are by no means the only necessary step.” In order to achieve the desirable results, appropriate communication, strong enforcement, and top management’s commitment are essential. El’fred and Koh (2001) survey 400 master of business administration

50

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

students employed as top or middle managers to examine the effectiveness of a code of conduct. Their results show that the code of conduct together with code-supporting variables (i.e., communication, enforcement, and use of code) and organizational ethics variables (i.e., top management’s support for ethical behavior, association between ethical behavior and career success, and ethical climate) have a significant and positive incremental influence on organizational ethical behavior. The significance of communication, implementation, and monitoring in ensuring the effectiveness of codes of conduct is also stressed by Kolk and Van Tulder (2002) and Somers (2001). In short, the studies reviewed suggest that a corporate code of conduct is useful in adding value to the integrity of financial reporting. In order to ensure effectiveness, it is critical that strong enforcement support the development of an appropriate corporate code.

2.4.5. Summary By identifying independent directors, audit committees, auditor independence, and corporate codes of conduct as important corporate governance mechanisms that directly affect financial reporting quality, this section has reviewed prior studies that focus on corporate governance related financial reporting issues. Three themes emerge from the literature review. First, the majority of the studies examining the relationship between corporate governance and financial reporting use a quantitative research methodology with a focus on capital market research and survey. While these studies shed light on the issues under investigation, there are some common limitations. By relying on quantifiable data and statistical testing, this trend of research has largely failed to provide an adequate understanding of the dynamic interrelationships among important parties involved in real practices, including directors, management, audit committee members, and internal and external auditors. In addition, by relying heavily on archival, experimental, and survey data, these studies do not provide adequate insight into corporate governance and accounting practices and the contextual settings that shape those practices. Furthermore, these studies often produce mixed results. The conflicting results likely suggest that implementing good corporate governance mechanisms does not necessarily guarantee improved financial reporting. However, without an adequate examination of interactions among organizational players and the contextual environment, these studies provide limited insights into the issues under investigation.

Corporate Governance Related Financial Reporting Issues

51

Second, while there are a few studies using a qualitative approach, these studies largely fail to provide a rich understanding of the issues under investigation. For example, although the impact of local institutional settings in shaping the operation and effectiveness of imported principles and standards is recognized by some researchers (e.g., MacLullich & Sucher, 2005; Sucher & Kosmala-MacLullich, 2004), there has been no adequate discussion of the relevant contextual characteristics of the countries under examination. Additionally, these studies usually focus only on one or two corporate governance mechanisms and thus fail to provide a comprehensive understanding of corporate governance related financial reporting issues, given the complex interactions among corporate governance mechanisms in general and independent directors, audit committee, auditor independence, and corporate codes of conduct in particular.13 Third, regardless of the considerable changes in corporate governance and financial reporting practices in China, only a limited number of studies have been directed at examining issues associated with these changes. Further, these studies provide limited insight into China’s convergence with internationally acceptable standards because they largely fail to thoroughly examine China’s contextual environment. Corporate governance and financial reporting do not operate in a vacuum, and their operation and effects cannot be adequately examined without considering the institutional context in which they function. Particularly, China has a different institutional environment from that of Anglo-American countries, and the institutional differences in terms of infrastructure, culture, legal, socioeconomic, and political systems may considerably shape the enforcement of the imported principles and standards.

2.5. CONCLUDING REMARKS Over the past few decades, the process of globalization has substantially altered the fields of corporate governance and accounting. More specifically, Anglo-American models of corporate governance and financial reporting have received increasing momentum in emerging economies, including China. However, regardless of their growing acceptance, there is limited research examining the implementation of Anglo-American concepts in emerging economies. A clear mismatch between the wide spread of Anglo-American principles and the extant literature has been revealed after reviewing studies that

52

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

investigate the governance roles of independent directors, audit committees, auditor independence, and corporate codes of conduct in improving financial reporting. The review shows that most studies have been conducted in Anglo-American countries. The effectiveness of AngloAmerican models of corporate governance and financial reporting has not been rigorously examined in countries that have different contexts from Anglo-American countries. This is particularly the case in China. This monograph extends the existing literature by comprehensively investigating the adoption of internationally acceptable principles and standards in China. In addition, this review has a number of implications for developing the theoretical framework and determining the research methodology for the current study. First, to thoroughly understand the adoption and enforcement of the imported standards and principles in China, which has different economic, social, and political environments, a comprehensive examination of China’s context is required. Second, instead of a narrow focus on quantification and statistical testing, this monograph seeks to provide insights into the complex processes of corporate governance and accounting practices and offer a richer account of the behaviors of key players involved in those practices by conducting the study in a real setting informed by a qualitative research methodology. Third, by incorporating independent directors, audit committees, auditor independence, and corporate codes of conduct in a single study, this monograph seeks to provide a comprehensive understanding of the adoption of internationally acceptable principles and standards in China. .

NOTES 1. In contrast to the unitary board in the Anglo-American system, there are typically two separate boards in the communitarian system, with an executive board responsible for managerial decisions and a supervisory board responsible for overseeing the executive board (Epstein, 2012). 2. Choi et al. (1999) argue that emerging economies still have relatively young legal systems that have yet to fully develop the legal framework necessary to classify their corporate governance systems into the other categories. 3. http://www.oecd.org/daf/ca/, accessed on September 7, 2013. 4. http://ec.europa.eu/internal_market/consultations/2011/corporate-governanceframework_en.htm, accessed on September 7, 2013. 5. http://www.iasplus.com/en/resources/ifrs-topics/use-of-ifrs, accessed on September 7, 2013.

Corporate Governance Related Financial Reporting Issues

53

6. Unlike most other studies that focus on financial statement fraud, corporate fraud in this study includes fraud of stakeholders, fraud of government, and frauds of financial reporting and regulatory violations (Uzun et al., 2004). 7. Turley and Zaman (2004) provide a review of earlier empirical research on the governance effects associated with audit committees. 8. In this study, they predict that firms with a higher proportion of independent directors on the audit committee will be less likely to receive qualifications for errors or noncompliance and more likely to disclose qualifications such as uncertainties and scope limitations than firms with a lower proportion. They argue that with regard to errors and noncompliance, the audit committee can place pressure on management to accept the auditor’s proposed adjustments, thus reducing the possibility of receiving a qualified opinion. 9. Both documents were replaced by the new Code of Ethics for Certified Public Accountants issued in 2010. 10. News-based conservatism refers to situations where accounting income reflecting bad news is released on a more timely basis than good news (Ruddock et al., 2006). 11. They argue that audit fees reflect auditor effort and audit quality, which explains the positive impact of audit fees on accrual quality. In contrast, the provision of nonaudit service compromises auditor independence and therefore undermines accrual quality, which results in a negative relationship. 12. The results indicate no significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements while some positive association for unspecified nonaudit services and restatements. Surprisingly, a significant negative association between tax services fees and restatements is documented, which is explained by the net benefits associated with tax services. 13. For example, codes of conduct are set up by boards consisting of a majority of independent directors. They are particularly binding on directors, including audit committee members and senior managers, who set the tone at the top. Audit committees are charged with mediating conflicts between managers and auditors, strengthening communication between boards and auditors, and protecting auditor independence.

CHAPTER 3 THE DEVELOPMENT OF ACCOUNTING THOUGHT AND PRACTICES IN CHINA

ABSTRACT This chapter examines the development of accounting thought and practices in China with the purpose of illustrating its relevance to current accounting policies and practices. The review indicates that changes in accounting in China did not usually occur completely and easily. Over the past three decades, while Chinese accounting has gradually moved toward the Anglo-American model, convergence has presented unique features in China. For example, the review suggests that the accounting reforms in China have been heavily government-driven and that uniform accounting systems still remain. Chinese regulators maintain a cautious attitude toward the application of fair value and professional judgment, which are essentially the center of the Anglo-American accounting system. Furthermore, Chinese accounting regulators have a different view of business combinations from the IASB and have developed alternative accounting methods for those transactions. China’s departure from IFRS reflects its politico-economic context and essentially challenges the IASB’s goal of achieving international accounting convergence. China’s approach to internationally acceptable practices is likely to have implications for the effectiveness of the imported ideas. Keywords: Accounting thought; historical and cultural characteristics

55

56

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

3.1. INTRODUCTION This chapter examines the historical development of accounting in China and provides an understanding of its contemporary relevance to current accounting policies and practices. Accounting history allows us to better understand our present and to forecast or control our future (Haskins, 1904). It supports contemporary research in policy making, practice, and standard setting and encourages thoughtful scholars to consider the interdisciplinary nature of accounting and its environmental context (Previts, Parker, & Coffman, 1990). Accounting in China has a long history that can be traced back to the Hsiu Dynasty, around 2200 BC (Doupnik & Perera, 2011). Traditional Chinese accounting dominated in China’s feudal society before the 20th century. The Opium War, which began in 1840, opened the door of China to Western countries and turned China into a semi-feudal and semi-colonized country.1 Since then Western accounting thought and practices have been introduced by colonists in key industries that are under their control, such as customs, railways, and post offices. Following the overthrow of the Qing Dynasty (1636 1911), the last feudal dynasty in China’s history, the Warlord government (1911 1927) issued accounting law and auditing law that were largely based on Japanese laws. The accounting reforms under the Nationalist government (1927 1949) were heavily influenced by the United Kingdom and the United States. The formation of the People’s Republic of China in 1949 began a new era in China. The accounting system underwent significant changes in accordance with changes in the political, economic, legal, and cultural systems. A uniform accounting system was imported from the Soviet Union to serve the government’s planning and control needs in the centrally planned economy. Accounting under the Soviet model was characterized by being simple, being based on historical cost, being highly legalistic, and involving little professional judgment. The economic reform and open-door policies initiated in 1978 have gradually transformed China from a centrally planned economy to a market-oriented one. Accordingly, Chinese GAAP has been increasingly moving toward internationally acceptable accounting practices that are largely based on the Anglo-American model. Accounting practices have become more complex and flexible, emphasizing the substance over form principle, the role of professional judgment in ensuring a “true and fair view” of financial reports, and increasing the application of fair value. As indicated by the theoretical framework in the chapter “An Integrated Institutional Perspective,” in the context of globalization, accounting in

The Development of Accounting Thought and Practices in China

57

China is largely shaped by both international and domestic influences. An analysis of accounting development in China provides insights into how Chinese accounting has over the years interacted with those contextual factors. These insights are important in understanding the issues associated with the recent globalization and convergence. The remainder of this chapter is organized as follows. Section 3.2 explains the evolution of traditional Chinese accounting. Section 3.3 discusses accounting under a centrally planned economy. Accounting under China’s market-oriented economy is reviewed in Section 3.4. Section 3.5 ends the chapter with some concluding remarks.

3.2. TRADITIONAL CHINESE ACCOUNTING Traditional Chinese accounting has a history of thousands of years, gradually evolving from a single-entry to a double-entry framework. The decline of traditional Chinese accounting was largely attributable to influences of Western accounting.

3.2.1. From Single-Entry to Double-Entry The earliest accounting records were found in the inscriptions on bones or tortoise shell of the Shang Dynasty (1700 1100 BC). However, a formal accounting system emerged only in the Western Zhou Dynasty (1100 771 BC; Aiken & Lu, 1998). China had been a feudal society since the Western Zhou Dynasty, with a natural economy of being self-sufficient. The government focused mainly on agriculture and comparatively undervalued commerce (Ji, 2003). The development of industry and commerce was very slow under the feudal system (Aiken & Lu, 1998). As a result, there was no need for sophisticated accounting, and the single-entry accounting framework was used for over two millennia before it evolved into the double-entry accounting framework. 3.2.1.1. Chinese Single-Entry Framework The concept of accounting was initially developed by the government in the Western Zhou Dynasty (1100 771 BC). During this period, the government appointed officers to be responsible for recording, revenue accounts,

58

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

expenditure accounts, and balance accounts, respectively, and established regular accounting reporting and property auditing systems (Qian, 2002). The method used in government accounting was single-entry bookkeeping. The account books took two forms, Cao Liu and Zong Qing (Guo, 1988). Cao Liu was used to record daily transactions as they occurred, which were subsequently posted to various accounts in Zong Qing according to transaction categories. Government accounting transactions usually involved financial revenue and expenditure items. Accordingly, Chinese Ru (in) and Chu (out) were designated as recording symbols. Because of the lack of a single unified monetary unit, which was not created until the Qin Dynasty (221 206 BC), accounting entries in the two books were mainly descriptive and the inventories were recorded in their weight and size instead of monetary value. The Three Column method was used to calculate ending balances.2 Early in the period of Spring and Autumn (770 476 BC), Confucius Kung Tze (551 479 BC) proposed the earliest accounting principle “balanced, reliable and accurate accounting” in China. The earliest form of feudalistic law Fa Jing, formed in the Warring States Period (476 221 BC), contained provisions concerning accounting that prescribed the requirements for accounting accuracy and record keeping, the responsibilities of accounting-related officers, and penalties for misconduct (Li, 2002). Emperor Qin Shi Huang (259 210 BC) of the Qin Dynasty unified the nation and introduced standardized writing characters, a unit of currency, and a system of weights and measures, which facilitated economic development and commercial trade. This enabled nongovernment accounting to start to grow. Initially, nongovernment accounting was separate from government accounting and developed independently (Aiken & Lu, 1998). While Ru (in) and Chu (out) were used for government accounting, the Chinese characters Shou (receipt) and Fu (disbursement) were determined as recording symbols in nongovernment accounting. Accounts, including sales, expenditure, profit, accounts receivable, and accounts payable, began to emerge at this time (Guo, 1988). In addition, with currency unification, the monetary value of goods began to be recorded. The Tang and Song Dynasties (618 1297) constituted a golden age during which China experienced considerable development in manufacturing and commerce, which entailed the invention of the Four Column method.3 Gradually, government accounting and nongovernment accounting came to influence each other, and Ru (in) and Chu (out) and Shou (receipt) and Fu (disbursement) were used in both the public and private sectors. Accounting reports were required on a regular basis.

The Development of Accounting Thought and Practices in China

59

During the Ming and Qing Dynasties (1368 1911), the single-entry method became more systematic and complete. Shou (receipt) and Fu (disbursement) gained more widespread use. The Four Column method was used to prepare government accounting reports. It was also used in nongovernment accounting to calculate profit. 3.2.1.2. Chinese Double-Entry Framework The development of manufacturing, commerce, and banking in the Ming and Qing Dynasties (1368 1911) introduced increased complexity into economic activities and business relationships and facilitated the evolution from single-entry to double-entry bookkeeping. The most influential Chinese double-entry frameworks, known as the Longmen and the Four Feet Bookkeeping Systems, were developed in this era (Wei, 1984). Before the emergence of the Chinese double-entry frameworks, Three Feet Bookkeeping, based largely on the single-entry framework, functioned as an intermediate system and was widely used. The Three Feet Bookkeeping System incorporated features of both single-entry and double-entry. Double-entry was used to record noncash transactions, while cash transactions were only recorded in single-entry. The practice was known as Three Feet Bookkeeping because the doubleentry for a noncash transaction represented two feet and the single-entry for a cash transaction showed one foot. A cash diary was maintained to record cash receipts and cash payments. The Four Column method was used to arrive at the cash balance, which was then checked with the actual cash on hand. The Longmen Bookkeeping System originated from the Four Column method at the end of the Ming Dynasty (1368 1644), and the beginning of the Qing (1636 1911) and was applied in private business accounting. It was invented by Qingshan Fu, a businessman in Shanxi Province (Zhu, 2002). Under this system, Sou (receipt) and Fu (disbursement) were used as recording symbols and had to appear simultaneously because a doubleentry was required for each transaction. All accounts were grouped into four categories: Jin (receipt), Jiao (payment), Cun (keeping), and Gai (owing). Each category had a number of subitems. Receipt reported all the income, and payment recorded all the expenses. Keeping represented the increase in assets, while owing represented the increase in liabilities and owner’s equity. Receipt and owing items were always recorded under Sou (receipt) and keeping and payment items under Fu (disbursement). At the end of each financial year the difference between keeping and owing was worked out, which was used to match the difference between receipt and

60

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

payment to check the accuracy of the calculation and obtain the profit or loss amount.4 The process of dual calculation of profit (or loss) and checking account balance relationship was called He Longmen. The Longmen framework was an embryonic symbol of Chinese double-entry, reflecting the development of early capitalism. The development of a commodity economy during the Qing Dynasty contributed to the creation of the Four Feet Bookkeeping System. At this time in China it was recognized that all transactions were grouped into either cash or noncash transactions. Double-entry bookkeeping recorded four lines for two types of transactions, hence the origin of the term Four Feet Bookkeeping (Kang, 2007). The system was also known as the Heaven and Earth Matching bookkeeping system (Tian Di He Zhang). The framework for the Four Feet Bookkeeping System emerged in the middle of the 18th century. Its inventor remains unknown, but it was widely used in Yunnan Province (Guo, 1986). It was an advanced form of Chinese doubleentry framework that had evolved from the previous Three Feet and Longmen Bookkeeping Systems. The main improvement of the Four Feet over the Longmen was that it made accounts classification, recording, accounts control, and reporting more scientific and systematic.5 It is worth noting that while Chinese double-entry framework was invented during this period, the single-entry framework still dominated the accounting domain. In short, the development of traditional Chinese accounting was slow and the transition from single-entry to double-entry was incomplete (see also Aiken & Lu, 1998; Ji, 2003). The main reason for this was the strong resistance exhibited by the forces of feudalism (Ji, 2003). The feudal government’s oppression of commerce, industry, and foreign trade impeded the development of capitalism in China. Furthermore, under feudal society accounting was regarded only as a technical skill and taught by masters to their apprentices. There was little uniformity in accounting methods, and they varied from industry to industry and from region to region. Different people used different methods and passed them on orally from generation to generation (Ji, 2003). As a result, until the 20th century China had little literature about accounting, and accounting experience was not converted into a formal body of knowledge (Aiken & Lu, 1998).

3.2.2. The Decline of Traditional Chinese Accounting China had experienced a turbulent period from 1840 to 1949, passing through the late Qing Dynasty (1840 1911), Warlord government (1911 1927), and

The Development of Accounting Thought and Practices in China

61

the Nationalist government (1927 1949). Accordingly, accounting underwent considerable changes. The practice of traditional Chinese accounting started to decline, and Western accounting concepts and practices were gradually introduced. 3.2.2.1. The Introduction of Western Accounting The defeat in the First Opium War (1840 1842) transformed China from feudalism to semi-colonialism and semi-feudalism. Ancient feudal foundations were rapidly eroded by the power of capitalism (Su, 1985). Western accounting, including debit credit bookkeeping,6 was introduced in China along with the colonialists’ capital and their takeover of key industries, including customs, railways, and post offices. Western accounting was used, for example, in manufacturers, trading companies, and banks established by foreigners. The customs administration began to use Western bookkeeping methods and regularly presented financial reports according to the Gregorian calendar following the takeover by the colonial powers of Portugal, Spain, and Great Britain in 1845.7 These methods were also adopted by the railways and post offices (Guo, 1999). Xi-Yong Cai’s Lian Huan Zhang Bu (Chain Accounting System) in 1905 was the first indigenous book to introduce Western double-entry accounting practice. Cai believed that China’s industries lagged behind those of Western countries. Reforming traditional Chinese accounting was a prerequisite for developing industries in China. He intended to integrate Chinese and Western accounting methods, absorbing the benefits of Western accounting to compensate for the weaknesses of Chinese accounting methods while maintaining their strengths. This book had a significant influence on reforming traditional Chinese accounting (Guo, 1999). 3.2.2.2. Reforms of Traditional Chinese Accounting Western accounting was gradually adopted by the Chinese government in its reform of traditional Chinese accounting. For example, in 1908 the government Hubu Bank was replaced by the Daqing Bank,8 which attempted to experiment with Western accounting thought and practices. The government sent students to Japan to learn Western accounting and set up a school to train accountants in the use of the new bank accounting methods. In 1911, the Qing Dynasty was overthrown by the Xinhai revolution and replaced with the Republic of China, initiating China’s Warlord era. In 1912, the Warlord government founded the Bank of China using the format of the Daqing Bank. Lin Xin was nominated as the chief accountant and set out to reform bank accounting. By 1916 the accounting methods

62

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

used in the Bank of China had become Western in nature, and the traditional accounting system had been abandoned (Li, 1982). Under the Warlord government the Ministry of Finance was set up in 1912 to take charge of accounting affairs. Government accounting reform was begun with the introduction of the Accounting Law of the Republic of China (the country’s first accounting law) and the Auditing Law of the Republic of China (its first auditing law), which were framed largely on the basis of Japanese laws (Lu, Ji, & Aiken, 2009). In 1915, the government drew up financial regulations and issued the General Bookkeeping Manual for Governments. In addition, several accounting regulations for the four state-monopolized industries, namely, post, railroads, telecommunication, and shipping were issued during the period 1911 1927 (Xu & Xu, 2003). In 1927, the Nationalist government was established. Because of the government’s relationship with the United Kingdom and the United States, the Japanese influence was replaced with the Anglo-American influence. Experts from the United Kingdom and the United States were invited to assist in government restructuring (Aiken & Lu, 1998). Among other things, the Nationalist government endeavored to strengthen the government accounting system and to unify accounting practices in industries. In July 1932, the Unified Government Accounting System was promulgated. It prescribed the classification, form, and filing methods for source documents, the use of journals, posting from journals to ledgers, and reporting requirements. The Accounting Regulations for All Government Agencies was issued in 1938, which, among other things, encouraged the use of debit credit double-entry bookkeeping (Aiken & Lu, 1998). Furthermore, the Nationalist government also set up uniform accounting systems for monopolized industries. For example, the Accounting System of Railways and the Accounting System for Telecommunications were issued in 1934, and the Accounting System for Post Service enterprises was issued in 1938. In addition, in the 1930s some leading accounting practitioners initiated an enterprise accounting reform campaign that aimed at reviving declining local industries. How to reform traditional Chinese accounting was hotly debated. The focus of the debate was whether China should completely import Western accounting methods or retain and improve its own traditional ones. Yong-Zha Xu (1891 1959) and Xu-Lun Pan (1893 1985), representatives of both sides, were prestigious accountants. According to Yong-Zha Xu, although there were many problems within traditional Chinese accounting, such as lack of organization of recording books and confusing relationships between various accounts, they could be solved by referring to Western accounting. The main features of indigenous Chinese

The Development of Accounting Thought and Practices in China

63

accounting, including the recording symbols Shou and Fu, along with traditional recording methods should be retained (Xu, 1933). Yong-Zha Xu invented a cash receipt payment method that was intended to gain the advantages of the Western bookkeeping methods while recognizing Chinese accountants’ traditional habits. This method was welcomed by accountants (Lu et al., 2009). Also, Xu-Lun Pan argued that improving traditional Chinese accounting was only a temporary solution and from a long-term perspective traditional Chinese accounting must be replaced with Western accounting (Cheng & Guo, 2001). Xu-Lun Pan’s arguments significantly influenced accounting reform in the majority of enterprises in his time (Guo, 1999). In short, Western accounting thought was adopted in China along with the introduction of capitalism. Chinese governments, including Warlord governments and the Nationalist government, played a leading role in reforming accounting, which aimed at unifying accounting practices. The reforms were considerably influenced by outside influences such as Japan, the United Kingdom, and the United States. However, reforms based on imported ideas encountered resistance in China. For example, the first Chinese accounting and auditing laws, modeled on those of Japan, were never fully implemented (Lu et al., 2009). The debate with regard to reforming Chinese bookkeeping methods lasted for six decades.9

3.3. ACCOUNTING UNDER A CENTRALLY PLANNED ECONOMY Following the establishment of the People’s Republic of China in 1949, a centrally planned economy imported from the Soviet Union was in place for three decades. The basic purpose of accounting in the planned economy was to serve the government’s planning and control needs (Winkle, Huss, & Chen, 1994). The accounting system had two main features, namely, a uniform accounting system approach to accounting regulation and fund-oriented accounting practice.

3.3.1. A Uniform Accounting System Approach to Accounting Regulation A uniform accounting system used in the Soviet Union was introduced to accommodate the planned economy (Chen, Jubb, & Tran, 1997; Tang,

64

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Chow, & Cooper, 2003).10 The development of the accounting system had focused on unifying fiscal revenue and expenditure since the central government issued the Decision on Unified Fiscal and Economic Work in March 1950. The Provisional General Budget Accounting System for Governments at Different Levels and Provisional Budget Accounting System for Governmental Departments at Different Levels were promulgated in December 1950. In addition, a series of uniform accounting systems tailored for various industries came into effect in 1950. The Accounting Guideline of Compilation and Submission of Financial Statement for SOEs was issued in 1955. The accounting regulation composed of unified government and industry-specific accounting systems significantly contributed to the recovery of the national economy and the development of the planned economy (Guo, 1999).

3.3.2. Fund-Oriented Accounting Practice Accounting practices had been developed based on the concept of “sources and applications of funds,” which were the two basic accounting elements to report on fund management practice. Fund applications reflected information about the employment and utilization of funds, such as acquiring property, goods, and materials for production, while fund sources referred to the channels from which the funds were obtained (Chow, Chau, & Gray, 1995). The acquisition of fixed assets was financed by the fixed funds, current funds were used for current assets, and specific funds were particularly used for specific development projects. The corresponding relationship between fund applications and fund sources must be strictly maintained. The Chinese format of the balance sheet presented the relationship between fund sources and fund applications. While some generally accepted accounting principles in Anglo-American countries, including those of accrual, consistency, revenue realization, going concern, historical cost, and the distinction between capital and revenue expenditure, were adopted in Chinese accounting regulations (Bai, 1988), the concept of conservatism was not practiced in China. Enterprises were not allowed to provide for possible losses arising from obsolete stock and doubtful debts. Conservatism was regarded as a tool of capitalist exploitation (Xin & Huang, 1951; Yan, 1951). Furthermore, Bai (1988) and Zhou (1988) point out that there was no need to practice this principle in China’s context of a planned economy. Under a planned economy, the central government strictly controlled the prices of commodities, and this,

The Development of Accounting Thought and Practices in China

65

coupled with the scarcity of resources and goods, meant that it was impossible for stock to become obsolete. Historical cost was the sole basis permitted to measure the value of assets according to the accounting regulations. Therefore, in such particular circumstances, conservatism was unnecessary and prohibited.

3.4. ACCOUNTING UNDER A MARKET-ORIENTED ECONOMY Following the reform and open-door policies in the 1980s, in order to accommodate emerging types of ownership, particularly foreign-invested enterprises and shareholding enterprises, a series of accounting reforms was launched by the government that directed Chinese accounting practices toward internationally acceptable ones. However, China’s approach toward international accounting harmonization reflects its politico-economic context.

3.4.1. Accounting for Foreign-Invested Enterprises The initial demand for international accounting harmonization was created by foreign-invested enterprises (Xiang, 1998). These enterprises differed from state enterprises in terms of their organizational and capital structures. To accommodate foreign-invested enterprises’ unique features, the MOF announced the Accounting System for Foreign Joint Ventures in 1985, based on the Law of the People’s Republic of China on Foreign Joint Ventures promulgated in 1979. In consideration of the need for foreign investors to consolidate Chinese operations with their parent financial statements, the accounting system was developed to a large extent by reference to international accounting practices. This represented the first attempt at international harmonization in China. For example, the Accounting System for Foreign Joint Ventures identified five accounting elements, namely, assets, liabilities, equity, revenue, and expenses, and adopted AngloAmerican accounting equations, such as assets equal liabilities plus equity. Assets were classified into six major categories comprising current assets, long-term investments, fixed assets, construction in progress, intangible assets, and other assets, while liabilities were composed of current liabilities, long-term liabilities, and other liabilities. The system also explicitly required

66

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

application of the principles of historical cost, matching, consistency, and revenue recognition. However, to align with China’s uniform accounting system a uniform chart of accounts and format of financial statements were also issued by the MOF. In response to the rapid growth of foreign investment, the Accounting System for Foreign-Invested Enterprises was issued by the MOF in 1992 to replace the Accounting System for Foreign Joint Ventures. The Accounting System for Foreign-Invested Enterprises took a closer step toward international accounting practices. For example, it was the first time that provisions for possible losses arising from doubtful debts and obsolete stock were allowed.

3.4.2. Accounting for Shareholding Enterprises The emergence of shareholding enterprises created new information user groups and called for changes in financial reporting. The traditional accounting regulations designed for the planned economy and public ownership were inadequate for investors entering the emerging Chinese stock markets (Winkle et al., 1994). In May 1992, the MOF issued the Accounting System for Experimental Joint Stock Limited Enterprises, which required enterprises to provide a balance sheet, an income statement, and a statement of changes in financial position. The classification of assets, liabilities, and equity also referred to international accounting practices. This was the first time international accounting principles were applied to domestic enterprises. In 1998, based on the accumulated experience of governing shareholding companies, the MOF issued the Accounting System for Joint Stock Limited Enterprises to replace the Accounting System for Experimental Joint Stock Limited Enterprises, which represented a comprehensive effort at harmonization (Chen, Sun, & Wang, 2002).

3.4.3. Coexistence of Accounting Standards and Industry-Specific Accounting Rules A variety of ownership, including state-owned, privately owned, foreign joint venture, town- and village-owned, and shareholding enterprises, coupled with new forms of economic activities, such as business combinations and lease transactions, challenged the traditional accounting system. The major concern for the system was the lack of a set of complete and

The Development of Accounting Thought and Practices in China

67

coherent accounting theories underpinning a uniform and rigid accounting system. There was an urgent need to develop a conceptual framework that would provide a theoretical justification for accounting practices and serve as guidance for dealing with contemporary accounting issues (Chow et al., 1995). In 1988, the MOF embarked upon a standard-setting project that aimed at establishing accounting standards appropriate for China’s socioeconomic environment. Four years later, the MOF issued the first accounting standard, ASBE-Basic Standard. The ASBE-Basic Standard was equivalent to the conceptual framework in Anglo-American countries and served as the framework for developing specific accounting standards and other accounting regulations in China. It set out the objective, qualitative characteristics, and elements of financial reports, as well as assumptions underlying financial reports.11 In particular, it expanded the traditional accounting function of the provision of information for government decision-making in the planned economy to incorporate the needs of external users for an understanding of an enterprise’s financial position and financial performance and the needs of managers of enterprises for strengthening their financial management and administration. The standard was applicable to all enterprises established in China and superseded in principle all other accounting regulations issued earlier. As a result the fund-oriented accounting system that had been practiced for decades was abolished. However, the ASBE-Basic Standard did not provide sufficient guidance on the application of permitted accounting methods. Furthermore, the accounting standard development was still at the transitional stage, and it might take several years to develop a full set of operational accounting standards. To facilitate the implementation of the ASBE-Basic Standard, the MOF subsequently issued 13 industry-based accounting rules to provide technical guidelines. Both the ASBE-Basic Standard and the 13 industry-based accounting rules came into force in July 1993. In accordance with the ASBE-Basic Standard, the MOF issued the first ASBE-Specific Standard (one of a series of 16 specific accounting standards) Disclosure of Related Parties and Transactions in 1997. The other 15 ASBE-Specific Standards, such as Revenue, Investments, and Construction Contracts, were issued during the period 1998 2001. These specific standards focus on individual accounting topics or issues rather than particular industries. This series of accounting standards is also referred to as old Chinese Accounting Standards. In January 2001, a new comprehensive uniform accounting system, the Accounting System for Business Enterprises, came into effect with the

68

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

purpose of generating the desired uniformity and comparability in accounting regardless of ownership structures and types of industries. It was applied to all enterprises, with the exceptions of small businesses and financial institutions. The new system incorporated the ASBE-Basic Standard and many issues addressed in the 16 ASBE-Specific Standards. In particular, this system introduced a new accounting principle of substance over form, expanded application of the prudence principle, addressed segmental reporting, and stressed the information needs of users other than the government (Xiao, Weetman, & Sun, 2004a). In addition, 11 industry-specific accounting guidelines were issued during the period 2002 2005, which gradually replaced the old 13 industry-specific accounting rules.

3.4.4. China’s Approach to IFRS In 2006, the MOF issued new Accounting Standards for Business Enterprises (new ASBE) standards (also referred to as new Chinese accounting standards), consisting of one new basic standard and 38 specific accounting standards applicable to enterprises established within China. The new standards are considered to be substantially in line with IFRS. The convergence process has been considerably dominated by the Chinese government, which has determined that the adoption of IFRS must reflect China’s politico-economic context. The IASB strives to serve the needs of global capital markets by producing one global accounting language. In particular, IFRS has reduced the number of permissible accounting methods and moved toward the fair value accounting model. However, Chinese regulators need to respond to pressures from China’s unique political and economic environment in developing Chinese accounting standards that may not necessarily be entirely consistent with IFRS. As a result, there are differences remaining between IFRS and ASBE. IFRS depends heavily on Anglo-American accounting practices and increases the use of fair value in accounting standards in order to present a “true and fair view,” which is the center of the Anglo-American accounting system. However, regulators in China have been cautious with this approach and emphasize that fair value should be introduced carefully and gradually because the prices applied in unsophisticated markets may not form a good basis for fair value (Ding & Su, 2008). In addition, Biondi and Zhang (2007) raise questions about the ultimate convergence of Chinese and international accounting standards on the basis of a comparative analysis between IFRS and Chinese accounting standards. The disharmony between

The Development of Accounting Thought and Practices in China

69

the IASB approach and the Chinese approach is illustrated in the case of business combinations (Baker, Biondi, & Zhang, 2010; Biondi & Zhang, 2007). IFRS only allows the acquisition method of accounting for business combinations. In contrast, given the existence of both mergers and acquisitions in China, the Chinese standards setters have created two different methods of accounting for business combinations, namely, the pooling of interest method for transactions involving entities under common control and the purchase method for transactions involving entities not under common control. The development of an alternative approach to accounting for business combinations by the Chinese standards setters effectively challenges the IASB’s goal of achieving international accounting convergence. Essentially, such departure from IFRS reflects local politico-economic factors related to the need for industrial reorganization in China rather than a desire to serve the needs of global capital markets (Baker et al., 2010). Government influence is further illustrated by the implementation of IFRS. For example, in November 2006 the MOF issued a 263-page book of implementation guidance for implementing 32 of the 38 new accounting standards. Additional guidance on the new accounting standards, a 622-page book of Interpretations of New Accounting Standards for Business Enterprises, was published in May 2007. In addition, the MOF governs the implementation by way of issuing explanation and expert team opinion. Consequently, although financial reporting is expected to be governed by accounting standards, accountants are likely to continue to rely heavily on detailed technical rules. In short, the evolution of accounting discussed above illustrates that under both planned and market-oriented economies, accounting is highly government regulated. While accounting reforms in China are moving toward internationally acceptable accounting standards, China’s accounting tradition and culture will hinder this trend, and the development and enforcement of accounting standards will remain government-driven.

3.5. CONCLUDING REMARKS This chapter has reviewed the development of accounting thought and practices in China. It shows that the evolution of traditional Chinese accounting has been slow. The single-entry method remained dominant for centuries after the emergence of double-entry, and the transition from single-entry to double-entry was incomplete. Considerable debate arose during the course

70

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

of reforming traditional Chinese accounting and introducing Western accounting practice. It took nearly one and a half centuries for Chinese accounting practitioners to eventually embrace Western debit credit double-entry after it was first introduced in the 1840s. Furthermore, the governments in China have played a leading role in recent accounting history. Particularly, the new Chinese government has dominated accounting affairs since its formation in 1949, mainly through the MOF, the body responsible for formulating and implementing accounting regulations. The review indicates that changes in accounting in China did not usually occur completely and easily. Over the past three decades, while Chinese accounting has gradually moved toward the Anglo-American model, the convergence has presented unique features in China. For example, the review suggests that the accounting reforms in China have been heavily government-driven and that uniform accounting systems still remain. Chinese regulators maintain a cautious attitude toward the application of fair value and professional judgment, which are essentially the center of the Anglo-American accounting system. Furthermore, Chinese accounting regulators have a different view of business combinations from the IASB and have developed alternative accounting methods for those transactions. China’s departure from IFRS reflects its politico-economic context and essentially challenges the IASB’s goal of achieving international accounting convergence. China’s approach to internationally acceptable practices is likely to have implications for the effectiveness of the imported ideas. In conclusion, the historical review suggests that internationally acceptable accounting principles are likely to encounter difficulties in China and be implemented differently from what is expected by international communities given the historical and cultural characteristics of Chinese accounting. It reinforces the concept that to examine whether harmonized accounting standards will lead to harmonized practices in China it is important to understand China’s context.

NOTES 1. Following the Opium War, the Qing government was forced to sign a series of treaties that demanded that China give up part of its territories’ sovereignty, pay reparations, or open trading ports. For example, Macau and Hong Kong were colonized by the Portuguese and British, respectively. Consequently, China turned into a semifeudal and semicolonized country. 2. The formula for the Three Column method was new receipt − amount paid out = ending balance.

The Development of Accounting Thought and Practices in China

71

3. The basic equation for the Four Column method was balances brought forward + new receipts − amounts paid out = balance in hand. 4. The basic equation used in this system was receipts − payments = keeping − owing = profit/loss. 5. While some researchers argue that the underlying principles of Chinese double-entry bookkeeping were similar to the Italian-style bookkeeping developed in Europe at about the same time (e.g., Kang, 2007; Lin, 1992), Pan (1934) summarizes six major differences between the two methods, namely, recording subject, recording scope, recording format, organization of recording books, accounts classification, and supporting document. For example, Pan (1934) indicates that the main difference is the recording subject. Chinese bookkeeping used Shou (receipt) and Fu (disbursement) as recording symbols. Shou recorded cash inflow, while Fu was for cash outflow. The criteria for Shou and Fu were based on the operator’s subjective observation. Transactions were recorded from the operator’s perspective. In contrast to Italian-style bookkeeping, debit and credit were classified based on the operator’s objective observation. An amount was debited because the other party of the transaction (not the operator) was a debtor. Similarly, an amount was credited because the opposite party of the transaction was a creditor. Transactions were recorded from the other party’s perspective (Pan, 1934). 6. Debit credit bookkeeping (also known as Italian-style bookkeeping) originated in Italy during the 13th century (Peragallo, 1983). Luca Pacioli summarized the method in his book, which was translated into different languages (Nobes, 1984). 7. Traditionally, financial reports were prepared in accordance with the Chinese lunar calendar. 8. Hubu Bank was the earliest state bank established by the government. Daqing Bank was a stock company jointly owned by the state and individuals. 9. The MOF of the People’s Republic of China officially ended the debate in 1992 by stating that accounting records should use the debit credit method in the ASBE. Wei (1984) notes that after the establishment of the new China in 1949, some new alternative bookkeeping methods were invented on the basis of traditional Chinese bookkeeping methods that continued to be used by governmental units and other entities for many years. Of those alternatives, the increase decrease method and receipt disbursement method were the most popular (Aiken & Lu, 1998). 10. Aiken and Lu (1998) argue that uniform accounting systems in China had existed since the 1910s instead of being imported from the Soviet Union in the 1950s, as suggested by other scholars. 11. The ASBE-Basic Standard established several accounting assumptions, namely, accounting entity, going concern, accounting period, accrual basis, and monetary measurement. Objectivity, reliability, comparability, consistency, timeliness, and understandability were identified as the qualitative characteristics of financial reports. Matching principle, conservatism, historical cost, and distinction of capital and revenue expenditure were recognized. In addition, it defined six accounting elements, namely, asset, liabilities, equity, revenue, expenses, and profit (or loss), and three main accounting statements, comprising balance sheet, income statement, and statement of changes in financial position (or cash flow).

CHAPTER 4 AN INTEGRATED INSTITUTIONAL PERSPECTIVE

ABSTRACT This chapter develops the theoretical framework used to inform the study, which is based largely on neoinstitutional theory. This monograph recognizes that a holistic perspective and richer insights are needed when examining complex issues associated with the adoption of internationally acceptable practices. The proposed theoretical framework incorporates international influences, domestic influences, and intraorganizational dynamics. In the context of globalization, China’s convergence with internationally acceptable principles and standards is largely shaped by international forces, including supranational organizations, foreign investors, and international accounting firms. Furthermore, in order to examine the operation of those imported ideas, it is essential to consider China’s contextual setting, which comprises the political system, economic system, legal system, social and cultural system, and accounting infrastructure. In addition, the convergence process is also influenced by interaction among organizational players who may actively mobilize their power to preserve the status quo and protect their power and interests. The outcome and the process of loose coupling deeply intertwine with and reflect upon international influences, domestic influences, and intraorganizational dynamics. Keywords: Institutional theory; international influences; domestic influences; intraorganizational dynamics

73

74

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

4.1. INTRODUCTION As suggested by the review of prior studies and accounting development in China, there would be no automatic relationship between the adoption of internationally acceptable principles and standards and improved accounting quality. A clear understanding of the effectiveness of adopting AngloAmerican ideas in Chinese listed companies requires that the associated issues be considered within a comprehensive and holistic perspective that takes into account China’s contextual factors. Indeed, corporate governance and accounting are increasingly viewed as part of social science, which is shaped by institutional contexts. Thus, an integrative framework largely based on neoinstitutional theory (see Greenwood & Hinings, 1996) was constructed to inform the study. By focusing on the interplay of institutional influences and organizational dynamics, this monograph seeks to provide an in-depth understanding of the process and outcome of adopting AngloAmerican models of corporate governance and financial reporting in China. The chapter is organized as follows. Section 4.2 explains the selection of institutional theory and different approaches within institutional theory. Section 4.3 presents the formation of the proposed framework for this monograph mainly on the basis of neoinstitutional theory. Particularly, this section justifies the incorporation of international influences, domestic influences and the nature of accounting, and intraorganizational dynamics. The final section ends the chapter with some concluding remarks.

4.2. INSTITUTIONAL THEORY 4.2.1. The Selection of Institutional Theory The theoretical framework of this monograph is based on institutional theory primarily because of its strength in examining the context in which corporate governance and accounting operate. An emphasis on holistic analysis rather than isolated economic events from social context is fundamental to the institutional perspective (Gruchy, 1967; Myrdal, 1978). Institutional theorists view economic activity as a social phenomenon and emphasize its relationship with social institutions. While agency theory, focusing on aligning conflicting interests,1 has traditionally been used to study corporate governance issues (Aguilera & Jackson, 2003), a consideration of shareholders’ rights alone may not

An Integrated Institutional Perspective

75

capture the entire complexity of institutional domains, particularly in a country like China. In the context of the global isomorphic process of corporate governance,2 agency theory fails to account for key differences in business enterprises across countries and overlooks the influence of institutional environments, leading to an undersocialized view of corporate governance (Aguilera & Jackson, 2003; Lubatkin, Lane, Collin, & Very, 2007). Institutional theory overcomes this issue by addressing the embeddedness of corporations in a nexus of formal and informal rules (North, 1990). Aoki (1994) states that corporate governance needs to be understood in the context of a wider range of institutional domains. Institutional theory has been employed to understand corporate governance innovation and change in many countries, including France (Lee & Yoo, 2008), Germany (Chizema & Buck, 2006), Japan (Yoshikawa et al., 2007), and China (Lau et al., 2007). Furthermore, the significance of the wider economic and social setting of accounting is often stressed, and calls for studies of accounting in the context in which it operates are often made (e.g., Burchell et al., 1980; Hopwood, 1983, 1987; Hopwood & Miller, 1994). While institutional theory has been more commonly applied in the field of management accounting, it has also been used in explaining the adoption of international accounting standards across different countries, for example, in Bangladesh (Mir & Rahaman, 2005) and the United Arab Emirates (Irvine, 2008). Touron (2005) deploys institutional theory to explain the adoption of US GAAP by French firms in the 1970s. Rahman, Yammeesri, and Perera (2010) point out that institutional theory is a more general theory that can be used in studying accounting practices of different countries largely because of its capability of appreciating the variety of international business settings compared to agency theory. They argue that agency theory can also be identified as an institutional theory applicable to a particular setting where there is separation of ownership and control. Institutional theory captures both exogenous and endogenous factors that affect corporate practices (Hussain & Hoque, 2002; Rahman et al., 2010). Given the Chinese government’s persistent intervention and dominant ownership in many listed companies in particular, institutional theory is likely to offer comprehensive insights into the research question investigated. 4.2.1.1. Different Approaches The development of institutional theory over the years has been characterized by influences from different ideas. In their review of the state of institutional theory, DiMaggio and Powell (1991) distinguish between old and

76

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

new institutionalisms. Old institutionalists argue that individuals’ tastes and preferences are shaped by institutional influences, including rules, habits, routines, norms, and taken-for-granted assumptions (Hogdson, 1988). In the old institutionalism, issues of influence, coalitions, and competing values are central, along with power and informal structures (Clark, 1960, 1972; Selznick, 1949). In contrast, new institutionalism places emphasis on legitimacy and the embeddedness of organizational fields (DiMaggio & Powell, 1983; Meyer & Rowan, 1977). New institutional theorists assume that intraorganizational structures and procedures, including corporate governance and accounting, are largely shaped by external factors. Institutions consist of cognitive, normative, and regulative structures and activities that provide stability and meaning to social behavior. Organizations operating in similar environmental settings are expected to present similar features, including their internal structures and procedures, which are considered appropriate by the society (DiMaggio & Powell, 1983; Meyer & Rowan, 1977; Meyer & Scott, 1983). Thus, new institutionalists argue that an organization is legitimizing its operations by conforming to external pressures, rather than improving internal efficiency. This explains the adoption by an organization of particular institutional arrangements, such as corporate governance and financial reporting. Some institutional theorists call for a more complete account for understanding the emergence, persistence, and abandonment of institutions and the interactive nature of institutional processes (Moll, Burns, & Major, 2006). Selznick (1996) argues that drawing a sharp line between the old and the new institutionalisms inhibits the contribution of institutional theory to major issues of bureaucracy and social policy. A number of scholars have endeavored to reconcile old and new institutionalisms by integrating institutional explanations, intraorganizational dynamics, and the interests and power of actors into the perspective to provide a more integrative and explanatory framework (e.g., Greenwood & Hinings, 1996; Hirsch & Lounsbury, 1997; Selznick, 1996). Greenwood and Hinings (1996) label the convergence around multiple themes of old and new institutionalism as neoinstitutionalism, which is the approach used in this monograph with some modifications. This approach provides a number of suitable analytical tools to address the issues that are of interest in the study. First, a broader view of investigation in accordance with neoinstitutional theory helps gain insights into the institutional environment under which corporate governance and accounting operate and the contextual pressures confronting Chinese companies. Second, the focus on

An Integrated Institutional Perspective

77

the interaction of organizational context and organizational action helps explain Chinese companies’ interpretations of, and responses to, contextual pressures by stressing the political dynamics of intraorganizational behavior.

4.3. PROPOSED FRAMEWORK The proposed framework (see Fig. 4.1) depicts linkages among various components of the institutional environment, namely, international influences, domestic influences, and intraorganizational dynamics. Mir and Rahaman (2005) and Irvine (2008) have demonstrated that there are considerable international influences in the process of adopting internationally acceptable practices in Bangladesh and the United Arab Emirates, respectively, which, like China, are classified as emerging and developing economies by the International Monetary Fund.3 International actors play an increasingly important role in China as a result of facilitating China’s integration into the global economy, for example, by granting China membership in the WTO in 2001. Therefore, an examination of international influences is useful for an understanding of the issues under investigation in this monograph. The impact of international pressures on different institutional domains in the context of globalization may be mediated by the wider configuration of national institutions (Aguilera & Jackson, 2003). Irvine (2008) calls for evaluating the implementation of internationally acceptable practices by examining local contextual elements. Hence, an examination of domestic influences is essential for this study because Chinese listed firms operate in an environment different from that of Anglo-American countries, and the process and the outcome of implementing internationally acceptable ideas is mainly shaped by local institutional influences. In addition, it is also worth noting that in this monograph the market is viewed as an integral part of the institutional environment. This is in contrast to the dominant view in the extant literature, which either ignores market forces or separates institutional environment and market competition. DiMaggio and Powell (1983) tend to overlook the competitive marketplace while paying more attention to pressures from the state and the profession. However, Oliver (1992) contends that economic considerations should be incorporated into the institutional perspective in order to present a more insightful explanation (see also Greenwood & Hinings, 1996;

78

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

INTERNATIONAL INFLUENCES Supranational Organizations

Accounting Infrastructure

DOMESTIC INFLUENCES AND THE NATURE OF ACCOUNTING

Legal System

INTRAORGANIZATIONAL DYNAMICS

INNOVATION Listed Companies

Economic Globalization

Conflict of Interest

Financial Reporting Standards (IFRS)

Equity Market

Economic System

International Accounting Firms

Corporate Governance Guidelines (AngloAmerican Model)

Power Dependence

Loose Coupling

Behavioral Patterns

Political System

Social System

Foreign Investors

Fig. 4.1.

Framework to Examine the Adoption of Anglo-American Models of Corporate Governance and Financial Reporting in China.

An Integrated Institutional Perspective

79

Powell, 1991). Organizational behaviors respond to both market and institutional pressures (Greenwood & Hinings, 1996). Following this approach, a number of studies concerning accounting and corporate governance have taken into account both institutional and market forces and generated fruitful results (see Brignall & Modell, 2000; Hoque & Hopper, 1997; Hussain & Gunasekaran, 2002; Hussain & Hoque, 2002; Modell, 2002; Tsamenyi, Cullen, & Gonza´lez, 2006). Nevertheless, the separation of institutional and market forces in these studies implies conflict between institutional requirements and those imposed by market. It understates “the extent to which technical/market arrangements are themselves defined and constituted by institutional processes” (Scott, 2008, p. 436). Institutional forces and market forces may not necessarily be in opposition (see also Powell, 1991; Scott, 2001, 2008). Accordingly, market forces in this monograph are treated as an inalienable part of the institutional setting and interplay with other institutional forces in a contradictory and/or a cooperative manner. Furthermore, this framework emphasizes intraorganizational dynamics to gain an understanding of organizational actions. Although the Chinese government is able to impose innovation in a top-down manner, it is the listed companies that interpret and practice the imported concepts. As Oliver (1991) indicates, organizations do not passively adapt their formal structures to the demands of the environment (see also Scott, 2008). The institutional requirements are “subject to interpretation, manipulation, revision, and elaboration by those subject to them” (Scott, 2008, p. 430). Therefore, an examination of the role of organizational actors and conflict among those actors is important in providing an understanding of their construction of the meaning of effectiveness of imported principles and standards. As shown in Fig. 4.1, this framework recognizes that there is a causal relationship between the corporate governance and accounting innovation and the conflict of interest and power dependence among organizational players. The interplay of diverging interests and power imbalance in turn gives rise to loose coupling and certain behavioral patterns of organizational players. Orton and Weick (1990) define loose coupling as the coexistence of distinctiveness and responsiveness among system elements. For the purpose of this study, loose coupling mainly refers to the process and situation where the regulation concerning corporate governance and financial reporting is largely separate from an organization’s day-to-day operations. The adoption of Anglo-American models of corporate governance and financial reporting reshapes the interest and power relations within

80

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

organizations in China. The power imbalance and diverging interests within an organization are deeply rooted in the institutional setting and reflect the institutional contradictions in China. In the process of enforcing internationally acceptable principles and standards, functionally differentiated groups with different interests tend to compete for influence and dominance. Powerful players may mobilize their power to resist change to maintain the status quo and to make the implementation largely symbolic rather than instrumental. In the process of loose coupling, certain behavioral patterns such as resistance of powerful players and compromises among different power-dependent players are likely to emerge. In summary, the adoption of internationally acceptable financial reporting and corporate governance practices in China has been initiated and unfolded in the context of economic globalization and national economic reform. Consequently, the implementation process has been shaped by the interaction among international influences, domestic influences, and organizational dynamics. The proposed framework incorporating the three dimensions, focusing on exogenous and endogenous factors and treating loose coupling as both a process and an outcome is likely to provide a rich understanding of the isomorphic process and associated resistance (Burns, 2000; Burns & Scapens, 2000; Greenwood & Hinings, 1996; Moll & Hoque, 2000). The following sections further explain the elements in the proposed framework, namely, international influences, domestic influences and the nature of accounting, and intraorganizational dynamics.

4.3.1. International Influences The influence of globalization has been pervasive and intensive in the past few decades. Globalization facilitates the mobilization of capital, products, and labor and increases competition among firms and countries across the world (Khanna et al., 2006). Today all nations exist within an interdependent world that arises from the integration of national economies and markets and from the growth of capital flows across borders. The globalization of capital, capital markets, and trade has brought about the convergence, confluence, and homogenization of the international corporate governance structure (Fukao, 1995; Shi, 2005) and accounting practices (Lehman, 2005). In the context of economic globalization, supranational organizations, foreign investors, and international accounting firms reinforce one

An Integrated Institutional Perspective

81

another in promoting internationally acceptable corporate governance and accounting practice. 4.3.1.1. Supranational Organizations Organisation for Economic Co-operation and Development (OECD). The OECD is an international organization helping governments tackle the economic, social, and governance challenges in the global economy. Its mission is to provide a setting where governments of countries from around the world share policy experiences and identify good practice with the objective of supporting sustainable economic growth. The OECD has a significant impact on corporate governance development and practice across the world through its close partnership with both the business community and governments. For example, during the past decade, it has taken the lead among international organizations to promote good corporate governance. The OECD Principles of Corporate Governance, heavily influenced by the Anglo-American model, has become the global benchmark, accepted in OECD and non-OECD countries alike (OECD, 2008). International Accounting Standards Board (IASB). The IASB is responsible for the development of IFRS. As a single set of high-quality global accounting standards, IFRS is promoted by the IASB through establishing partnerships with stakeholders around the world, including other international organizations, national standard setters, regulators, investors, auditors, academics, and other interested parties. The past decade saw tremendous progress in the global convergence of IFRS. Currently, approximately 120 countries require or permit the use of IFRS, and approximately 90 countries have fully conformed with IFRS as promulgated by the IASB and include a statement acknowledging such conformity in audit reports (American Institute of CPAs, 2013).4 World Bank. The main role of the World Bank is to provide financial and technical assistance to developing countries around the world. The World Bank, in collaboration with the International Monetary Fund, launched the standards and codes initiative aimed at promoting the adoption of internationally acceptable standards in 1999. The OECD Principles of Corporate Governance and IFRS form the basis for the corporate governance and accounting components of the Report on the Observance of Standards and Codes of the World Bank Group (International Monetary Fund and World Bank, 2005).5

82

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

World Trade Organization (WTO). The WTO plays a key role in the world trade as the only global body dealing with the rules of trade between nations. The WTO maintains close relations with other international organizations, such as the OECD, the International Monetary Fund, and the World Bank. WTO agreements, negotiated and signed by member nations, provide the legal ground rules for international commerce. The WTO system’s overriding purpose is to help trade flow as freely as possible. Freer trade across the world essentially facilitates the diffusion of internationally acceptable corporate governance and accounting practices. International Organization of Securities Commissions (IOSCO). IOSCO, the international organization of stock exchanges, influences corporate governance and financial reporting regimes in different jurisdictions mainly through encouraging greater commitment to cross-border cooperation between regulators. It lends great support to the IASB by recommending to its members the application of IFRS by foreign issuers in cross-border security offerings and listings in 2000 (Erchinger & Melcher, 2007) and setting up in 2007 an IFRS database on the application of IFRS globally where members can exchange information about problems and noncompliance with IFRS (Securities Commission New Zealand, 2007). International Federation of Accountants (IFAC). IFAC is the global organization for the accountancy profession. It, through its independent standard-setting boards, sets international standards on ethics, auditing and assurance, education, and public sector accounting and promotes convergence to those standards as well as to IFRS. It is also committed to supporting the growth of the profession in developing countries and emerging economics. IFAC currently has 164 members and associations in 125 countries. By promoting strong ethical values, encouraging quality practice, and supporting the accounting profession development around the world, IFAC has made a considerable contribution to improving the quality of audit and financial reporting. 4.3.1.2. Foreign Investors In the context of economic globalization, foreign investors play an increasingly important role in developing and emerging nations’ economies in general and their corporate governance and accounting practices in particular. Multinational companies are described as “change agents” and “development agents” because of their role in the international transfer of technology and management and their impact on economic development in

An Integrated Institutional Perspective

83

the developing countries (Quinn, 1969; Thorelli, 1966). Mir and Rahaman (2005) document the pressure of foreign investors on the adoption of international accounting standards in Bangladesh. Multinational companies are also considered a major pressure driving the United Arab Emirates to adopt IFRS (Irvine, 2008). 4.3.1.3. International Accounting Firms Economic globalization has aided international accounting firms in expanding their operations around the world. Benefiting from globalization, international accounting firms have been strong proponents of globalizing accounting practices and important players in the globalization of accounting (Chand, 2005; Perera, Rahman, & Cahan, 2003). Irvine (2008) identifies Big 4 accounting firms as a major force contributing to the adoption IFRS in the United Arab Emirates.

4.3.2. Domestic Influences and the Nature of Accounting In order to investigate China’s isomorphic process of moving toward internationally acceptable standards, it is essential to understand China’s contextual setting, which imposes domestic influences on the implementation of those standards. Without considering the local cultural and legal environment, the desired effect of corporate governance reforms is likely to be limited (Machuga & Teitel, 2009; Wanyama, Burton, & Helliar, 2009). Accounting quality is also a function of the firm’s overall institutional setting, including the legal and political system of the country in which the firm operates (Soderstrom & Sun, 2007). For the purpose of this monograph, both domestic institutional factors and accounting infrastructure are viewed as shaping corporate governance and financial reporting in China. An examination of accounting infrastructure provides valuable insights into various aspects of accounting. Thus, the integration of domestic institutional elements and accounting infrastructure is able to present a comprehensive understanding of the environment under which the imported concepts are interpreted and practiced. 4.3.2.1. Political System Corporate governance arrangements within the firm interact deeply with a nation’s political system, including partisanship, coalition formation, political institutions, ideologies, and interest groups. Political forces are the primary

84

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

determinants of the degree of shareholder diffusion and the relationships among managers, owners, and other stakeholders of the firm (Roe, 2003). Political systems contribute substantially to a political account of patterns of corporate governance systems (Gourevitch, Carney, & Hawes, 2003). Political institutions create incentives that influence the behavior of corporate managers, investors, regulators, and other market participants, which in turn shapes the properties of reported accounting information. For example, Bushman and Piotroski (2006) examine the influence of political economy on incentives for financial reporting. They find that relative to firms in countries with low-state involvement, in countries with highstate involvement in the economy firms speed recognition of good news and slow recognition of bad news in reported earnings to avoid government intervention. Furthermore, firms with political ties, for example, those in Indonesia, dislike the transparency and scrutiny that come with publicly traded securities, suggesting a negative impact of political connection on corporate transparency (Leuz & Oberholzer-Gee, 2006). Furthermore, accounting standard setting and implementation is a political process in which relevant stakeholders, including government agencies, investors, practitioners, and managers, seek to influence the process (Soderstrom & Sun, 2007). Gallhofer and Haslam (2007) reveal the political dimensions of the IASB and international accounting standards by examining the IASB’s character and position, official principles, and work campaigns. Whittington (2005) and Armstrong, Barth, Jagolinzer, and Riedl (2010) document the influence of governments of some EU countries on the adoption of IAS 39, Financial Instruments: Recognition and Measurement. For example, the President of France and the Commissioner of European Commission expressed their concerns that adopting IAS 39 would not be in the best interest of Europe. Corporate governance and financial reporting in China are heavily influenced by political ideology. Before the 1980s the Chinese government focused on the class struggle between the proletariat and the bourgeoisie and tightly controlled economic activities (Yu, 1998). Following the shift from class struggle to economic development, a series of economic reforms was initiated by the government, which has significantly changed the corporate landscape and created new incentives that have affected the decisionmaking of corporate managers, owners, and other stakeholders of firms in China. In the reform process Chinese government plays a dominant role in determining the degree of shareholder diffusion and defining the relationship among stakeholders.

An Integrated Institutional Perspective

85

Accounting practices in China are also closely related to political ideology and economic development. Under the class struggle ideology, accounting was considered a mechanism promoting capitalism. A distinction was drawn between socialist accounting and capitalist accounting, with the former promoting a proletarian view and the latter protecting bourgeois interests. Accounting as a measure of economic activities has only been gradually accepted since the commencement of economic reforms. Moreover, the development of accounting is heavily government-driven in China and largely influenced by political institutions. Accounting in China is a “malleable object shaped by the force of the dominant political discourse” to accommodate different political ideologies in different eras by investigating the relationship between political ideology and accounting change (Ezzamel, Xiao, & Pan, 2007, p. 669). 4.3.2.2. Economic System In this monograph, financing system and business ownership are used as surrogates of economic system to explain its impact on corporate governance and financial reporting. Nobes (1998) divides business ownership and financing system into two distinct types: outsider and insider systems.6 In outsider systems, equity is widely distributed among individual and institutional investors and forms a significant source of finance for companies. Institutional investors, charged with the responsibility of securing the interest of their beneficiaries, have become more actively engaged in influencing the companies they invest in. Given the significance of outsider financing, the primary aim of financial accounting is to provide fair, balanced, and unbiased information to external shareholders, requiring extensive exercise of professional judgment. In contrast, in insider systems of finance, there is a dominance of family-owned businesses or long-term finance provided by either the banking system or governments (Zysman, 1983). In insider systems of finance, family owners, banks, or governments have access to the detailed internal accounting information; hence, the need for external reporting is minimal (Nobes, 1998; Nobes & Parker, 2008).7 Therefore, a characteristic shared by countries with an insider system is that financial accounting in these countries has developed to fulfill a different role compared to that in outsider system countries, for example, the provision of information to calculate taxation liabilities. A considerable amount of empirical research has investigated the impact of source of finance on corporate governance. For example, selecting a sample of 73 UK companies in which managers have an ownership stake

86

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

of greater than 50%, Hillier and McColgan (2008) find that a majority of owner-managed companies tend to place less emphasis on corporate control systems and are less likely to dismiss management team members following poor performance. Jeanjean and Stolowy (2009) find that in France ownership concentration and institutional ownership are positively associated with boards’ financial expertise. Also, the extant literature provides insights into the impact of ownership on accounting in various contexts. For example, managerial ownership’s influence upon the informativeness of earnings has been examined in countries such as Denmark (Gabrielsen, Gramlich, & Plenborg, 2002), Singapore (Yeo, Tan, Ho, & Chen, 2002), and Spain (Sa´nchez-Ballesta & Garcı´ a-Meca, 2007). The results from these studies suggest a relationship between insider ownership and accounting quality, although the evidence is mixed. In Indonesia, it has been found that family ownership has a significant influence on the type of earnings management (Siregar & Utama, 2008). In France, Zhao and Millet-Reyes (2007) document different effects of family and bank ownership on accounting information content, with book value carrying a significantly greater weight for family-controlled firms but bank owners tending to employ accounting accruals to achieve earnings persistence. In relation to public companies, the accounting quality of private companies is found to be lower in the United Kingdom (Ball & Shivakumar, 2005) and within the EU (Burgstahler, Hail, & Leuz, 2006). Chinese firms’ ownership has experienced significant change in the past three decades. In the planned economy of China, the government ran all state-owned enterprises, which were only considered units for implementing central plans with very little autonomy. The main purpose of accounting then was facilitating the Chinese government in planning and controlling the national economy. Following economic reforms, other forms of ownership, such as foreign investment companies and private companies, have played an increasingly important role. Furthermore, the Chinese government also diversified the ownership of state-owned enterprises. Small enterprises were sold to private investors. Medium and large enterprises were restructured into companies, which resembled those of Anglo-American countries. Some restructured state-owned enterprises were listed on the domestic stock exchange with the government being the controlling shareholder (Jiang, Yue, & Zhao, 2009; Wang & Chen, 2008). Emerging types of ownership reshaped the relationship among managers, investors, regulators, and other stakeholders and created new information demand from users such as investors and creditors in addition to the government. The

An Integrated Institutional Perspective

87

diversification of ownership, among other things, has evoked and shaped corporate governance and accounting innovation in China. 4.3.2.3. Legal System The legal system affects corporate governance and accounting quality mainly through enforcement of accounting and auditing standards and litigation against those who do not comply with them. Protecting shareholder rights is an important issue in corporate governance. A number of scholars find systematic differences among legal origins in the protection of shareholders, and minority shareholders in particular (Djankov, La Porta, Lopez-de-Silanes, & Shleifer, 2008; Djankov, McLiesh, & Shleifer, 2007; La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000). The strength of legal enforcement affects managers’ and auditors’ incentives. For example, Choi, Kim, Liu, and Simunic (2008) find that legal liabilities associated with audit failures are an important factor that determines auditor effort. They explain that as investor protection regimes become stricter, there is a greater possibility that misconduct and misreporting are detected, and managers and auditors are punished by strong legal enforcement. Francis and Wang (2008) report that in relation to non-Big 4 auditors, Big 4 auditors enhance clients’ earning quality only in countries with strong investor protection. Therefore, a strong investor protection regime and legal enforcement environment facilitate implementation of good corporate governance practice. The relation between investor protection in the legal system and accounting practices has been well documented in prior studies. Bushman and Piotroski (2006) find firms in countries with strong investor protections, and high-quality judicial systems recognize bad news in reported earning numbers faster than firms in countries characterized by weak investor protection and low-quality judicial systems, suggesting the significant role of legal systems in creating incentives for conservative accounting. A number of studies document that strong legal system and investor protection is associated with less earnings management (Burgstahler et al., 2006; Leuz, Nanda, & Wysocki, 2003; Nabar & Boonlert-U-Thai, 2007). An understanding of the legal system of a nation is useful in comprehending the effects of implementation of IFRS. First, the effective enforcement of the legal system is essential for ensuring appropriate implementation of IFRS. IFRS is issued by the IASB, which does not have enforcement power. Its implementation and enforcement is determined by the accounting profession, security exchanges, and courts of the country where firms are listed (Schipper, 2005). Furthermore, IFRS is principle-based

88

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

accounting standards that rely on general principles rather than detailed rules, suggesting the important role of managers and auditors in exercising professional judgment to interpret and apply accounting principles. Different legal systems have different influences upon the interpretation of IFRS. Soderstrom and Sun (2007) predict that in countries with strong shareholder protection, interpretation tends to present a fair view to shareholders. They also predict that interpretation is expected to satisfy contracting demands of banks, such as conservative approaches to record assets but aggressive approaches to record liabilities, in countries with strong creditor protection. The legal system in China is still underdeveloped and enforcement is ineffective. Laws and regulations in relation to accounting, including Accounting Law, Law of Certified Public Accountants, and Securities Law, were only developed following the economic reforms in 1980. It has been pointed out that the legal system in China offers little protection to investors (Wang & Chen, 2008; Zou et al., 2008), and CSRC actions and court enforcement are not effective (Anderson, 2000; Cai, 2007; Liebman & Milhaupt, 2008). Given the need to have a strong legal support for the implementation of internationally acceptable principles and standards, the weak legal system in China is likely to affect the effectiveness of these imported ideas. 4.3.2.4. Social and Cultural System According to Hofstede (1980, p. 25), culture is defined as “the collective programming of the mind which distinguishes the members of one human group from another.” It describes a system of societal or collectively held values (Gray, 1988, p. 4). Bloom and Naciri (1989, p. 72) define culture as “the total pattern of human behavior and its products embodied in thought, speech, action and artifacts.” Culture is therefore viewed as collectively held values that in turn have a significant impact on human behavior. Culture affects corporate governance and accounting by way of influencing human behavior and judgment. Corporate governance is a complexly determined cultural phenomenon (Fanto, 1996). For example, culture is considered a reason for differences among various national regimes of insider trading regulation. In Germany, traditionally, people accept insider trading as part of the game of securities trading (Standen, 1995), whereas in the United States insider trading is prohibited under legislation and regulation and considered immoral (Kehoe, 1995). Researchers have documented that when the concept of auditor independence and its Anglo-American perspective has been imported to other countries, the construction and

An Integrated Institutional Perspective

89

realization of auditor independence is shaped by local culture. For example, Hudaib and Haniffa (2009) argue that the imperialist culture represented by the ruling family and its cronies in Saudi Arabia partly constrains auditors’ professionalism. In the Czech Republic, the culture of loyalty to friends and family is likely to make it difficult for local auditors to be independent (Sucher & Kosmala-MacLullich, 2004). MacLullich and Sucher (2005) emphasize the importance of recognizing differences in local culture and accounting tradition by indicating that local cultural features such as ideas of freedom in Poland have considerable influence on the local realization of auditor independence. Perera (1989, p. 43) contends that accounting is not culture-free since “accounting is a sociotechnical activity involving human and nonhuman resources or techniques as well as the interaction between the two.” Hofstede (1980, 1991, 2001) conceptualizes five cultural dimensions individualism versus collectivism,8 large versus small power distance,9 strong versus weak uncertainty avoidance,10 masculinity versus femininity,11 and long-term versus short-term orientation12 to describe differing cultural features in various countries. Gray (1988) focuses on the first four value dimensions identified by Hofstede and establishes relationships among societal values and accounting practice from a theoretical perspective.13 In another study, Velayutham and Perera (2004) link Hofstede’s dimensions to two emotional states (i.e., guilt and shame) and point out that cultures embracing the emotional state of guilt tend to encourage more information disclosure than cultures associated with the emotional state of shame. The relationship between national culture and financial reporting has been identified by empirical studies. Drawing on Hofstede’s model, researchers have shown cultural influence on earnings management (Doupnik, 2008; Nabar & Boonlert-U-Thai, 2007), audit-detected accounting errors (Chan, Lin, & Mo, 2003), perceptions of the acceptability of earnings management (Geiger et al., 2006), auditor risk assessment (Hughes, Sander, Higgs, & Cullinan, 2009), and auditor choice (Hope, Kang, Thomas, & Yoo, 2008). In addition, Braun and Rodriguez Jr. (2008) have documented a relationship between earnings management and Gray’s (1988) accounting values. Other empirical research has also documented the impact of culture on accounting by examining different aspects of culture rather than Hofstede’s cultural indices. Drawing on philosophical, sociological, and other literatures to identify cultural differences among Australian, Indian, and Chinese Malaysian professional accountants, it was found that culture influences professional judgments of accountants in relation to auditor client conflict

90

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

resolution (Patel, Harrison, & McKinnon, 2002) and in relation to whistleblowing as an internal control mechanism (Patel, 2003). An understanding of the cultural impact on accounting is of particular importance in assessing the adoption of IFRS across different countries. As discussed in the preceding section, the interpretation of IFRS involves extensive exercise of professional judgment, which is significantly influenced by cultural idiosyncrasies in various nations. Chinese culture has its unique features, with Confucian philosophy playing the most important role (Lin & Ho, 2009). Confucianism stresses interdependent, stable, and harmonious relationships. These Confucian values are largely reflected by the pervasiveness of China’s unique networks of relationship, namely, guanxi. Existing literature documents that guanxi has dominated all business and social activities (Hwang, Staley, Chen, & Lan, 2008; Lovett, Simmons, & Kali, 1999). In Hofstede’s (2001) model, China’s ranks in various cultural dimensions are significantly different from those of the United States, United Kingdom, and Australia.14 For example, on the dimension of individualism, the United States, Australia, and the United Kingdom have the highest scores, namely, 91, 90, and 89, respectively, while China has a relatively low score of 20. The difference suggests that the ties between individuals in the former three countries tend to be looser than those in China. The cultural difference between China and Anglo-American countries is likely to have implications for the adoption of Anglo-American models of corporate governance and financial reporting. In addition to the institutional factors at the macro level mentioned above, an examination of accounting infrastructure is also essential because it helps gain insights into accounting information producers, users, and intermediaries. The integration of institutional factors and accounting infrastructure is likely to provide a comprehensive understanding of the context in China. 4.3.2.5. Accounting Infrastructure Accounting infrastructure is composed of several basic elements, including the information producers and end users; the information intermediaries; the laws and regulations that govern the production, transmission, and usage of information; and the legal entities that monitor and implement laws and regulations (Lee, 1987). In this monograph, two elements of accounting infrastructure, namely, (1) laws and regulations in relation to accounting and (2) enforcement legal entities are incorporated in the legal system under domestic influences, thus the discussion of accounting infrastructure focuses on the remaining elements.

An Integrated Institutional Perspective

91

Following China’s economic reform policies in 1980s, its accounting infrastructure changed considerably. For example, accounting practice has been moving toward IFRS. The accounting profession was re-established, and its operation has been largely shaped by international influences. The information needs of users other than the government, such as shareholders and creditors, were formally recognized. The value of financial reports and audit reports has been increasingly appreciated. Nevertheless, China’s accounting infrastructure presents its unique features. For example, Chinese information preparers lack an appropriate level of professionalism (Chow et al., 1995) and have difficulties in exercising professional judgment in their routine work (Xiao et al., 2004a). Information users lack sufficient appreciation of the value of financial statements and audit reports (Chen, Su, & Wu, 2007; Lin, Tang, & Xiao, 2003). The accounting profession is still very young and underdeveloped. Particularly, the Chinese government essentially maintains the control over the accounting profession, including control over CPAs, CPA firms, and the CICPA and the development of Chinese GAAP.

4.3.3. Intraorganizational Dynamics 4.3.3.1. Conflict of Interest and Power Dependence Greenwood and Hinings (1996) recognize the important role of conflict of interest and power dependence among individual actors in organizational changes and incorporate these concepts into their framework for understanding those changes. According to power dependence theory, people are mutually dependent and form exchange relations and groups. A person’s dependence is inversely related to his or her power. Actors with greater dependence, that is, less power, are constrained in terms of their ability to act in ways that satisfy their interests (Molm, 1988). Inequalities in dependence and power imbalances can lead to conflicts of interests and social change (Emerson, 1972). Consistent with this view, Greenwood and Hinings (1996) argue that certain organizational actors, with less dependence, are able to resist change that is incompatible with their existing institutions. They may have the capability to actively shape the process of change, mobilizing their power to intervene in the change process, preserve the status quo, and protect their power and interests from the adverse effects of the innovation. Therefore, the power and interests of organizational actors can result in ceremonial rather than instrumental change.

92

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

The introduction of Anglo-American ideas of corporate governance and financial reporting into China is likely to be the result of both legitimacy and efficiency considerations. In the context of economic globalization, obtaining external legitimacy of participating in the global market seems to be the primary driver for convergence with Anglo-American practice. Given the poor performance of Chinese enterprises, particularly former SOEs, and the government’s keen desire to improve corporate efficiency and accounting quality in the context of national economic reform, it is also possible that the internationally acceptable practices are adopted as an economically rational attempt to reform day-to-day operation practices rather than simply a “symbolic” implementation. Hence, such adoption of corporate governance and accounting innovation constitutes an attempt to hold relevant parties, including controlling shareholders, corporate management, independent directors, and auditors, accountable and eventually improve the quality of financial reporting. Nevertheless, the above objectives of improving organizational players’ accountability and financial reporting quality may not be achieved because of resistance from powerful players against the corporate governance and accounting innovation. While the general objective of improving corporate efficiency may be unanimously held by functionally differentiated groups within organizations, contradictions inevitably arise because organizations have to respond to diverse stakeholders and contradictory institutional pressures. The introduction of Anglo-American ideas of corporate governance and financial reporting redefines relationships among company managers, independent directors, auditors, investors, regulators, and other stakeholders, creating threats to the power and autonomy of certain groups, including managers and controlling shareholders. In accordance with power dependence theory, powerful players, company managers, and their alliance of controlling shareholders may mobilize their power to resist change and maintain the status quo. 4.3.3.2. Loose Coupling In this monograph, the notion of loose coupling is used to capture the process and outcome of adopting Anglo-American models of corporate governance and financial reporting in China. Orton and Weick (1990) distinguish loose coupling from tight coupling and decoupling in describing the extent of responsiveness and distinctiveness among system elements. They state that “if there is responsiveness without distinctiveness, the system is tightly coupled. If there is distinctiveness without responsiveness, the system is decoupled. If there is both distinctiveness and responsiveness,

An Integrated Institutional Perspective

93

the system is loosely coupled” (p. 205). They further argue that compared to tight coupling and decoupling, loose coupling is a “durable” concept and allows theorists to capture both organizational stability and flexibility. For the purpose of this monograph, loose coupling refers to the process and situation where the regulation concerning corporate governance and financial reporting is largely separate from an organization’s day-to-day operations. Anglo-American ideas of corporate governance and financial reporting are adopted with modifications to suit the Chinese context. Institutional theorists argue that while the adoption of institutionalized myths can increase organizations’ social legitimacy and prospects for survival, there is a tendency to loosely couple formal structures and actual operations because of the contradictions between the institutional pressures and the organizations’ day-to-day activities (DiMaggio & Powell, 1983; Meyer & Rowan, 1977). Loose coupling is considered to be essential in resolving institutional contradictions (Meyer & Rowan, 1977; Oliver, 1991) while satisfying the need to conform to institutional expectations. The organizational field and structures become infused with a taken-for-granted quality over time. The embeddedness of the prevailing structure creates resistance to change and maintains the stability of organizational arrangement (Tolbert, 1985). The resistance and associated loose coupling reflect the contradictory institutional pressures in the institutional context. However, rather than simply assuming that any loose coupling is the outcome of the contradictory institutional pressures, this study treats loosing coupling as both a process and an outcome (e.g., Burns & Scapens, 2000). Scott (2001) calls for empirically examining how loose coupling emerges and its implications on organizational activities. Collier (2001) also argues that the concept of loose coupling needs to be unpacked by exploring how contradictions in the institutional environment are accommodated and/or reproduced within individual organizations. This monograph explores the interaction between institutional context and intraorganizational dynamics through which regulation and actual operations become separate at the organizational level. Furthermore, mere separation between regulation and actual operations does not exclude substantial change. As indicated by Orton and Weick (1990), loose coupling contains both resistance and adaptability, with the former implying opposition to corporate governance and accounting innovation through neutralizing the impact of the change and the latter implying accommodation of the change. In addition to preventing change, institutions can also be analyzed as dynamic and active instruments that facilitate change (Boland, 1979). Scott (2008) acknowledges the possibility

94

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

that superficial changes could become more significant over time. With regard to the phenomenon under investigation in this monograph, it could be that some elements (e.g., enhancing auditor independence) in AngloAmerican models have more substantial impact on Chinese companies’ operations than others (e.g., the introduction of independent directors).

4.4. CONCLUDING REMARKS In the context of globalization, China’s convergence with internationally acceptable principles and standards is largely shaped by international forces, including supranational organizations, foreign investors, and international accounting firms. Furthermore, in order to examine the operation of those imported ideas, it is essential to consider China’s contextual setting, which comprises the political system, economic system, legal system, social and cultural system, and accounting infrastructure. In addition, the convergence process is also influenced by interaction among organizational players who may actively mobilize their power to preserve the status quo and protect their power and interests. The outcome and the process of loose coupling deeply intertwine with and reflect upon international influences and domestic influences and intraorganizational dynamics. This monograph recognizes that a holistic perspective and richer insights are needed when examining complex issues associated with the adoption of internationally acceptable practices. Corporate governance and accounting practices are shaped by the institutional context as their form and role are determined by the organizational environment, and in turn they also contribute to shape this environment. The proposed theoretical framework is developed on the basis of the neo-institutional theory largely because of its strength in examining the context in which the organizational players interpret and practice those imported ideas.

NOTES 1. According to Berle and Means (1932), separation of ownership and control is a typical feature of many modern corporations. Agency theory explains that the diverging interests between shareholders (owners) and managers result in a nexus of contracts among these parties in order to minimize the conflicts of interest (Jensen & Meckling, 1976).

An Integrated Institutional Perspective

95

2. In the institutional theory literature, isomorphic process refers to the process by which external institutions permeate internal structures and procedures, which drives organizations to adopt similar structures and practices (DiMaggio & Powell, 1983). 3. The International Monetary Fund in its World Economic Outlook Report (April 2010) divides the world into two major groups: advanced economies and emerging and developing economies. Accordingly, Bangladesh, the United Arab Emirates, and China are considered emerging and developing economies (http:// www.imf.org/external/pubs/ft/weo/2010/01/weodata/groups.htm#oem). 4. For example, the EU has adopted virtually all IFRSs, though a time lag has occurred in the adoption of several recent IFRSs. In the EU, the audit report and basis of presentation note refer to compliance with “IFRSs as adopted by the EU.” 5. The initiative has required the development of appropriate standards and assessments of the degree of implementation of these standards by various countries. An assessment results in a Report on the Observance of Standards and Codes of the World Bank Group. 6. Outsider systems typically include the US, the UK, Australia, and New Zealand, and insider systems typically include Germany and Japan. 7. In the context of banks providing a significant amount of long-term financing for business such as Germany, banks and companies have tended to develop longterm supportive relationships. Usually banks have a representative on the supervisory boards of companies as major lenders, and these representatives are provided with the detailed accounting information. In the systems where governments provide the dominant financing, government representatives will often become directors of the state-funded companies and will thus have access to the inside management information (Nobes & Parker, 2008). 8. This dimension measures the degree of interdependence within individuals and groups. Individualism refers to a society that prefers a loosely knit social framework wherein the degree of interdependence a society maintains among individuals is low and individuals are supposed to take care of themselves and their immediate families only. Conversely collectivism represents a tightly knit social framework where individuals will look after other members in the group in exchange for unquestioning loyalty; hence, the degree of interdependence within individuals is high. 9. Power distance is the extent to which the members of a society accept that power in institutions and organizations is distributed unequally. People in large power distance societies accept a hierarchical order in which everybody has a place without any need for further justification, while justification for power inequities is required by people in small power distance societies, who will actively fight for power equalization. 10. Uncertainty avoidance is the degree to which the members of a society feel uncomfortable with uncertainty and ambiguity. Strong uncertainty avoidance societies maintain rigid codes of belief and are intolerant toward deviant persons and ideas. Weak uncertainty avoidance societies maintain a more relaxed atmosphere and rely more on principles; hence, deviance is more easily tolerated. 11. The issue addressed by this dimension is the way in which a society allocates social roles to the sexes. Masculinity values achievement, heroism, and material success, while femininity stresses relationships, modesty, and caring for the weak.

96

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

12. Long-term and short-term orientation is also called Confucian dynamism, which deals with a choice from Confucius’s ideas. Both the values (long term and short term) are in line with the teachings of Confucius. Long-term orientation is more oriented toward the future, while short-term orientation selects Confucian values oriented toward the past and present. As a result, people in long-term orientation societies stress thrift, adaptation of traditions to a modern context, willingness to subordinate oneself for a purpose, respect for social and status obligation within limits, and concern with “face.” On the other hand, a short-term orientation values respect for traditions, respect for social and status obligations regardless of cost, concern with self-respect, and possessing the truth. 13. The societal value of long-term versus short-term orientation was not included in Gray (1988), as it was added by Hofstede later. Accounting practice refers to authority, enforcement, measurement, and disclosure. 14. In Hofstede’s (2001) model, the US, the UK, and Australia have similar rankings in all five dimensions.

CHAPTER 5 RESEARCH DESIGN

ABSTRACT This chapter explains the research design. An interpretive methodology was considered most suitable for the study. Informed by an institutional framework, the interpretive methodology was selected for this monograph for its strengths of focusing on the research context, interactive processes, and meanings that are not measurable by quantitative approach. The interpretive methodology is also consistent with the ontological and epistemological positions of the researchers. Data were collected from interviewing four groups of key persons and a document survey. The data triangulation and multiple perspectives helped increase the reliability and validity of the study. Also, conducting data collection in a natural setting produced a rich data source. This enabled the provision of an enhanced understanding of the operation and effectiveness of corporate governance and financial reporting practice in a real setting. In addition, the systematic set of data analysis procedures helped improve research rigor and develop conceptual and theoretical understanding of issues of interest. Keywords: Interpretive methodology; data collection; analysis methods

5.1. INTRODUCTION The purpose of this chapter is threefold: It explains the research methodology, outlines data collection methods, and sets out the procedures for data analysis. The research methodology presents the philosophical framework

97

98

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

with which the research project is developed. It shows how the research is conducted. Researchers’ beliefs about the world and knowledge, and the nature of study, largely determine the research methodology. Choosing appropriate data collection methods is important for producing useful data to inform the issues under investigation. Proper design of data analysis procedures increases the rigor and validity of data interpretation. All three elements are interrelated and influence one another, with the common objective of answering the research question. Corporate governance and financial reporting are increasingly viewed as social practices rather than merely technical practices. A better understanding of the process and outcome of adopting internationally acceptable principles and standards requires a comprehensive and holistic theoretical perspective integrating international influences, domestic influences, and intraorganizational dynamics. Consistent with the theoretical framework developed in Chapter 4, an interpretive research methodology within the qualitative research tradition is chosen to explore the relevant issues in the institutional context and provide a richer explanation for the issues under investigation. To explore the context and nature of governance and reporting practices, it is useful to collect data in a natural setting. The main sources of data were interviews and a document survey. The procedures suggested by some prior studies (Lye et al., 2006; Parker & Roffey, 1997; Taylor & Bogdan, 1998) were largely followed to develop the data analysis procedures. The chapter is organized as follows. Section 5.2 describes the selection of the research methodology. Data collection methods are presented in Section 5.3. Section 5.4 explains the data analysis procedures, with a summary and conclusion in the final section.

5.2. RESEARCH METHODOLOGY The term methodology refers to the way in which research is conducted and problems are addressed. Researchers’ assumptions, interests, and purpose determine the methodology chosen (Taylor & Bogdan, 1998). A researcher’s assumptions about the world are based on his or her basic beliefs that define the nature of the world and knowledge. Beliefs about what is regarded as accepted knowledge in a discipline affect how the research is carried out and the findings are interpreted (Bryman, 2012). Research interests and research purpose reflect the nature of research.

99

Research Design

A researcher’s basic beliefs are identified by answering three questions related to ontology, epistemology, and methodology. The ontological question refers to the form and nature of reality, namely, what is there that can be known about reality? The relationship between the knower and what can be known is examined by the epistemological question. The answer to this question is determined by the answer to the ontological question. The methodology used is largely determined by the researcher’s beliefs about ontology and epistemology (Chua, 1986; Guba & Lincoln, 1994). According to Crotty (1998), the research methodology can be either qualitative, quantitative, or both, as long as the adopted research methodology serves the research purpose best and helps the researcher answer the research question. As Morgan (1983) states, any decision on how to conduct a research project is impacted by the question “What is being studied?” He further argues that there are many different ways of studying the same social phenomenon, and considering the significance and merits of the different logics of research that are available to a particular research study is much more important than just debating about the merits of different kinds of methodology. Social researchers have been encouraged to examine what they are doing within the context of available options (Morgan, 1983). An interpretive research methodology was considered appropriate to address the research question of this monograph because the researchers believe knowledge about corporate governance and accounting is subjectively constructed. This methodology was expected to facilitate the researchers’ obtaining insights into the issues associated with the adoption of AngloAmerican models of corporate governance and financial reporting in China through interacting with the key players involved in this innovation. The remainder of the section is organized as follows. Section 5.2.1 explains the interpretive methodology and discusses its main features. Section 5.2.2 illustrates the selection of the interpretive methodology for this monograph, including the consistency between the beliefs of the researchers and the interpretive perspective, and the strengths of the interpretive methodology in answering the research question.

5.2.1. Interpretive Methodology Guba and Lincoln (1994) identify four basic belief systems, defined as paradigms, embraced by researchers in informing and guiding studies, namely, positivism, post-positivism, critical theory, and constructivism, which reflect different ontological and epistemological positions.1

100

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

While positivists, post-positivists, and critical theorists have different research objectives, they share the common belief that a real reality does exist, with fully comprehensible reality, incompletely comprehensible reality, and misapprehended reality being assumed by the three paradigms, respectively. A positivist assumes a comprehensible real reality driven by unchangeable natural laws and mechanisms. Post-positivists indicate that the real reality can only be imperfectly comprehensible. Critical theorists argue that the virtual reality is shaped by social, political, cultural, economic, ethnic, and gender factors and is crystallized into social structures over time (Guba & Lincoln, 1994). On the other hand, the ontology embraced by constructivists is relativism, suggesting local and specific constructed realities. Unlike positivists and post-positivists, who seek true findings and strive for objectivity, constructivists intend to enhance understanding about the world and acknowledge subjectivity involved in the interpreting process because the values of both the researchers and the participants constitute an integral part of the research (Holloway, 1997). There are no absolutely right or wrong constructions but more or less informed or sophisticated ones (Guba & Lincoln, 1994). The research focus is placed on answering questions that explore how social experiences are created and given meanings. The methodology used by constructivists is interpretive in nature. This is also known as a constructivist-interpretive paradigm (Denzin & Lincoln, 2008). According to Denzin and Lincoln (1994, p. 2), interpretive research, alternatively known as naturalistic or qualitative research, is “multi-method in focus, involving an interpretive, naturalistic approach to its subject matter.” Interpretive research takes place in a real-world setting and adopts a naturalistic perspective to interpret phenomena in terms of the meanings people bring to them (Patton, 2005). There are three main features associated with an interpretive research methodology. First, it emphasizes a holistic approach to research. Interpretive research assumes that research inquiry is shaped by various environmental constraints. It is important to explore and understand the diverse, complex, and unique research context when interpreting social actions because people do not live in a vacuum (Holloway, 1997). As Patton (2005) points out, one aim of interpretive research is to construct a holistic understanding of the research context. Second, interpretive research aims at exploring the research question from multiple perspectives because it assumes that both the researchers and the participants play important roles in the research process. Conducting a research project is an interactive process that is influenced by the personal

101

Research Design

backgrounds and constructions of both the researchers and the participants (Denzin & Lincoln, 2008). The task of interpretive researchers is to understand multiple social constructions of meaning given to a particular context by the research participants, who are viewed as helping construct the “reality” with the researchers (Robson, 2002). Hence, researchers are expected to interpret the research context and understand social interactions from the participants’ point of view (Bryman, 2012; Denzin & Lincoln, 2008). However, it is important to take account of researcher bias (Patton, 2005) because it is the researchers who decide what to report and how to report the story and consequently have significant impact on the research outcome. Therefore, the belief systems of both the researchers and the participants influence the final results. Third, interpretive research deploys a wide range of interconnected methods, such as case study, personal experience, interview, and observation, to collect a variety of empirical materials in order to obtain better informed constructions. Such qualitative data provide rich descriptions of the social world, particularly the meanings attached to actions and events in the language of the principal actors, and facilitate exploring unforeseen relationships (Covaleski & Dirsmith, 1990; Gendron, 2009). An interpretive methodology may have some limitations. For example, it tends to be time intensive and underdeveloped in the areas of analysis. Further, the scientific community is of the view that an interpretive methodology is problematic as to the meanings attributed to the concepts of reliability, validity, and researcher detachment (Ahrens & Chapman, 2006; Covaleski & Dirsmith, 1990).

5.2.2. The Current Study An interpretive methodology was considered appropriate for this monograph mainly for two reasons. First, the beliefs of the researchers are consistent with a constructivist perspective. The researchers believe that corporate governance and financial reporting issues are primarily related to human interaction and considered social and institutional practices (see also Hopwood, 2000; Potter, 2005; Roth & Kostova, 2003). Accordingly, knowledge about the issues under investigation is considered to be socially and experientially constructed. The researchers also believe that both researchers and participants have their own biases due to their social status, educational background, and life experience that in turn have an impact on constructions. As Morgan (1983) argues, the nature of social research is a

102

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

distinctively human process through which researchers make knowledge instead of simply revealing or discovering knowledge through a neutral and technical process. It is also recognized that knowledge about corporate governance and financial reporting is not static and can be accumulated in terms of informed and sophisticated reconstructions. This monograph, through an interpretive methodology, aims to provide informed constructions to enable a comprehensive understanding of the implication of adopting internationally acceptable principles and standards in China. The second reason is that an interpretive methodology has its strengths of focusing on the research context, interactive processes, and meanings that are not measurable by statistical data. As suggested by the theoretical framework developed in Chapter 4, it is essential to examine the environmental setting in China, including political, economic, cultural, and legal aspects (see also Chua, 1996; Covaleski & Dirsmith, 1990; Hopper, Storey, & Willmott, 1987; Hopwood & Miller, 1994; Lee & Humphrey, 2006; Lye et al., 2006). An interpretive methodology is able to provide a rich description of China’s institutional context by getting involved in the real setting and appreciating the complex and unique research context (see also Covaleski & Dirsmith, 1990; Patton, 2005). Further, collecting data in a natural setting (as explained in detail later) helps provide insights into the dynamic process of corporate governance Table 5.1.

Determination of an Interpretive Methodology.

The ontological position The researchers of this monograph believe that there is no reality over there to be discovered. This is particularly the case in social science where social reality is believed to be subjectively constructed through human interaction. The epistemological position The researchers believe that there are no absolutely right or wrong constructions, but more or less informed ones. Subjectivity is inevitably involved in the interpreting process. The research purpose is to build up sophisticated constructions to enhance the understanding about the world rather than seeking true findings. The nature of the current study The researchers view corporate governance and financial reporting as parts of social science which are shaped by broader environmental context. Interpretive methodology Interpretive research was conducted in a real-world setting. Through the direct interaction with participants involved in corporate governance and accounting innovation, the researchers were able to create informed constructions regarding issues under investigation.

103

Research Design

and financial reporting practices in China (see also Ahrens & Chapman, 2006). By undertaking research in a real-world setting, the researchers were able to provide a comprehensive understanding of the issues that are of interest to this monograph. In summary, the suitability of an interpretive methodology for the research objective of the current study is illustrated in Table 5.1.

5.3. DATA COLLECTION 5.3.1. Data Triangulation Data triangulation is often described as the use of multiple data-gathering techniques to investigate the same phenomenon and to mutually confirm measures and validation of findings (Hopper & Hoque, 2006; Leedy & Ormrod, 2001). In this monograph, multiple sources of evidence, including interviewing key persons and surveying publicly available documents, were used.2 Data triangulation helped explore the richness and complexity of human behavior because it allowed the researchers to obtain various perspectives (Borman, LeCompte, & Goetz, 1986; LeCompte, Preissle, & Tesch, 1993) and allowed the display of multiple, refracted realities simultaneously (Denzin & Lincoln, 2008). By addressing a broader range of issues pertaining to events investigated (Yin, 2009), data triangulation helped construct a comprehensive, holistic, and contextual understanding of corporate governance and accounting practices in China. In particular, multiple data collection methods can enhance the validity and reliability of research findings.3 Studies that use only one method are considered to be more vulnerable to errors associated with that particular method than studies that use multiple data collection methods (Patton, 2005). Different sources were used to cross-check the validity of the data (Lillis, 1999). Data triangulation also helped to reduce biases from both researchers and participants (Robson, 2002). Different data sources may not always produce essentially the same result (Patton, 2005). Inconsistencies in the findings, instead of being considered as weakening the credibility of the research, actually offered opportunities for further investigation; added richness to the inquiry; and helped to present a better, more substantive picture of reality.

104

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

5.3.2. Interviews with Key People Interviewing is the central resource through which contemporary social science researchers engage with issues that concern them (Atkinson & Silverman, 1997). It enabled data to be collected through direct verbal interchanges between individuals (Denzin & Lincoln, 2008) and provided the researchers with unique access to the participants’ thoughts (Robson, 2002). Compared to self-completion questionnaires, participants may feel more involved and motivated in an interview (Patton, 2005). The philosophy underlying this method is consistent with an interpretive framework, as interviewing is based on the view that knowledge can be constructed by individuals through interaction (Patton, 2005). There may be several limitations associated with interviewing, including high cost and being time consuming (White & Gunstone, 1992) and respondent biases and lapses in memory (Robson, 2002). Nevertheless, interviewing is considered to be one of the most common and powerful ways to understand human beings (Fontana & Frey, 1994). A semi-structured interview approach was considered the most suitable among various interview forms for this monograph because it would overcome the limitation of increasing difficulty in analyzing data in unstructured interviews (Robson, 2002) and the weakness of lacking flexibility in pursuing issues in depth in structured interviews (Bryman, 2012; Fontana & Frey, 1994).4 Particularly, this approach helped maintain a certain degree of consistency and flexibility. A set of predetermined questions was designed (as explained in detail later), but the order and wording of the questions were modified based on the interviewer’s judgment about the most appropriate way (Robson, 2002) to gain insights into various issues under investigation. For example, an auditor was expected to be familiar with auditing-related issues; hence, interviews with auditors started with auditing issues and probed questions with this regard. By covering the same basic questions, data consistency was maintained, which in turn enhanced the efficiency of data analysis. In addition, allowing some flexibility to probe issues in depth helped “quiz the subject further about any unsolicited statements that were made, or about a response to a specific question” (McKinnon, 1988, p. 51) and elicit information in circumstances where the researcher was keen to obtain the interviewee’s view (Chua, 1996). 5.3.2.1. Selection of Interviewees Interviewees comprised company managers, independent directors, auditors, and academics. These groups of people were included because they

Research Design

105

were considered to be involved in the process of corporate governance and financial reporting innovation. Further, the sample, drawn from a variety of groups of people involved in the phenomenon, brought a diversity of perceptions, which helped generate a comprehensive set of data. Perspective diversity, combined with skillful use of probing questions, helped reduce threats to validity and reliability (McKinnon, 1988). Several criteria were used to target interviewees to ensure the quality of interview data. These interviewees were selected mainly based on their knowledge and expertise.5 All selected participants had more than 5 years of experience in the relevant field and held relatively senior positions in their institutions. Interviewees’ profiles are explained in detail later. Selecting knowledgeable participants allowed the researcher to gather more useful and relevant information within a short amount of time (Perera, 2005). In accordance with the selection criteria, initially 42 persons were identified as suitable interviewees by searching websites of listed companies, universities, and government agencies. The first author contacted these persons by phone or by email. Initially, many potential interviewees showed their concern or reluctance about being interviewed. Through communication, eventually 23 of them agreed to participate in the project. The common reason given by persons who refused to accept the invitation was lack of time and knowledge. It is worth noting that for the purpose of this monograph, government officials were considered an important group of interviewees, as corporate governance and financial reporting have been largely driven by the government. For example, the MOF of the central government is responsible for developing accounting policies; thus, it is valuable to seek views of MOF officials regarding accounting development in China. However, the researchers found it was extremely difficult to obtain an interviewee from the MOF at the central government level and thus were unable to secure insights from the perspective of government agencies. 5.3.2.2. Design of the Interview Guide The design of the interview guide was informed by a number of texts on research methods, including Dane (1990), Denzin and Lincoln (1994), Patton (2005), and Robson (2002). In addition, it was also informed by the interpretive framework used in this monograph and the extant literature with regard to corporate governance and financial reporting to ensure that the interview questions focused on relevant issues and were able to elicit useful information. Interview questions were designed to help examine how the adoption of Anglo-American models of corporate governance and

106

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

financial reporting is shaped by the interaction between institutional settings and intraorganizational dynamics in China. In addition to detailed questions, the interview guide also incorporated some broad, open-ended questions to engage interviewees in a loosely guided conversation and thus elicit rich and in-depth insights (Smith, 2011; Taylor & Bogdan, 1998). The questions were divided into six sections, namely, independent director, audit committee, auditor independence, corporate code of conduct, transparency and disclosure, and the adoption of IFRS. All questions sought to elicit the impact of China’s institutional settings and interplay of organizational players from a variety of perspectives. After extensive consultation with the supervisors of the research project, two accounting academics at one Australian university, and two Chinese academics who returned to China after completing finance and accounting degrees overseas, the initial English version of the questionnaire was generated. In order to ensure that the respondents understood the meaning of the questions, and hence improve the wording of the questions, a pilot study was conducted, as suggested by Robson (2002). The pilot study included pre-interviewing persons with considerable knowledge about corporate governance and accounting and gaining their feedback to further clarify any issues arising. It comprised four stages. The first stage tested the interview questions among three academics at an Australian university with expertise in corporate governance and financial reporting. Then the content and order of the questions were refined on the basis of their suggestions. For example, more questions were designed to elicit information about the selection of independent directors and auditors. The refined interview questions were tested among four accountants worked in accounting firms or companies in Australia in the second stage. As the research topic focuses on listed companies in China, accountants with a Chinese university degree were selected. In the third stage, three participants from Chinese-listed companies were selected for interviewing. Before the interview, information about their companies’ business, corporate governance practice, and financial reporting was obtained from newspaper, company websites, and reports of government agencies. By spending some time reviewing records and documents, some insights into the shape of the study that were not apparent previously were uncovered (Janesick, 1994). The fourth stage was to gain feedback on the interview questions from the supervisors of the research project. During this process, any perceived problems, such as questions that were likely to be misunderstood and ambiguous, were identified and rectified to improve the usefulness and effectiveness of the interviews.

Research Design

107

Finally, an important step in the interview guide design was to develop an equivalent Chinese version, as interviews needed to be conducted in China. It was essential to ensure that there were no misinterpretations arising from translation errors. To deal with this problem, the translation and back-translation procedures developed by Hui and Triandis (1985) were followed. This procedure aims at creating a Chinese version of the questionnaire that is linguistically equivalent to the English version. First, the first author translated the English material into Chinese characters. An independent translator then reproduced the resultant Chinese version back in English. The original and second English versions were compared to identify inconsistencies that were resolved with the help of a second expert in Chinese. After that, the first author produced a second Chinese version of the questionnaire that was then used for interviews in China. The English and the Chinese versions of the interview guide are in the appendix. The final step was preparing the Information Statement and Consent Form that would be signed by both the researcher and the interviewee in each interview. 5.3.2.3. Conducting Interviews Twenty-three interviewees participated in the study, comprising seven company managers, seven independent directors, five auditors, and four academics. These interviewees’ profiles are summarized in Table 5.2. A copy of the Chinese version of the interview guide was distributed to all participants prior to the interview to enable them to prepare for the interview and help the researcher conduct the interview more effectively (see also Perera, 2005). All interviewees signed the Information Statement and Consent Form, which formally ensured confidentiality to them. Such assurance was essential to gain their confidence, as the corporate governance and reporting issues were likely to be considered as being sensitive by participants. Further, in order to enhance the accuracy of data collected, it was decided to tape record the interviews with the permission of the participants. Fifteen interviews were tape recorded, and the remaining eight were recorded by taking notes. The interviews were conducted by the first author and ranged from 40 minutes to 2 hours in duration. The transcripts in Chinese were mailed to the interviewees to verify, and any ambiguity was clarified. All Chinese transcripts were translated into English. To maintain data accuracy, an experienced translator with considerable knowledge in the business and accounting field was deployed. In addition, the translator’s work was thoroughly reviewed by the first author.

Table 5.2. Interviewee

Education/ Qualification

Profile of Interviewees.

Years of Work Experience

Position Company secretary in a large non-stateowned company Company secretary in a large stateowned company CFO in a medium non-state-owned company CFO in a large state-owned company Company secretary in a large stateowned company Company senior manager in a large non-state-owned company Company senior manager in a large state-owned company Audit committee chair or member in a number of listed companies Audit committee chair or member in a number of listed companies Audit committee chair or member in a number of listed companies Audit committee chair or member in a number of listed companies Audit committee chair or member in a number of listed companies Audit committee chair in a listed company Audit committee member in two listed companies Senior manager in one of the Big 4 international accounting firms Partner in one of the top 10 local accounting firms Senior manager in one of the Big 4 international accounting firms Senior manager in one large local accounting firm Senior manager in one large local accounting firm MBA director Associate director of master’s program Head of accounting department Associate head of accounting department

CM1

Master’s

20

CM2

Bachelor’s

20

CM3

Master’s

20

CM4 CM5

Bachelor’s Master’s

20 20

CM6

Master’s, CPA

15

CM7

Bachelor’s

20

ID1

PhD, CPA, Professor

25

ID2

PhD, CPA, Professor

25

ID3

PhD, CPA, Professor

25

ID4

PhD, CPA, Professor

25

ID5

PhD, Professor

20

ID6 ID7

PhD, Professor PhD, Professor

10 10

AU1

Bachelor’s, CPA

10

AU2

Master’s, CPA

15

AU3

Master’s, CPA

10

AU4

Master’s, CPA

10

AU5

Master’s, CPA

10

ACA1 ACA2 ACA3 ACA4

PhD, Professor PhD Master’s Master’s

30 5 10 10

Notes: The classification of enterprise is on the basis of The Classification of Large, Medium, and Small Enterprises in Statistics (Provisional) issued in 2003 by the National Bureau of Statistics of China (http://www.stats.gov.cn/). State-owned company refers to a listed company whose controlling shareholder is the state or a state agency. On the other hand, a non-state-owned company is controlled by nonstate entities. The universities that are associated with the four academic interviewees are among the top 100 universities in China.

109

Research Design

In addition, throughout the data collection process, reflection notes were prepared by the first author immediately after interviews (see also Parker & Roffey, 1997). These notes typically included a brief summary of interview content, particular researcher impressions of events, reactions to questions, the interviewee’s stance, and other contextual information.

5.3.3. Document Survey Documentary study was an important method of data collection in this study because of its low cost and easy access and ability to provide information unavailable in spoken form and to provide historical insight (Hodder, 1994). In addition, unlike other sources of qualitative data, collecting data from documents requires minimal cooperation from persons within the setting being studied (Fetterman, 2010); thus, these data are virtually nonreactive to the presence of investigators (Berg, 2004). Documents can be divided into two major categories: public documents and personal documents (Merriam, 2009). Although personal documents can help the investigator understand how the participants see the world and what they want to communicate to an audience, because of the nature of the current study and the difficulties in collecting personal documents in China, this monograph relied upon public records. Public documents are materials created and prepared to attest to an event or provide an account (Lincoln & Guba, 1985). Sources of public documents used in this monograph included corporate governance guidelines and accounting regulations issued by government agencies, government reports, reports issued by supranational organizations, rating agencies’ reports, official statistics data, relevant content on firms’ websites, mass media reports, and analysts’ reports. Such materials were useful in better understanding the business environment, corporate governance practice, and accounting disclosure in China. An examination of the extant literature that investigates corporate governance and financial reporting issues in China also helped to understand the phenomena under investigation.

5.4. DATA ANALYSIS Qualitative data analysis is a dynamic and creative process involving inductive reasoning, thinking, and theorizing (Taylor & Bogdan, 1998). Although

110

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

computer-assisted qualitative data analysis software is increasingly used in qualitative research, the data analysis for this monograph was conducted mainly manually. The computer software NVivo was only used to store and manage data,6 which allowed the researchers to access, retrieve, and view the data conveniently. While recognizing computer software as a useful data management tool, Blismas and Dainty (2003) argue that computer-assisted approaches often restrict rather than aid the analytical process. Computer software can never replace the researcher’s insight, judgments, and intuition in theorizing and interpreting data (Blismas & Dainty, 2003; Taylor & Bogdan, 1998). Lye et al. (2006) also point out that caution needs to be taken in seeking the assistance of computer software packages to avoid having to compromise the interpretive nature of the study. The purpose of this monograph is to provide an understanding of the implementation of Anglo-American models of corporate governance and financial reporting in China. The issues under investigation were viewed as sensitive, particularly from the perspective of interviewees, because most of the interviewees were directly involved in the process and had a stake in it. Sometimes their responses tended to be vague and subtle. Further, corporate governance and financial reporting practices are shaped by the institutional setting within which they operate. Meaning ascribed by actors needs to be interpreted and understood in the institutional context. This study, by its nature, is dependent on the researchers’ interpretation and understanding of the data for meaningful analysis (see also Blismas & Dainty, 2003). Coding and sorting manually, rather than relying on computer software, allowed the researchers more opportunities to think about the data and to develop ideas and intuition about the data. Procedures suggested by some prior studies (Lye et al., 2006; Parker & Roffey, 1997; Taylor & Bogdan, 1998) were largely relied upon in this monograph, with some variation. As indicated above, there were two sets of data: interviews and a document survey. Any data in Chinese were translated into English.7 They were coded and analyzed separately but largely using the same procedures. For illustration purposes, the following description is based on interview data. In this study, interview data include interview transcripts (also referred to as original data hereafter) and reflection notes. They were stored separately. Only interview transcripts were imported into NVivo and coded to ensure the original data were not contaminated by the researchers’ interpretation. Informed by the interpretive theoretical framework, the data analysis started with developing a coding scheme in order to facilitate the

111

Research Design

identification of emerging themes and abstraction of concepts in the later stage. To answer the research question, six constructs (referred to as basic codes hereafter) were identified in relation to organizational changes in corporate governance and financial reporting. Each construct generated at this stage was labeled by a unique code (see Table 5.3).8 A node was used to manage evidence related to each basic code in the NVivo software. First, the researchers read the original data stored in the software. As evidence pertaining to a particular basic code was identified, the evidence was highlighted and added into the node allocated to that basic code. The software automatically sorted the evidence in accordance with sources (i.e., from which interview), which means that evidence from the same interview was sorted together. For example, one of the basic codes is “ID,” which means “independent directors.” All types of evidence related to this basic code were imported to the node of “ID” from the original data. After all relevant items of evidence were coded, it was shown that there were 43 references (one piece of evidence is referred to as a reference in the software) from 18 sources (interviews) in relation to independent directors. Such arrangements enabled the researchers to keep track of the number of references under each basic code. Further, the researchers could conveniently revisit and corroborate coded evidence with the original data sources. Upon the completion of coding all interview transcripts, the researchers revisited the transcripts to ensure that all portions related to any basic code had been coded. This check was also conducted by an outside reader, the translator, as suggested by Taylor and Bogdan (1998). This approach was useful in constraining the researchers’ selective perception and interpretation, which is one major threat to the reliability and validity of qualitative research (McKinnon, 1988). In addition, the translator’s familiarity with the data and sound knowledge of business and accounting helped discover subtle aspects that were overlooked by the researchers (Taylor & Bogdan, 1998). All coded items of evidence were printed out and Table 5.3.

Coding of Data.

Organizational Changes Independent director Audit committee Auditor independence Corporate code of conduct Financial reporting Recommendations

ID AC AI CC FR RE

112

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

labeled under each of six basic codes. The rest of the analytical process was completed manually. The next step involved looking for emerging themes and developing concepts under each basic code. The researcher examined all coded evidence and reflection notes and revisited original data when necessary. Incorporating procedures suggested by prior studies, the process included identifying themes in open coding, developing core codes through constantly comparing the similarities and differences among open codes, and discovering concepts to explain the data (Lye et al., 2006; Parker & Roffey, 1997; Taylor & Bogdan, 1998).9 Taylor and Bogdan (1998) indicate that how a researcher interprets her or his data depends on the theoretical assumptions adopted. The theoretical framework developed in Chapter 4, which is based on institutional theory, incorporating institutional influences and intraorganizational dynamics, fundamentally guided the data analysis. For example, under the basic code “ID” (independent directors), the ideas and concepts were largely developed through the perspectives of institutional influences and interaction between independent directors and other organizational players, such as company management and external auditors. Further, throughout the data analysis process, theoretical memos were written to organize and stimulate coding at various levels. They were used to identify relationships between codes and to clarify, sort, and extend ideas (Parker & Roffey, 1997). Observed relationships from the data were recorded and thoughts and ideas that derived from the analysis process were captured in written format (Lye et al., 2006). In the later stage, memo writing was used to summarize all of the major findings of the study and make comments on specific aspects of the study (Taylor & Bogdan, 1998). While the above descriptions show a linear process, the process of abstracting from the data, through various levels of coding, to the discovery of concepts is a back-and-forth movement in essence. Through the iterative analytical process, the researchers were able to develop insights and generate theoretical understandings concerning the events under investigation. The systematic coding and analysis increased the rigor of the analysis process (O’Dwyer, 2004) and helped realize the richness of the field research in a coherent way (Ahrens & Dent, 1998). Further, it helped organize a large amount of data, hence partly addressed the issue of “drowning in the data” (Dent, 1991, p. 711), and enhanced the efficiency of data analysis. Moreover, it helped establish the credibility of the study by reducing threats to validity and reliability that may emerge at the interpreting

113

Research Design

process. The coding system forced the researcher to analyze the content of the initial information set carefully, limiting room for arbitrary interpretation (Perera, 2005).

5.5. CONCLUDING REMARKS This monograph examines issues involved in achieving the expected objectives of improving organizational players’ accountability and financial reporting quality by adopting internationally acceptable principles and standards in China. An interpretive methodology was considered most suitable for the study. Informed by an institutional framework, the interpretive methodology was selected for this monograph for its strengths of focusing on the research context, interactive processes, and meanings that are not measurable by quantitative approach. The interpretive methodology is also consistent with the ontological and epistemological positions of the researchers. Data were collected from interviewing four groups of key persons and a document survey. The data triangulation and multiple perspectives helped increase the reliability and validity of the study. Also, conducting data collection in a natural setting produced a rich data source. This enabled the provision of an enhanced understanding of the operation and effectiveness of corporate governance and financial reporting practice in a real setting. In addition, the systematic set of data analysis procedures helped improve research rigor and develop conceptual and theoretical understanding of issues of interest.

NOTES 1. A positivist assumes a real reality, driven by unchangeable natural laws and mechanisms, over there to be discovered. The research purpose is to find out about the real world. Thus, the investigator should be objective and value free in order to study the investigated object without influencing it or being influenced by it. Knowledge of “how things really are” and “how things really work” are conventionally summarized in the form of time- and context-free generalizations. Thus, to study the reality the focus within this paradigm is on objective collection and analysis of quantitative data (Guba & Lincoln, 1994). Post-positivists also assume the existence of a real world, but the real reality can never be fully comprehended (Guba & Lincoln, 1994). However, if rigorous procedures for validity are followed the replicated findings are probably true, but always subject to falsification, and are

114

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

likely to reflect reality most closely (Holloway, 1997). Compared to positivists, postpositivists tend to do inquiry in more natural settings and hence may also adopt qualitative methods. Critical theorists also assume an apprehendable reality. However, the virtual reality is shaped by social, political, cultural, economic, ethnic, and gender factors and is crystallized into social structures over time. Then these historically mediated structures are inappropriately taken as real. Findings and knowledge are value mediated and subjective. Fundamental conflict is inherent in injustice and ideology in the social, economic, and political domains (Chua, 1986). There is a deep structure below the surface of daily social existence that generates a coercive and exploitive existence for most agents. Therefore, the purpose of critical theory research is not only to understand but, more fundamentally, to reveal power and oppression and cause change in the oppressing power structures (Fay, 1987). 2. Denzin (2009) points out that triangulation includes the use of multiple data collection technologies, multiple theories, multiple researchers, multiple methodologies, or combinations of these four categories of research activities. 3. According to McKinnon (1988), validity is concerned with the question of whether the researcher is studying the phenomenon she or he purports to be studying, while reliability is concerned with the question of whether the researcher is obtaining data on which she or he can rely. 4. Structured interviews and unstructured interviews are the two other forms. A structured interview is where an interviewer asks each respondent the same set of predetermined questions in the same order and same wording (Fontana & Frey, 2003). The rationale underlying this structure is to offer each respondent approximately the same stimulus so that responses to questions will be comparable (Babbie, 2001). A main weakness associated with this approach is very little flexibility in the way questions are asked or answered; therefore, the interviewer loses the opportunity to explore the research question in depth (Fontana & Frey, 1994) and cannot pursue topics or issues that were not anticipated when the interview questions were prepared (Bryman, 2012). An unstructured interview is the most open-ended interview approach and presents maximum flexibility for the investigator to probe information in whatever direction appears to be appropriate (Patton, 2005). This interview approach avoids limiting the field of inquiry by providing great freedom to the investigator and is useful in inductive research that intends to explore complex actions (Fontana & Frey, 2003). There are some drawbacks to this approach. For example, it is more difficult to analyze the findings because of the variety of data gathered from different interviews (Robson, 2002). It is also more likely to introduce interviewer biases (Patton, 2005). 5. In order to assess the interviewees’ knowledge and expertise, the researcher mainly relied on information regarding their education, professional qualifications, work experience, and position held in the organization. 6. NVivo is a qualitative data analysis computer software package designed for qualitative research. 7. Any information in Chinese obtained via the document survey was translated by the first author. 8. The first step suggested by Parker and Roffey (1997) and Lye et al. (2006) in a ground theory study is open coding, which involves the analysis of the researcher’s

Research Design

115

interview transcripts and notes on a line-by-line, paragraph-by-paragraph basis to identify patterns and themes. This study was not a grounded theory study in the strict sense, and as it was guided by a theoretical framework, the coding procedure started with a number of constructs that were informed by the theoretical framework, which in turn guided the subsequent search for themes in later stages. 9. The core codes emerge as aggregates of the most closely interrelated open codes for which supporting evidence is strong (Corbin & Strauss, 2008). A core code can be considered to unite different codes on the basis of an analysis of underlying similarities within these codes. By comparing different pieces of data, the researcher refines and tightens up the ideas and gradually moves to a higher level of conceptualization (Taylor & Bogdan, 1998).

CHAPTER 6 THE CORPORATE GOVERNANCE AND ACCOUNTING ENVIRONMENT IN CHINA

ABSTRACT This chapter examines China’s corporate governance and accounting environment that shapes the adoption of internationally acceptable principles and standards. Specifically, it examines international influences, including supranational organizations; foreign investors and international accounting firms; domestic institutional influences, including the political system, economic system, legal system, and cultural system; and accounting infrastructure. China’s convergence is driven by desired efficiency of the corporate sector and legitimacy of participating in the global market. Influenced heavily by international forces in the context of globalization, corporate governance and accounting practices are increasingly becoming in line with internationally acceptable standards and codes. While convergence assists China in obtaining legitimacy, improving efficiency is likely to be adversely affected given that corporate governance and accounting in China operate in an environment that differs considerably from those of Anglo-American countries. An examination of the corporate governance and accounting environment in China suggests heavy government involvement within underdeveloped institutions. While the Chinese government has made impressive progress in developing the corporate governance and accounting environment for the market economy, China’s unique institutional setting is likely to affect how the imported concepts are interpreted and implemented.

117

118

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Keywords: International forces; legitimacy; government intervention; underdeveloped institutions

6.1. INTRODUCTION In the context of economic globalization, China has increasingly moved toward global practices, and international influences considerably shape corporate governance and accounting innovation in China. Further, the implementation of internationally acceptable principles and standards is also largely determined by domestic influences. Thus, the discussion in this chapter unfolds at both the international level and domestic level. The chapter proceeds as follows. Section 6.2 describes the background of corporate governance and accounting innovation in China. The international influences are examined in Section 6.3. Section 6.4 discusses the domestic institutional elements, including the political system, economic system, legal system, and cultural profile. Accounting infrastructure is examined in Section 6.5. Because of the interrelation among institutional elements and accounting infrastructure, the discussion of certain issues somewhat overlaps. Section 6.6 ends the chapter with some concluding remarks.

6.2. BACKGROUND China is the largest and fastest growing transitional economy (Allen et al., 2005; Lin & Liu, 2009) and overtook Japan in 2010 as the second largest economy in the world (Bloomberg News, 2010). China has moved from a centrally planned economy to a market-oriented one. Corporate governance and financial reporting constitute important parts of China’s economic reforms. Historically, corporate governance practice in China has been heavily influenced by the German model, with a two-tier board structure comprising a board of directors and supervisory board.1 Although the weak supervisory board has been long criticized, the Chinese government does not seem to intend to change this arrangement, and the revised Company Law seeks to reinforce the power of the supervisory board (Feinerman, 2007). On the other hand, the Anglo-American model plays an

The Corporate Governance and Accounting Environment in China

119

increasingly important role in the Chinese corporate sector. Since the late 1990s, China’s corporate governance system has been designed to resemble more closely the Anglo-American practices (Chen, 2009; Lau et al., 2007; Miles, 2006; Tam, 2002). The Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies issued in 2001 and the Code of Corporate Governance for Listed Companies in China issued in 2002 reflect the government’s intention to converge with the Anglo-American model. Financial reporting in China has also undergone significant changes. Following the unfolding of economic reforms, the industry-specific accounting rules, which had been developed within the planned economy, have been gradually replaced by accounting principles prevailing in mature market economies. In the early stage of the economic reforms, international accounting standards were only adopted by foreign invested companies. With the increasing appreciation of globally accepted accounting practice, all listed companies have been required to adopt new Chinese accounting standards, which are largely in line with IFRS, since January 2007 (Ding & Su, 2008). The convergence is justified by both efficiency and legitimacy reasons. The Chinese government initiated economic reforms to revive the national economy. Poor performance of SOEs imposed an urgent pressure on the Chinese government to reform the state-owned corporate sector. Further, it is stated that the purpose of the Code of Corporate Governance for Listed Companies in China is to “promote the establishment and improvement of modern enterprise system by listed companies, to standardize the operation of listed companies and to bring forward the healthy development of the securities market” (CSRC, 2002). The objective of new Chinese accounting standards is “to standardize accounting recognition, measurement and reporting of enterprises, and to ensure quality of accounting information” (MOF, 2006). Thus, corporate governance and accounting innovation was internally driven by domestic pressure to improve corporate efficiency. In the context of globalization, international pressures also played an essential role in determining the Anglo-American corporate governance and financial reporting models with which China converged. These pressures have accorded power to Anglo-American models in the global context. Along with its integration into the global economy, China encounters increasing international pressures to converge with internationally acceptable practices in order to gain legitimacy in participating in the global market, as suggested by institutional theorists (DiMaggio & Powell, 1983; Meyer & Rowan, 1977).

120

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

6.3. INTERNATIONAL INFLUENCES The Chinese government’s promotion of the open-door policies is an indicator of the recognition of the power of globalization, and it became an important driver of the economic reform in China (Zheng, 2004), which has transformed China into one of the most important players in the world economy. The total amount of foreign trade (including imports and exports) reached USD 2,207.2 billion in 2009 from USD 20.6 billion in 1978, making China the third largest nation in foreign trade. Foreign direct investment increased from USD 0.92 billion in 1983 to USD 90 billion in 2009, with an average annual increase rate of around 19.3%.2 Participation in globalization helps to significantly improve China’s competitiveness in foreign trade and solve problems of lack of capital, technical equipment, and management talent. In 2010, China overtook Japan as the world’s second largest economy (Bloomberg News, 2010). Within the context of globalization, China’s adoption of AngloAmerican models of corporate governance and financial reporting is primarily due to the influences of supranational organizations that reinforce one another in promoting internationally acceptable principles, standards, and codes. These organizations are the OECD, IASB, World Bank, WTO, IOSCO, and IFAC. In addition, other international influences, including foreign investors and international accounting firms, also play an important role in the convergence process.

6.3.1. Supranational Organizations 6.3.1.1. OECD Since the OECD Council announced the launch of a program of dialogue and cooperation with China in October 1995, the relation between the OECD and China has developed strongly and covered a wide range of areas, including corporate governance (Langer, 2005). A series of high-level meetings under the title of OECD-China Policy Dialogue on Corporate Governance were convened to exchange experience on corporate governance, and the OECD came to be considered “a natural partner of China’s reform” (OECD, 2005). Although China is not a member country of the OECD yet, it became one of five key partners of the OECD following the OECD’s launching of Enhanced Engagement in 2007, which aimed at advancing the OECD’s relationship with those key partners.3

The Corporate Governance and Accounting Environment in China

121

6.3.1.2. IASB The IASB has provided great support to China in its development of accounting standards. For example, the China Accounting Standards Committee and the IASB jointly held a series of working meetings in October 2005, followed by a successful convergence meeting on accounting standards in November 2005, cochaired by China’s Vice-Minister of Finance Wang Jun and IASB Chairman Sir David Tweedie. Three IASB members and two IASB directors also attended the meeting. During this meeting a joint statement that recognized the substantial convergence between Chinese accounting standards and IFRS was signed. The IASB assisted the China Accounting Standards Committee in reviewing the revisions to the accounting standards exposure drafts, existing standards, and the implementation guidance (Wang & Tweedie, 2005). In his first visit to China as the new chairman of the IASB during July 2011, Hans Hoogervorst commended China’s efforts on the continuous convergence with IFRS and stated that “Chinese interests are well represented on the IASB … I will ensure that Chinese interests are given careful consideration in IASB debates, and that China gets the credit it deserves for its commitment to IFRSs” (Hoogervorst, 2011). 6.3.1.3. World Bank The World Bank has been playing a significant role in China’s economic reform. Since the first loan in 1981 supporting development of Chinese universities, the World Bank’s cumulative lending to China as of June 30, 2012, was more than USD 50.41 billion for 349 projects, making China the largest portfolio in the Bank. The portfolio is concentrated in the environment, transportation, urban development, rural development, energy, water resources management, and human development (World Bank, 2013). China’s accounting reform has directly benefited from the financial support of the World Bank.4 In addition, the World Bank helps the Chinese government to train regulators, company directors, business owners, and investors and disseminates best corporate practices through the Global Corporate Governance Forum, studies, and workshops (Tenev et al., 2002). 6.3.1.4. WTO China’s accession to WTO membership in 2001 brought about China’s participation in economic globalization at a higher level and with a wider scope and significantly accelerated the convergence process. As a condition for WTO accession, China has committed to a broad range of measures, such as increasing transparency in business and government activities,

122

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

reducing price restrictions, adopting internationally acceptable standards, decreasing tariffs, eliminating nontariff barriers, and opening up the service industry (including accounting and finance). These commitments add to the urgent need to tackle corporate governance issues in a comprehensive and systematic manner (Tenev et al., 2002). To adapt to the new environment, Chinese enterprises have been speeding up reforms, increasing productivity and efficiency, instituting more standardized forms of governance and management, and generally improving their overall quality (Mar & Richter, 2003). 6.3.1.5. IOSCO The relationship between IOSCO and China’s regulator of securities has been strengthened steadily over the last two decades. The CSRC became a member of IOSCO in 1995. The Shanghai Stock Exchange and Shenzhen Stock Exchange joined the Consultative Committee of the IOSCO, and the Chairman of the CSRC was elected Vice-Chairman of the IOSCO Executive Committee in 2006 (Diplock Ao, 2006). The 2012 IOSCO Annual Conference was held in the capital city of Beijing by the CSRC, which reflects the importance of China for current international financial markets (Maijoor, 2012). 6.3.1.6. IFAC The CICPA joined IFAC in 1997. The admission to membership in IFAC has facilitated China’s participation in developing international auditing standards. The communication and cooperation between China and IFAC has been increasingly strengthened. For example, in the joint statement by the chairman of the Chinese Auditing Standards Board and the chairman of the International Auditing and Assurance Standards Board issued in November 2010, the Chinese government clearly stated its firm support of international convergence of auditing standards and announced the release of the revised Chinese Standards on Auditing, which achieved full convergence with the International Standards on Auditing (IFAC, 2010).

6.3.2. Foreign Investors Following the open-door policy, China has attracted an increasing number of foreign investors who have played an important role in transforming corporate governance and accounting. For example, multinational companies act as a role model by demonstrating to Chinese managers how

The Corporate Governance and Accounting Environment in China

123

Western management practices work (Fan, 2004). Foreign investors have introduced new management styles that serve as a reference point for domestic enterprises (Dees, 1998). Most Chinese partner companies in large and medium-sized joint ventures are SOEs, and the Chinese government has also called on SOEs to learn management practices from exemplary international joint ventures (Li, 1992). The initial demand for international accounting harmonization was driven by foreign invested enterprises.

6.3.3. International Accounting Firms International accounting firms have largely influenced public practice in China and helped raise the professional standards of Chinese CPAs. Their practice standards have been implemented and learned by Chinese CPAs through joint ventures and membership system.5 In addition, international accounting firms actively participate in the development process of financial reporting in China. For example, in the course of developing auditing standards, the MOF set up two advisory groups to facilitate standards setting. International accounting firms were members of one advisory group, the Foreign Advisory Group, and provided technical support to enhance the consistency of Chinese auditing standards and the practices of public accounting prevailing in developed countries (Lin, 1998). In 1993, the MOF engaged Deloitte Touche Tohmatsu, an international accounting firm, as a consultant to help develop Chinese accounting standards. In 2000 Deloitte Touche Tohmatsu was reappointed as a consultant in the second phase.

6.4. DOMESTIC INSTITUTIONAL INFLUENCES The purpose of this section is to examine influences of local institutional elements upon corporate governance and accounting innovation in China. Previous discussion indicates that the Chinese government determined to move toward Anglo-American models for both efficiency and legitimacy considerations. While the convergence satisfies international pressures, regulation alone does not automatically ensure the realization of expected outcomes. As informed by the theoretical framework, the implementation of internationally acceptable ideas is largely influenced by the local context in which those ideas are interpreted and practiced, including the political system, economic system, legal system, and cultural environment.

124

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

6.4.1. Political System China was formed as a socialist country with single-party leadership in 1949.6 Maoism, which dominated the country since her formation, was gradually replaced by Dengism after the 1970s. Maoism stressed class struggle, central planning, and public ownership. Accounting was considered to have class nature in Mao’s era.7 Under Dengism the ideology shifted to economic development, which led to a market-oriented economy based on socialist principles. The Chinese government has made considerable efforts to reduce its involvement in the business sector and improve its administration. Accounting practices and theories are no longer viewed as having a class nature and have been gradually recognized as measures to report economic activities with no national boundaries (Ge, 1980, 1981). However, government involvement in corporate governance and accounting remains because of the unique political structure and the government’s controlling shareholder status in many restructured state-owned enterprises. 6.4.1.1. Single-Party Leadership Unlike the multiple-party model adopted in most Anglo-American countries, in China the political power is assumed by the Communist Party of China regardless of the existence of a number of minority parties. Consequently, the Chinese government is firmly controlled by the Communist Party. The form of government in China is a single-party people’s republic with one legislative chamber. In accordance with the state constitution, all national legislative power is vested with the National People’s Congress. China has a parallel hierarchy of party and government leadership, whose functions are often intertwined. For example, the head of the state is also the party leader. This parallel arrangement helps the Communist Party control the government at all levels of the national hierarchy.8 The Communist Party maintains the control over all key appointments in government and other major organizations, such as enterprises and universities, through a personnel department and organization department. In contrast to the big strides in economic reforms, the changes in the political system in China are more conservative. Some internationally acceptable political concepts, such as liberalism and Western democracy, have not yet been embraced by the Chinese government (Y. Cheng, 2008; Goldman, 2005). Political philosophy stresses that only through the continued monopoly of power of the Communist Party of China can the social order and stability be maintained and healthy economic development be

The Corporate Governance and Accounting Environment in China

125

ensured. In addition, the global norm of checks and balances among the executive, legislature, and judiciary is still absent in China (Lam, 2009). 6.4.1.2. Reduced Government Involvement in Business Operation The Chinese government has been striving to improve its administration. Further, since the commencement of economic reforms in 1978, the government has gradually reduced its involvement in business operations. Traditionally, the Chinese government used to dominate every aspect of the nation, including the business sector. For example, prior to the economic reforms, the government ran all enterprises, which were considered production units and implemented the government’s economic plan. The new policies have gradually separated the function of the government from enterprises and service institutions. Further, a series of administrative laws and regulations were issued to build an open and responsive style of government. For example, the Chinese government issued the Administrative Procedure Law in 1989 to encourage transparency and fairness of decision making by government agencies. Recognizing the widespread outrage of the public regarding power abuse, the government issued the Administrative License Law in July 2004. The Regulations on Freedom of Government Information were introduced in May 2008 to increase the amount of government information available to the public (Zhang, 2009). Although the administrative laws and regulations in China are less developed and sophisticated compared to those in Anglo-American nations such as the United States,9 the progress suggests the Chinese government’s awareness of the severity of issues caused by bureaucracy and willingness to address those issues. 6.4.1.3. Political Influence on Corporate Governance and Accounting Current literature provides evidence that suggests persistent government intervention in the business sector in general and corporate governance and financial reporting in particular. Because of the unique political structure the Chinese government seems to have more direct and profound influence upon the business sector compared to Anglo-American countries. In addition, although the government has gradually withdrawn from enterprise operation, it remains a controlling shareholder in many restructured SOEs (Liu & Sun, 2005; Xu, Zhu, & Lin, 2005). The multiple roles, including regulator and shareholder, enable politicians and public sector administrators to still routinely intervene in SOEs (Liu, 2006). The government continues to offer favorable treatment to state-owned companies. For example, SOEs were given priority in listing on stock

126

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

exchanges compared to non-state-owned entities. To help them grow and reorganize, the government specified some commercial and state banks to help SOEs with loan support (Brandt & Li, 2003; Wang, Wong, & Xia, 2008). SOEs continuously receive privileged treatment even after they are restructured and listed. For instance, entry into the WTO led the Chinese government to recognize the importance of forming world-class big companies. Accordingly, in 1998, the government decided to invest more than RMB 20 million (approximately USD 3 million) annually in each of the six large SOEs, namely, Bao Gang, Haier, Fang Zheng, Chang Hong, Hua Bei Medicine, and Jiang Nan Ship, to support their technological improvement, along with other preferential policies on financing, technology access, and import tariffs (Yang, 2007). The government’s favorable treatment creates an environment that deviates from the free competitive mechanisms and impairs the foundation of the market economy (Wang, Shi, & Fan, 2006). Further, Wang et al. (2008) indicate that SOEs’ incentive to improve their corporate governance is also likely to be affected by government intervention, such as preferential access to capital and government bailouts. Several studies have documented the Chinese government’s domination over the nomination of management and board members in listed companies. Fan, Wong, and Zhang (2007) find that politicians and state controlling owners occupy most board seats, with almost 50% of the directors appointed by state controlling owners and another 30% affiliated with various layers of governmental agencies. In 2007, the government arranged for the CEOs of China Telecom, China Netcom, and China Mobile to swap posts, though these three listed firms were in competition with one another (Jiang et al., 2009). Fan et al. (2007) document a significant presence of politically connected CEOs in Chinese listed companies and suggest that these firms are more likely to have boards populated by current or former government bureaucrats. Politically connected boards show low degrees of professionalism, with fewer directors having relevant professional backgrounds (Fan et al., 2007). Further, the management of the state shareholding companies is accountable to the government as a controlling shareholder (Jiang et al., 2009) and “naturally pursues a political relationship with government officials rather than improvement in performance” (Wang & Deng, 2006, p. 8). Liu (2006) describes the corporate governance system adopted by the Chinese listed companies as a control-based model, in which the state tightly controls the listed firms as the controlling shareholder. The original purpose of establishing the stock markets was to raise capital for SOEs through partial privatizations while retaining the government’s status as the controlling shareholder (Jiang et al., 2009; Liu, 2006;

The Corporate Governance and Accounting Environment in China

127

Walter, Fraser, & Howie, 2003; Wang & Chen, 2008). Although these listed companies are expected to be run efficiently to maximize shareholder interest, they are still expected to assume political roles, including provision of employment, direct control of sensitive industries, and politically motivated job placement (Liu, 2006). In short, although the Chinese government has endeavored to reduce its involvement in the corporate sector, it still has considerable influence largely because of China’s unique political system and the government’s controlling shareholder status. The government’s intervention in various aspects of corporate practices is likely to undermine the attempts at improving corporate governance and financial reporting. 6.4.2. Economic System The economy is closely related to politics in China because of its socialist nature. The class struggle focus had largely slowed the growth of China’s national economy in Mao’s era. The decision to shift from class struggle to economic development and to adopt economic reform and open-door policies was made at the 3rd Plenum of the Communist Party of China in 1978. This was the beginning of Deng’s era. In 1992 the 14th National Congress of the Communist Party of China passed the Resolution on Several Issues of Building Socialist Market Economy System, which established the goal of economic reform of developing a socialist market economy (Guo & Zhang, 2008).10 China’s economy has experienced dramatic growth in the last three decades. Since the nation opened its doors in 1978, the economy has witnessed tremendous growth. Its GDP has surged from less than USD 150 billion in 1978 to USD 8,227 billion in 2012 (Purdy, 2013). The SOEs model, which had dominated the national economy from the 1950s through to the 1980s in the planned economy system, has diminished, while other forms of enterprises have grown rapidly. Currently there are a variety of enterprise forms coexisting in China, including state-owned enterprises, town and village enterprises, privately owned enterprises, Sino-foreign joint ventures, foreign-owned enterprises, and listed public companies. Corporate governance and accounting practices have changed considerably in the context of these economic transformations. 6.4.2.1. Planned Economy China adopted the planned economy after its formation in 1949. Public ownership, including state and collective ownership, was considered

128

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

superior to private ownership (Yu, 1998) in terms of eliminating capitalist exploitation and class differences and achieving equal rights for all individuals. By 1955, all private companies had been transformed into state or collective ownership, with the state-owned enterprises dominating the national economy (Doupnik & Perera, 2011). Under the planned economy, businesses were operated and strictly controlled by government agencies. Enterprises were only considered units for implementing central plans with very little autonomy. They obtained funds, mainly from state appropriations and bank loans, and were directly managed either by the central government through national ministries or by local governments. The production budgets were allocated to enterprises in accordance with national plans. Profits made by enterprises were remitted to the state, forming part of the national revenue. Instead of financial rewards based on financial performance, titles such as excellent manager or model worker were awarded to employees (Chinese Reform and Development Report Expert Group, 1995). SOEs, being considered quasi-government agencies, were required to pursue the broad social, political, and economic objectives of the government. Activities conducted by a typical SOE included assisting the government in pursuing full employment; producing designated and likely unprofitable products; and running unprofitable operations, such as hospitals, child care, and employee accommodations (Adhikari & Wang, 1995). 6.4.2.2. Market-Oriented Economy China’s market-oriented economy was developed through a series of economic reforms that reflected a strong desire to rebuild its economy and strengthen economic relations with the rest of the world. The Chinese leadership adopted a pragmatic and gradual approach to developing the national economy. The economic reforms proceeded in different stages to turn the planned economy into a more market-oriented system, but one that was still under the tight control of the Communist Party of China and the central government. These reforms included agricultural reforms, development of the nonstate sector, development of foreign invested firms, financial reforms, and SOE reforms. Agricultural Reforms. The first experiment in economic reforms is agricultural land reform. The household responsibility system was introduced in the countryside, which phased out collectivized agriculture. Farmers were allowed to own their own piece of land as well as to decide how to use and cultivate it. Agricultural product prices were liberalized, and procurement

The Corporate Governance and Accounting Environment in China

129

prices paid for those products increased dramatically. Consequently, farmers were greatly motivated to increase land productivity considerably (Huang, 1998). Development of the Nonstate Sector. In 1981, the establishment of sole traders was encouraged. Prices for most industrial goods and products were liberalized gradually since 1982. Nonstate enterprises were allowed to be set up in the countryside to absorb the surplus labor. Collective township and village enterprises and small-scale private enterprises in services and light manufacturing increased in great numbers and became increasingly important in the country’s economy (Schlevogt, 2000). Private enterprises further boomed following the government setting out constitutional guarantees and policy incentives to encourage the healthy development of the sector and protect the property of entrepreneurs. Private ownership secured the protection of China’s Constitution for the first time in 1988. The 1999 Constitution included a provision acknowledging and enhancing the status of nonstate ownership. The legal system was strengthened for individuals and companies to pursue their legitimate interests, which were prohibited under the planned economy. Today, the nonstate sector is a major driver of the national economy. The domestic private enterprises created half the country’s wealth, provided 8 out of 10 new jobs in nonagricultural sectors in 2005, and was predicted to play an even bigger role in the years ahead (Zhao, 2006). Development of Foreign Invested Firms. Following the open-door policy the first international joint venture was registered in Beijing in 1980. Since then China has continued to receive foreign investment in various forms, including Sino-foreign equity and contractual joint ventures and wholly foreignowned firms. By 1980, four special economic zones, Shenzhen, Zhuhai, Shantou, and Xiamen, had been set up to experiment with special policies. Those zones enjoyed a great degree of financial autonomy and offered strong incentives for foreign investors. For example, investors in special economic zones benefited from low-cost labor, tax exemptions, duty-free importation of raw material, and technology (Schlevogt, 2000). Based on the experiences of the pilot sites, the Chinese government further extended the reform across the nation. Financial Reforms. The big four state-owned banks, namely, the Bank of China, Industrial and Commercial Bank of China, Construction Bank of China, and Agricultural Bank of China, have dominated the financial

130

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

industry and played an important role in the national economy since 1949. Traditionally, banks, including the big four, were considered government agencies and operated under government instruction. This largely explains the low profitability of Chinese banks (Garcı´ a-Herrero, Gavila´, & Santaba´rbara, 2009). Policy lending resulted in a large amount of nonperforming loans taking the form of triangular debt among government, enterprises, and their suppliers.11 It was estimated that the nonperforming loans reached 3.3 trillion RMB (USD 400 billion) before the reform (Shih, 2004). Large proportions of bad debt led many banks to become technically insolvent. In addition, the provision of cheap policy loans to SOEs made it difficult to liberalize financial markets and introduce market-determined interest rates (Schlevogt, 2000). In order to revive the banking sector, the Chinese government launched a series of reforms in the 1980s. Under the financial reforms policy lending was delegated to policy banks.12 Other banks (except for the People’s Bank of China, which is equivalent to the Federal Reserve Bank in AngloAmerican countries) were converted into commercial banks to act as intermediaries between savers and investors responding to market forces. To date, all big four banks have been listed on domestic stock exchanges. Nevertheless, in China, it is unrealistic to expect that the banking industry, the big four banks in particular, could be substantially independent of the government. SOE Reforms. It has been generally agreed that the government’s direct control and management, and the overcentralized national economy, resulted in poor performance of SOEs (Tang et al., 2003). Managers of these entities had little incentive and managerial authority to enhance efficiency (Adhikari & Wang, 1995). Since the early 1980s, the government has pursued reforming the SOEs with the objective of improving their economic efficiency by reducing government involvement. Since 1983, SOEs have been required to pay taxes instead of remitting profits to the government. In addition, they started to be financed through loans instead of budget allocations. Production autonomy was introduced in 1984. In 1988, the contract responsibility system, which defined managers’ rights of control and obligation, was initiated. Under the contract responsibility system, while the government retained ownership, the SOEs were subcontracted to selected individuals (usually previous managers) who were expected to run them independently. The managers were rewarded with sharing of the profits in excess of the operating target set in the contract. However, the contract responsibility system failed to achieve the

The Corporate Governance and Accounting Environment in China

131

expected outcomes, as it was unable to address the issues associated with excessive public ownership (Tang, Chow, & Lau, 1999). State ownership led to a situation known as shanbufeng,13 in that resources were allocated on the basis of government plans rather than efficiency. Property rights relations were unclear and the concept of economic agency was ill-defined, or even absent, as lines of responsibility were still blurred (Lin & Tan, 1999). Subsequently the government introduced a corporatization scheme in 1991, under which SOEs were converted into shareholding companies. Small- and medium-sized SOEs were allowed to be merged, closed, or privatized, while the state retained control over large SOEs. Except for large and key SOEs, operations of most SOEs were no longer subjected to state plans, and they competed in freer markets. Accordingly, the government no longer guaranteed a market for SOEs’ products and stopped subsidizing losses incurred by SOEs. The managers and boards of directors were responsible for decision making and economic performance. The state’s shares in these restructured SOEs were managed by state-asset administration bureaus and state-asset investment companies with a high degree of autonomy. In order to solve the shortage of funds for SOEs the Chinese government established two stock exchanges, and a small proportion of restructured SOEs were listed (Jiang et al., 2009; Liu, 2006; Walter et al., 2003; Wang & Chen, 2008). 6.4.2.3. Capital Market The Shanghai Stock Exchange and Shenzhen Stock Exchange were established in the early 1990s. Since the inception of the two exchanges, the domestic equity market growth has been remarkable. The total number of listed companies increased from 183 in 1993 (Xu & Wang, 1999) to 1,831 by the end of April of 2010 (Ren, 2010). The Shanghai Stock Exchange and Shenzhen Stock Exchange emerged as the 6th and 11th largest exchanges in the world with market capitalization of USD 2,704,778 million and USD 868,374 million, respectively (Ren, 2010).14 The main features of China’s emerging equity market are the high level of government influence, conflict between controlling shareholders and minority shareholders, and speculative behaviors. High Level of Government Influence. The establishment, administration, and development of China’s capital market are highly government driven. A number of measures have been taken by the Chinese government to retain control over the capital market, including CSRC administration,

132

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

accounting-oriented listing requirements, share classification, and state dominance in shareholding structure. The CSRC is the major market regulator in China. It was initially established as the executive organ of the State Council Securities Commission in October 1992 and responsible for day-to-day management activities.15 In April 1998, the CSRC inherited regulatory power from the State Council Securities Commission and the People’s Bank of China and became the security market regulator under direct supervision of the State Council (Jiang et al., 2009). It oversees China’s stock market and issues disclosure requirements for listed companies. The main functions of the CSRC include drafting securities legislation and regulations; managing senior managers of securities companies; supervising issuance, listing, trading, and settlement of stocks and bonds; overseeing listed companies; regulating security-related organizations, such as securities companies, funds, future settlement institutions, and securities rating entities; and monitoring information transmission. Further, unlike mature markets, in which exchanges are self-regulated entities owned by their members, the two stock exchanges in China are essentially government organs. Theoretically, China’s stock exchanges are defined as self-regulatory organizations in the revised 2005 Securities Law. In practice, however, the exchanges continue to be subject to the authority and control of the CSRC, with senior officials at both exchanges appointed by the CSRC (Liebman & Milhaupt, 2008). Among other things, financial indicators are frequently used by the CSRC to administer initial public offerings (IPOs), right issues, trade suspension, and delisting. The CSRC regulates the stock market mainly through controlling IPOs. A quotation system for IPOs was used until 2000. Approval for a company to obtain a listing was determined by the CSRC (or by its predecessor before 1998) on the basis of an annual quota broken down to each province and ministry, which then selected companies to fill their allocated quotas. Therefore, the listing of a company was usually decided not on commercial merits but on political and sectional considerations (Tam, 2002). The government became aware of the weakness of the IPO quota system and replaced it with an approval system in March 2001. Under the approval system, the government no longer allocates specific quotas. Instead, the CSRC substantially audits IPO candidates in accordance with relevant laws and regulations. Hence, the ability of IPO candidates to generate sustainable profits became important in determining the success or failure of the applications for IPO (Kao, Wu, & Yang, 2009). In accordance with the Administrative Measures on Initial Public Offering and

The Corporate Governance and Accounting Environment in China

133

Listing (CSRC Decree No. 32, issued in May 2006), to be eligible for IPO, a company must report profit, cash, and operating revenue.16 Accounting-oriented administration is also found in other areas. For example, the latest regulatory requirement for rights issue is set in the Administrative Measures on Securities Issuance of Listed Companies (CSRC Decree No. 30, issued in May 2006), which demands no less than 6% of the weighted average return on equity for the latest three years. According to the Announcement on Promulgating “Implementing Procedure on Listing Suspension and Termination of Listed Companies Operating at Loss (Amended)” (CSRC Announcement No. 147, issued in November 2001), a company’s shares will be suspended if it operates at a loss for three consecutive years.17 Classifying shares into A shares and B shares, tradable shares and nontradable shares, state-owned shares and non-state-owned shares is another measure used by the Chinese government to keep the stock market under control. The various forms of classification are illustrated in Table 6.1. The classification of A shares and B shares is a unique feature of China’s equity market not found in stock markets of more developed economies. Initially A shares were traded in Chinese currency by domestic investors while B shares were traded in foreign currencies by overseas investors. The market for B shares is separate from that of A shares. They are denominated in US dollars on the Shanghai Stock Exchange and in Hong Kong dollars on the Shenzhen Stock Exchange. Companies issuing A shares should comply with Chinese GAAP, whereas both Chinese GAAP and international accounting standards are required for companies with B shares. In 2001 domestic investors were allowed to invest in B shares. Foreign investors have been allowed to invest in A shares since the Qualified Foreign Institutional Investors (QFII) scheme began in 2002.18 The majority companies listed in China’s two stock exchanges only issued A shares. A shares can be further classified as tradable shares and nontradable shares. The main reasons for issuing nontradable shares include the Table 6.1.

Share Classifications in China’s Stock Market. A Shares

Nontradable A Shares State

Legal person

B Shares Tradable A Shares

Employee

Individual

QFII

Domestic institutional investor

Note: Following the share structure reform in 2005, all shares became tradable.

Tradable

134

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

government’s concerns on state-asset reduction and attempt to maintain state control over listed companies (Qi, 2007). As illustrated in Table 6.1, nontradable shares include state shares, legal person shares, and employee shares.19 The nontradable shares account for the majority of total shares, for example, representing 64% of total shares in December 2004 (Qi, 2007). The differentiation of tradable and nontradable shares caused a number of issues. It distorted pricing mechanisms and created great uncertainties for the market. Movements in stock price are generated mainly by the trading of shares among individual shareholders.20 Because of the high rate of saving and the very limited range of investment instruments available in China, individual investors in the stock market have from the beginning exhibited a highly speculative tendency with a very short investment horizon (Tam, 2002). Moreover, this practice also failed to evaluate and manage state assets on a market basis (Qi, 2007) because large shareholders normally held nontradable shares and were not concerned about a company’s share price movement. The recent Split Share Structure Reform launched by the government in 2005 terminated trading constraints on restricted shares (Cumming & Hou, 2014). The principles of creating a win win situation, maintaining market stability, and protecting the legitimate interests of investors, especially the public investors, were established to guide this reform. Detailed strategies implemented include pilot testing of reform program, a lock-up period and trading restrictions on the selling of nontradable shares after the conversion, and controlling the pace of the reform to maintain market stability. In April 2005, the first batch of 4 companies participated in the pilot program, which was followed by the second batch of 42 companies. The 35 large state-owned companies joined the reform in November 2005. As of December 2006, 96% of the listed companies had completed the reform (Qi, 2007). However, whether this reform was a success is debatable and untested. In particular, for various political reasons the government might not intend to reduce its ownership. Thus, it is doubtful whether stateowned shares become truly tradable although they are technically tradable in the market. The shareholding structure in Chinese public companies is still characterized by state dominance. First, the majority of listed companies are restructured SOEs, and the state is the largest shareholder, as the listing priority was given to SOEs (Clarke, 2006; Lau et al., 2007; Liu & Sun, 2005; Tam, 2002).21 Further, the majority of listed companies are either directly or indirectly controlled by the government. It is generally agreed that the state, legal persons, and local individual investors are the three

The Corporate Governance and Accounting Environment in China

135

dominant groups of shareholders that account for approximately 90% of total outstanding shares, with 30% in each group (Liu & Sun, 2005; Qi, Wu, & Zhang, 2000; Xu & Wang, 1999). However, the distinction between state shares and legal person shares is ambiguous and inconsistent, although it is established in law and statistics (Clarke, 2006). The official classification fails to identify the ownership identity of the legal person shares. It is quite possible that the owners of the legal person shares are enterprises or institutions ultimately controlled by the central or a local government. By classifying shareholdings of Chinese publicly listed companies on the basis of the principle of ultimate ownership, a state-dominant shareholding structure was found, in which 81.6% of companies were identified as ultimately controlled by the state by the end of 2001 (Liu & Sun, 2005). Conflict between Controlling Shareholders and Minority Shareholders. The main agency problem in China is the expropriation of minority interests by controlling shareholders within the concentrated ownership structure (Chen, Chen, & Chen, 2009; Su et al., 2008; Zou et al., 2008). The severity of the expropriation issue is partly reflected by the fact that the Code of Corporate Governance for Listed Companies in China allocates one chapter to governing the relationship between listed companies and their controlling shareholders. Ownership in Chinese listed companies is heavily concentrated compared to the dispersed shareholding structure in Anglo-American countries. The five largest shareholders accounted for 58% of the outstanding shares as compared with 25% in the United States (Xu & Wang, 1999). Concentrated ownership was also found by Gul, Kim, and Qiu (2010) and Chen (2001). The concentrated ownership structure has given controlling shareholders considerable power to dominate company decisions and benefit themselves at the expense of minority interests (Zou et al., 2008). The arrangement of related party transactions is a major measure used by Chinese controlling shareholders to expropriate minority shareholders (Aharony, Wang, & Yuan, 2010; Cheung, Jing, Lu, Rau, & Stouraitis, 2009). The prevalence of related party transactions between listed companies and controlling shareholders has its historical origin. Most listed companies in China were spinoffs from former SOEs with the parent groups serving as their largest shareholders, which creates inherent business and personnel connections between the listed companies and their parent companies. Related party transactions can have positive effects, such as reducing transaction costs and improving asset utilization efficiency. However, in the

136

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

absence of appropriately functioning mechanisms, controlling shareholders have discretion to expropriate minority shareholders through structuring related party transactions, which would eventually undermine the financial reporting quality and the public confidence in the stock market. Evidence shows that controlling shareholders frequently engage in related party transactions to gain benefits at the expense of minority shareholders and listed companies in China (Aharony et al., 2010; Chen et al., 2009; Cheung et al., 2009). Cheung et al. (2009) find that in the Chinese capital market related party transactions are conducted with the purpose of expropriating minority shareholders and are accompanied by significantly less information disclosure compared to related party transactions that aim at improving efficiency. It has been pointed out that Chinese corporate groups tend to make extensive use of related party transactions for the purpose of earnings management (Aharony et al., 2010; Jian & Wong, 2010). Speculative Behaviors. The Chinese stock market is found to be highly volatile and speculative. Yao and Luo (2009) report that the Shanghai Stock Exchange Composite Index increased more than sixfold from 1,012 in 2005 to 6,124 by the end of 2007 and then declined continuously to reach a low of 1,929 on September 17, 2008, a drop of 70% from its peak in less than 10 months. They identify investor speculation as one major psychological factor contributing to the extreme fluctuations. In their study, Wang et al. (2006) also reveal a speculative orientation and a low level of risk perception among Chinese investors from a psychological perspective. The existence of speculative bubbles in the Chinese stock market is empirically documented by a number of studies (e.g., Ahmed, Li, & Rosser, 2006; Zhang, 2008). The persistent government intervention appears to be a major reason for speculative behaviors. Wang (2003) describes the Chinese stock market as the “policy market” where investors assign more importance to government policy than to the intrinsic value of companies when making investment decisions (see also DeFond, Wong, & Li, 1999). Government intervention promotes policy-oriented speculative investment behaviors and reduces investors’ risk perception in stock markets (Wang et al., 2006) because the market observes that the SOEs are continuously receiving various forms of government support and expects government bailout in times of SOEs’ financial difficulty, which prevents SOEs from delisting (Wang & Chen, 2008).22 In addition, the Chinese capital market lacks transparency. Bhabra, Liu, and Tirtiroglu (2008) point out that the Chinese market exhibits high information asymmetry. As a result, investors who possess inside information

The Corporate Governance and Accounting Environment in China

137

are likely to reap abnormal gains, which in turn encourages other investors to dig for inside information and engage in speculative behaviors. 6.4.2.4. Economic Influence on Corporate Governance and Accounting The government’s tight control over the capital market partly stimulates incentive for earnings management. The government’s control makes equity financing a lucrative business. In order to satisfy various accountingoriented administrative measures, listed companies and companies that have the potential to be listed are likely to have an incentive to manipulate accounting information. A growing body of empirical literature has documented frequent use of earnings manipulation by listed companies in order to meet the CSRC’s profitability requirements for rights issue (Chen & Yuan, 2004; Liu & Lu, 2007; Yu, Du, & Sun, 2006). Further, given the unique share structure, controlling shareholders are likely to impose considerable influence on corporate governance and financial reporting. Firth, Fung, and Rui (2007a) document that controlling shareholders have a significant impact on CEO compensation. Firms with large controlling shareholders are less likely to hire high-quality auditors in China, suggesting the incentive to reap private gains from weak corporate governance and less transparent disclosure (Lin & Liu, 2009). Moreover, in China’s capital market, investors are speculative and corporate governance tends to be undervalued. For instance, Cheung, Jiang, Limpaphayom, and Lu (2008) document that the benefits of good corporate governance have not been incorporated into the market valuation of listed companies, although many Chinese companies have been making progress in improving their corporate governance. In short, China has moved from a planned economy to a marketoriented economy, and the capital market has grown rapidly since its formation. However, several factors are likely to impede the proper functioning of corporate governance and accounting. The CSRC’s accountingoriented measures largely stimulate incentive for accounting manipulation. Further, controlling shareholders are able to impose considerable influence on listed companies. In China’s highly speculative market, the value of good corporate governance tends to be understated.

6.4.3. Legal System In contrast to Anglo-American countries, where common law is widely practiced, China has adopted a rigid statutory law system in which laws

138

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

tend to be very detailed and cover most aspects of daily life. The legal system is dominated by criminal law, with a rudimentary civil code that has been in effect since January 1987. Although in the past three decades China has made tremendous efforts to reform its legal system following the economic reforms (Li & Ma, 2010), it is still underdeveloped and enforcement is ineffective. 6.4.3.1. Underdeveloped Legal System Compared to legal systems in Anglo-American countries, China’s legal system is much younger and underdeveloped (Allen et al., 2005; Cai, 2007; Hua et al., 2006). In the first three decades of the formation of the People’s Republic, the government leadership deliberately downplayed the rule of law because of the concern that codified laws might restrain the Party in its efforts to continue the revolution (Li & Ma, 2010). Social control or regulation was achieved more through administrative powers and machinery than through the legal system (Chen et al., 1997). Further, China’s legal system became almost entirely ineffective during the Cultural Revolution period (1966 1976) and has only resumed since 1980. Following economic reforms in the 1980s, a series of major laws governing economic activities was initiated.23 Continuous efforts are made to improve the legal system, but the market-oriented legal system is still relatively untested in many aspects (Hua et al., 2006), and unexpected policy changes add to the uncertainty and complexity (Schlevogt, 2000). For the purpose of this monograph, the following discussion focuses on major laws that govern accounting, including the Accounting Law, Law of Certified Public Accountants, and Securities Law. Although these laws have considerably strengthened accounting information disclosure and quality, the current system provides little protection to investors. Accounting Law. The Accounting Law was promulgated in January 1985 and revised in 1993 and 1999, aiming at standardizing accounting behavior, ensuring accuracy and completeness of accounting documentation, and strengthening financial management. It serves as the highest authority for the regime of accounting regulations, defining the accounting and reporting practices for all public and private sector organizations and prescribing the respective roles and responsibilities of the state, organization managers, and accountants for accounting procedures and accounting information. Among other things, it stipulates that the MOF and its local department offices are responsible for accounting regulation. The management is legally responsible for the accounting policies and financial reporting of

The Corporate Governance and Accounting Environment in China

139

a corporation. In addition, the Accounting Law requires maintaining a uniform accounting system, which is defined as rules and regulations issued by the MOF concerning accounting, accounting supervision, accounting offices, and accounting personnel as well as administration of accounting work. The enactment of the Accounting Law marks the shift from traditional accounting practice mainly concerning the implementation of the state plan to modern accounting practice focusing on information needs for economic decision making. Law of Certified Public Accountants. The Law of Certified Public Accountants issued in October 1993 defines the role of CPAs, reinforces regulation over CPAs, and aims to protect public interests and legitimate rights and interests of investors. It provides legal backing to the CICPA, lays down clear rules and regulations for CICPA’s administration system and organizational structure, and sets out CPA qualification procedures. It covers issues such as examination and registration, service scope and rules, accounting firms, institute of CPAs, and legal responsibilities. In particular, it requires CPAs and accounting firms to perform professional services in an independent and fair manner and makes CPAs liable to clients and other parties who may suffer a loss due to audit failures. Securities Law. The purpose of the Securities Law is to regulate the issuance and transaction of securities and protect the interests of investors. It was issued in December 1998 and revised in October 2005. Among other things, the Chinese Securities Law stipulates the requirements for information disclosure. For example, Article 63 provides that the information disclosed by listed companies shall be authentic, accurate, and complete and shall not have false record, misleading statements, and material omission. Listed companies must submit their half-yearly and annual reports to the securities regulatory authority and the stock exchange within a prescribed time period in accordance with Articles 65 and 66, respectively. Article 67 states that a listed company shall immediately submit a temporary report to the securities regulatory authority and the stock exchange regarding any major events that may have material impact on the company’s share price movement. According to Article 68, the directors and senior managers of a listed company shall sign on the periodic report of their company. The board of directors, supervisory board, and senior managers are responsible for the accuracy and integrity of the information disclosed. Investors’ rights for compensation due to misleading information are stated in Article 68. However, enforcement is ineffective, as explained in later sections.

140

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Little Protection for Investors. China’s legal system provides little protection to shareholders (Miles, 2006; Wang & Chen, 2008; Zou et al., 2008). The Supreme People’s Court has been cautious toward civil securities claims. For example, in September 2001, the Supreme People’s Court prohibited lower courts from accepting securities cases on the grounds that the legislative and judicial conditions were not ready for hearing such cases. Under pressure from lawyers, academics, and investors, it was forced to issue the Notice of the Supreme People’s Court on Relevant Issues of Filing Civil Tort Dispute Cases Arising From False Statement on the Securities Market to lift the temporary suspension in January 2002 (Wang & Chen, 2008). In January 2003, the Supreme People’s Court issued another circular, the Provisions on Hearing Civil Compensation Cases, setting out detailed rules and procedures on the handling of civil claims. Under these circulars, the courts were instructed to accept private securities litigation relating to misrepresentation only. Other forms of securities fraud, such as insider trading and market manipulation, remained prohibited from being used to initiate a civil compensation case, although insider trading and market manipulation are rampant in China (H. Cheng, 2008; SZSE, 2008b).24 In addition, the Provisions on Hearing Civil Compensation Cases stipulate that a plaintiff must base his/her civil compensation claim on an administrative sanction or criminal judgment.25 Such requirements largely restrict defrauded investors’ ability to seek civil remedy by limiting civil securities claims to misrepresentation only and conditioning an administrative sanction or criminal judgment for taking a legal action. Being criticized for weak shareholder protection, the Securities Law (1998) was revised and came into effect again on January 2006, for the first time establishing the possibility and procedures of statutory derivative lawsuits, whereby shareholders are able to sue directors, managers, and auditors for their misconduct (Zou et al., 2008). The new Securities Law provides detailed provisions concerning the civil liabilities for false corporate disclosure, although it is still dominated by administrative and criminal liability.26 Nevertheless, it remains to be seen how these civil provisions are applied by the judicial agencies. It is worth noting that minority shareholders particularly suffer more from insufficient legal protection compared to controlling shareholders. As indicated in the above discussion, the ownership of listed companies in China is usually concentrated, with the state being the controlling shareholder. The state, as a large shareholder, can protect its property rights through ownership concentration (La Porta, Lopez-de-Silanes,

The Corporate Governance and Accounting Environment in China

141

Shleifer, & Vishny, 2001) and exploiting political power (Wu, Xu, & Yuan, 2009) within the context of poor investor protection. 6.4.3.2. Ineffective Enforcement China’s relatively weak legal system is further worsened by ineffective enforcement. For the purpose of this study, the discussion mainly focuses on the enforcement of laws and regulations concerning investor protection. Courts in China lack expertise (Li & Ma, 2010; Peerenboom, 2002). In about four decades since the formation of the People’s Republic in 1949, there had been no laws regulating judges’ qualifications and selection. In 1984, of 150,000 court personnel, only about 3% of them had received a college-level legal education (Li & Ma, 2010). The shortage of qualified judges considerably affects law enforcement. Prior studies have pointed out that courts in China lack independence (Peerenboom, 2002). The function of the judiciary system is heavily influenced by the government. The court system has been developed on the basis of the governmental administrative structures. Local courts depend on local governments for funding. The standing committee of the local People’s Congress appoints the chief judge and other judges within their particular regional jurisdiction. These practices turn the courts into instruments of local authorities (Lin, 2003). Corruption in China’s judiciary system is widespread (Peerenboom, 2002). Cai (2007) points out that effective law enforcement will not be attained in the near future (see also Schlevogt, 2000). As indicated in the previous section, an administrative sanction or criminal judgment is the precondition for investors to bring civil compensation claim to court. Thus, the next section provides a discussion of the actions taken by the CSRC as the major capital market regulator, which is followed by a discussion concerning enforcement by courts. CSRC Actions. As the major market regulator, the CSRC has a number of measures available to exercise its administrative power. The CSRC can issue administrative sanctions in the form of formal warnings or fines.27 Fines for companies range from RMB 300,000 to 600,000 (approximately USD 43,000 87,000), and fines range from RMB 30,000 to 300,000 (approximately USD 4,300 43,000) for individuals. Further, individuals who commit serious violations may also be barred from participation in the securities markets and from serving as a senior manager or director of a listed company (see the CSRC website).

142

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

There has been much debate with regard to the administrative effectiveness of the CSRC. Anderson (2000) argues that the CSRC was not effective in identifying and prosecuting fraud. The lack of expertise in the CSRC, insufficient resources, lack of independence from the state, and its susceptibility to political pressures are often criticized. In contrast, Chen, Firth, Gao, and Rui (2005) argue that the reforms of 1998 (the passing of the Securities Law and consolidating regulatory power in the hands of the CSRC) have led to a significant improvement in the ability and independence of the CSRC. They contend that the CSRC’s enforcement actions do “have teeth” because such actions are followed by costly economic consequences such as negative stock returns, a greater rate of auditor change, a much higher incidence of qualified audit opinions, increased CEO turnover, and wider bid ask spreads. Although it is unrealistic to work out an exact percentage of frauds caught by the regulator, evidence shows that the CSRC has not adequately addressed the issues existing in the markets. In 2003, 1,278 companies were listed in the Shanghai and Shenzhen exchanges, but the number of total enforcement actions initiated by the CSRC or exchanges against listed companies was 51, implying that only 1 in 25 companies was subject to some kind of enforcement activity. Moreover, the sanctions administered were often mild, with only 22% of enforcement actions resulting in fines as opposed to warnings or informal reprimands (Cai, 2007). Liebman and Milhaupt (2008) report a total number of 210 sanction decisions issued by the CSRC from 2001 to 2006, giving 35 sanctions each year on average. They admit that the number of sanctions seems rather modest given the pervasiveness and severity of the problems with false accounting, insider trading, and inaccurate disclosure in China’s stock markets. In addition, the slowness of the CSRC approach in disclosing sanctions and enforcement information compared to the disclosure made by the two stock exchanges is blamed for reducing the effectiveness of enforcement actions (Firth, Rui, & Wu, 2009).28 In particular, it is rare to find CSRC enforcement action against insider trading (H. Cheng, 2008), although insider trading has long been widespread in the Chinese capital market (Huang, 2007; SZSE, 2008b; Tong, Zhang, & Zhu, 2012). The research conducted by the Shengzhen Stock Exchange points out that the paucity of insider trading and market manipulation cases does not necessarily indicate diminishing violations and that the major reason for the rare CSRC action is weak enforcement (SZSE, 2008b). H. Cheng (2008) argues that most insider trading cases involve high-ranking government and party officials and the CSRC lacks the power

The Corporate Governance and Accounting Environment in China

143

to directly administer discipline and penalties on government officials and party cadres (see also Anderson, 2000). In addition, the likelihood of being caught and punished does not deter people from engaging in insider trading because compared to the large amount of profits gained from insider trading the punishment is ignorable (Huang, 2007).29 Court Enforcement. The legal approach in China still has many difficulties, even in cases where the precondition for legal action has been satisfied. Liebman and Milhaupt (2008) report that the total number of suit-eligible companies is approximately 130, as a result of CSRC sanctions, MOF sanctions, and criminal rulings under the criteria specified in the Supreme People’s Court guideline during 2000 2006.30 Roughly only 20 companies have in fact been sued. Only a few cases have resulted in a judgment in favor of the plaintiffs. Many of these judgments have yet to be enforced, and other cases are languishing in the courts without any apparent progress toward a judgment. While CSRC-sanctioned companies would appear to be easy targets for investor lawsuits, approximately 85% of the eligible target companies have not been sued. The main reason is that the prospect of recovery is simply too small to justify the expense, time, and effort involved. Further, investors’ concern with regard to local favoritism in the courts and political pressure also contributes to their unwillingness to take action (Liebman & Milhaupt, 2008). An additional reason for the low rate of lawsuits could relate to Chinese culture. A number of researchers argue that, largely influenced by Confucian philosophy, China is a less litigious nation compared to Anglo-American common law jurisdictions (Miles, 2006; Wang & Chen, 2008). While it is common for shareholders in Anglo-American countries to resort to legal protection, Confucians tend to seek peaceful means to resolve disputes and avoid conflict and confrontation as much as possible. It might be true that Chinese investors’ awareness of their legal rights has improved along with the development of China’s legal system. Nevertheless, both ineffective regulatory and legal enforcement and cultural orientation result in shareholders’ reluctance to initiate private securities lawsuits. 6.4.3.3. Legal Influence on Corporate Governance and Accounting A well-developed legal system that protects shareholders from expropriation by the managers and protects the minority shareholders from expropriation by controlling shareholders of firms is the cornerstone of good corporate governance (La Porta et al., 2000). The above discussion

144

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

indicates that China’s legal system is underdeveloped, little protection is offered to shareholders and to minority shareholders in particular, courts lack independence, and court enforcement is ineffective. Thus, compared to Anglo-American countries with strong legal systems, the legal risk for wrongdoers in China is relatively low. Consequently, low legal risk is likely to have a negative influence upon the proper fulfillment of duties and responsibilities by organizational players.

6.4.4. Cultural Profile China is the largest of all Asian countries and occupies nearly the entire East Asian landmass. Its land area, 9.56 million km2, is the third largest in the world, which raises the world’s largest population, which reached 1.33 billion at the end of 2009 (National Bureau of Statistics of China, 2011). China is composed of 56 ethnic groups. Han is the main ethnic group that accounts for over 90% of the population, and the other 55 ethnic groups are called minorities. While Daoist, Buddhist, Muslim, and Christian are considered major religious groups, Confucian philosophy has the most profound impact on Chinese culture (Lin & Ho, 2009). Guanxi, a form of social network reflecting Confucian values, has extended to the business sector. In the transitional stage, the widespread practice of guanxi in the business community has a considerable impact on corporate governance and accounting and increasingly raises ethical issues. 6.4.4.1. Chinese Culture Confucian philosophy plays the most important role in Chinese culture (Lin & Ho, 2009). Confucianism codifies five types of social relationships relationships between the ruler and subject, father and son, elder brother and younger one, husband and wife, and friends (Fei, 1992; Lovett et al., 1999; Su & Littlefield, 2001) on the basis of mutual and complementary obligations (Hofstede, 1991). The relationship system is hierarchical, in which everybody accepts the existing hierarchical order and the place where they are with no further justification needed (Bond & Hwang, 1986). By focusing on loyalty and obedience to the superior and ruler, Confucianism strives for familial, social, and political stability and harmony (Bell, 2010; Yan & Sorenson, 2006). Also, Confucianism emphasizes that the individual is an inherent part of the collective to which he or she belongs. Glory or shame is not only a personal affair; it could affect the family, friends, and clan (Bond & Hwang, 1986). This is contrary to laissez-faire in

The Corporate Governance and Accounting Environment in China

145

Anglo-American countries, which emphasizes self-realized value and individual achievement. In accordance with the cultural measures developed by Hofstede (2001), the culture in China is considerably different from that in Anglo-American countries in terms of power distance, uncertainty avoidance, and individualism (explained in detail in Chapter 4). For example, the culture in the United States is described as individualistic, ranking first on the dimension of individualism among 88 countries, whereas the culture in China is described as mostly collectivistic, ranking 65th on the dimension of individualism. Compared to the Americans, Chinese are more likely to prefer a tightly connected social group that offers protection to them in exchange for unquestioning loyalty. 6.4.4.2. Guanxi In China, guanxi, as the social norm of conduct, prevails in every social activity, including business, and has its root in Chinese culture. Guanxi is considered a unique construct and a product of Confucian values and the contemporary political and socioeconomic system in Chinese society (Wong, 2010). It refers to the networks of informal relationships and exchanges of favors that dominate all business and social activities across China (Hwang et al., 2008; Lovett et al., 1999). Historically, Chinese society was built based on family clans. Today guanxi has developed beyond family relationships to include unrelated individuals on the basis of common interests. It involves the exchange of gifts and benefits and works on the basic, unspoken principle of reciprocity and equity (Luo, 1997). Guanxi has a considerable impact on the business sector. Maintaining good relationships with various parties involved in an enterprise operation is extremely important for the survival and prosperity of businesses in China. For example, Yeung and Tung (1996) study factors contributing to business success in China by asking managers of 19 diverse international companies to rank 11 key factors. Guanxi is the only item consistently identified as a key success factor. Further, Luo (1997) reports a direct correlation between a company’s level of guanxi and its sales growth in China’s market. The cultivation, development, and expansion of guanxi have become a priority of many Chinese business people (Warren, Dunfee, & Li, 2004). Schlevogt (2000) advises foreign investors that maintaining good connections with government officials is vital for doing business in China. However, misuse of guanxi is likely to be detrimental to the business ethics in China. First, within guanxi culture, people are likely to take a narrow view toward their duties and responsibilities. Statman (2009) points

146

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

out that, influenced by guanxi culture, people feel responsible to each other only within close connection nets, including family, friends, and business associates, while lacking a sense of accountability toward outside parties and the public as a whole. Further, guanxi is particularly harmful when it intertwines with bureaucracy (Braendle, Gasser, & Noll, 2005). Guanxi involving business people and government officials is the predominant form of business guanxi in China (Fan, 2002). Through this relationship companies obtain special treatment, bypass laws and regulations, and secure access to scarce resources (Braendle et al., 2005). Guanxi benefits people inside its circle but it penalizes people outside it (Statman, 2009). The practice of guanxi motivates Chinese officials to take advantage of their position by acting as intermediaries among people who need to establish business connections and results in widespread corruption and bribery (Fan, 2002; Statman, 2009; Su & Littlefield, 2001). Dunfee and Warren (2001) document a close association of particular types of guanxi with corruption and bribery by analyzing the potentially problematic aspects of certain forms of guanxi. The intertwinement between guanxi and corruption has fundamentally changed business culture and practices in China (Y. Luo, 2008). Indeed, during the transition from the planned economy to the market economy, ethical issues in the business community have frequently been raised (Hanafin, 2002; Lu & Enderle, 2006; Tam, 2002; Wang, 2003). Ip (2009) points out that during the transition, people’s behaviors are largely shaped and motivated by self-interests and greed due to the disruption in values and norms.31 Many companies with the profit-at-any-cost mentality have caused serious ethical violations, irregularities and corruption, and injustice in business and society at large. Leung (2008) also argues that in the current institutional environment, the social norms of emphasizing materialistic achievement lead some Chinese to become greedy, giving rise to widespread corruption. 6.4.4.3. Influence of Culture on Corporate Governance and Accounting To some extent, Chinese culture could conflict with the spirit of AngloAmerican models of corporate governance and financial reporting. For example, the value of an independent director in the Anglo-American models lies in the fact that he or she is expected to be free from the influence of management and controlling shareholders and must be inquisitive and courageous to ask penetrating questions. However, this is likely to be considered unfriendly, antagonistic, and assaultive in the Confucian tradition (Miles, 2006). The conflict is exacerbated by the practice in China that personal connections based on guanxi play an important role in job placement.

The Corporate Governance and Accounting Environment in China

147

Senior positions of SOEs are assigned based on personal connections rather than on merits or achievements (Braendle et al., 2005). Board positions are often politically determined and assigned to persons with party connections (Qiang, 2003; Tam, 2002). Based on Hofstede (1980) and Gray (1988), China’s accounting practices are likely to support statutory control, uniform practices, a conservative measurement approach, and secrecy in disclosure as opposed to accounting practices of Anglo-American countries with a higher rank in professionalism and a lower rank in each of uniformity, conservatism, and secrecy (Chow et al., 1995).

6.5. ACCOUNTING INFRASTRUCTURE In accordance with Lee (1987), accounting infrastructure consists of information producers and users, information intermediaries, laws and regulations governing accounting, and legal entities implementing those laws and regulations. The following discussion focuses on information producers, end users, and information intermediaries because the Accounting Law, Law of Certified Public Accountants, and Securities Law; CSRC action; and court enforcement were discussed in Section 6.4.3, “Legal System.”

6.5.1. Information Producers and End Users 6.5.1.1. Information Producers Theoretically, company managers are information producers. However, it should be noted that much detailed accounting work is completed by accounting staff that usually work in financial and accounting departments of firms and are generally called accountants in China. In this monograph, both managers and accountants are identified as information producers. Accountancy certification is the formal qualification recognition of accountants by the MOF. The Trial Regulations of Accounting Work Duties issued in 1986 established a rating system applicable to accountants in government organizations. The system was divided into four levels; starting from the highest level, they are senior accountant, accountant, assistant accountant, and junior accountant (Hao, 1999). Those qualifications were awarded by assessment until 1992, when it was replaced by the national examinations held once a year.

148

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

In 1990 the MOF issued the Administration of Accountancy Certification applicable to government organizations, including SOEs. It established the accountancy certificate as the basic qualification for people seeking accountancy careers in those organizations. In 1996 the revised Administration of Accountancy Certification extended the accountancy certificate system to all organizations, including enterprises with foreign investment. Those who have college diplomas majoring in accounting can acquire an accountancy certificate directly. Others must take examinations on accounting-related subjects. The MOF and its local financial departments are responsible for the issuance and administration of accountancy certificates. As competition is becoming fiercer in the accounting labor market, those qualifications are being increasingly valued by people who seek to enter into the accounting labor market (Hao, 1999). There is no direct relationship between the accountancy certificate and CPA qualification. In general CPA qualification is more difficult to obtain. Since 1991 the CPA examination has been the only way to acquire a CPA title. For those who seek to work in a professional accounting firm a CPA qualification is desirable, while an accountancy certificate is sufficient for employment in other enterprises. In addition, there is no particular professional organization for accountancy certificate holders. Three channels are available to appoint an accountant, including recommendation, internal selection, and public recruitment (Hao, 1999). Accountants are regarded as important staff, and it is common that they are recommended by senior officers within the organization. Accountants can also be selected internally from nonaccounting clerks and other employees. The public recruitment method has become increasingly popular over time, particularly following China’s reform policies in the 1980s. The Chinese information preparers’ level of professionalism is lower compared to that of their counterparts in Anglo-American countries (Chow et al., 1995). IFRS is principles based and demands extensive professional judgment to present a true and fair view of the performance and results of an entity. Rigorous implementation of quality accounting standards requires preparer professionalism, quality auditing, and effective enforcement (Wahlen et al., 2000). However, developing countries, including China, often lack such infrastructure to make accounting standards such as IFRS work as intended (Chen et al., 2002; Xiang, 1998; Xiao, Zhang, & Xie, 2000). The low level of professionalism in China has its origins in the Chinese culture and accounting tradition, lack of professional education and training,32 and strong incentives for manipulating accounting information.

The Corporate Governance and Accounting Environment in China

149

First, Chinese culture, which is characterized by collectivism-oriented societal values (Chow et al., 1995), appreciates obedience to authority (Fei, 1992; Hofstede, 1991). People do not observe something that has not been approved by systems and rules. Independence, belief in individual decisions, and respect for individual endeavor are not acknowledged. Collectivism supports a uniform accounting system and making accounting policy at the national level rather than within individual firms (Xiao et al., 2004a). In China the rigid uniform accounting system has been practiced since the 1950s. Accountants and managers are used to relying upon various guidelines issued by government agencies. Thus, the independent professional judgment emphasized in IFRS is a new concept in China. Second, Chinese accountants lack professional education and training. Among approximately 14 million accounting staff in China, over 90% of them do not have university degrees and lack clear understanding of the role of accounting (Xiao et al., 2004a). Ding and Su (2008) indicate that Chinese accountants have very little training in making professional judgments in a verifiable and ethical way. Poorly educated accountants would find it very difficult to rely upon accounting standards for guidance and exercise professional judgment in their routine work (Xiao et al., 2004a). Further, managers in Chinese listed companies have strong incentives to manipulate financial reports. Many listed companies forged accounts to mask true financial conditions, evade tax, embezzle state revenues, and appropriate state-owned assets (Noronha, Zeng, & Vinten, 2008). The World Bank recommended that the Chinese government implement an awareness program to motivate top management to comply with financial reporting standards on the basis of revealing a range of noncompliance and accounting manipulation of listed companies’ financial statements (World Bank, 2009). Zhu Rongji, the former Chinese premier, once wrote four characters to Chinese accountants “Don’t Cook the Book” showing the concerns from the top leadership. Consistent with previous discussion, there are a number of reasons for manipulation incentives. First, most controlling shareholders of listed companies in China are either state-owned enterprises or government agencies that evaluate the management of listed companies based on reported earnings. For example, the tenure, promotion, and political future of the management depend on earnings performance (DeFond et al., 1999; Xiao et al., 2000). In addition, security regulations contain specific performance-based requirements regarding listing, raising additional capital, trading suspension, and delisting, providing regulatory incentives for earnings management or manipulation (Chen, Wang, & Zhao, 2009; DeFond et al., 1999).

150

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

6.5.1.2. Information Users Prior to the economic reforms the Chinese government was the main information user who relied on accounting information to make centrally planned budgets and economic policies. Following the economic reforms, the government has gradually reduced its direct involvement in the administration of business operations. Accordingly, the information needs of nongovernment users such as investors and creditors are increasingly acknowledged (Lin, Chen, & Tang, 2001). The ASBE-Basic Standard issued in 1992, which was equivalent to the conceptual framework in AngloAmerican countries, identified investors, creditors, government agencies, and the public as the user groups of accounting information. It was the first time that the information needs of users other than government agencies were acknowledged, which was reinforced in the new ASBE issued in 2006. However, the government is still perceived as an important information user acting as either a major shareholder of restructured SOEs or the regulator of the business sector. There is a difference between conceptual frameworks of China and Anglo-American countries in terms of the priority given to various stakeholders’ information needs. In Anglo-American countries the special needs of government and management are subordinate to the overriding focus on investors and creditors. For example, in Australia the conceptual framework states that “as investors are providers of risk capital to the entity, the provision of financial reports that meet their needs will also meet most of the needs of other users that financial reports can satisfy” (AASB, 2007). However, in China accounting must serve government agencies equally as well as investors and creditors (Tang, 2000). Economic reforms and accounting development are government driven in China. Satisfying the information needs of the government still remains a priority of the accounting practice. In addition, financial statements and audit reports are less valued by Chinese investors compared to their counterparts in Anglo-American countries. For example, in the United States, the IPO market generates a demand for auditor independence, as US IPO firms tend to hire large audit firms to signal firm value (Beatty, 1989). This demand is absent in China because the government controls most IPO firms and Chinese investors perceive the value of these firms, including the success of the IPO and prospects after being listed, as ensured by the controlling government entity as opposed to the financial information reflected in the quality accounting reports (DeFond et al., 1999). Lin et al. (2003) find no significant difference in users’ investment or credit decisions with respect to their exposure to

The Corporate Governance and Accounting Environment in China

151

financial statements accompanied by an unqualified or a qualified auditor opinion.33 Chen et al. (2007) point out that audit quality benefits for investors and managers were either absent or minimal. Audits were mainly imposed by law or regulation, and their importance was rarely perceived by clients and users of audit reports (Lin et al., 2003). Information users in China still only have limited confidence in financial statements and audit reports (Ren, 2010), and they are generally unsophisticated in their understanding of the accounting information (Xiao et al., 2004a).

6.5.2. Information Intermediaries The information intermediaries add value to the information supplied by the management and include auditors, financial analysts, securities underwriters, and lawyers (Lee, 1987). For example, the role of an auditor is to add creditability to the financial report by providing independent opinion, while the financial analysts make the financial statement more understandable. As financial analysts and the financial press are still in their infancy and are ineffective as information intermediaries between listed firms and investors (Haw, Qi, & Wu, 2000), the following discussion focuses on the accounting profession in China. The experience of the accounting profession in China has been closely related to the economic transformation. The accounting profession was suspended under the planned economy on the grounds that independent auditing was not necessary for SOEs. The economic reforms revived the Chinese accounting profession to accommodate the market economy. The evolution of the Chinese accounting profession has been driven and controlled by the government. In addition, despite its dramatic growth, the accounting profession in China is young and underdeveloped compared to its counterparts in Anglo-American countries. 6.5.2.1. Suspension of the Accounting Profession in the Planned Economy Development of the accounting profession in China before the formation of modern China in 1949 was largely influenced by the accounting profession in Western countries. In the early 20th century, the Western accounting system was employed by the enterprises set up by the colonialists, such as the United States and the United Kingdom. The emergence of the public accounting system in China resulted from Western public accountants coming to China along with their clients. China’s own professional accounting

152

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

system grew steadily before 1949, when the revolution ended any further development (Guo, 1988; Li & Wang, 1989). A centrally planned economy was adopted by the new government, with the SOEs playing a dominant role since 1950s. SOEs were merely regarded as production units rather than commercial organizations with the objective of maximizing profit. The accounting system, imported from the Soviet Union, primarily assisted the state in economic planning, implementing state economic policies, and controlling the means of production (Adhikari & Wang, 1995). In addition to direct supervision exercised by the government ministries that were in charge of SOEs, the MOF and local financial department offices performed annual financial examinations of SOEs (Lau & Yang, 1990). The purposes of the financial examination were to ensure compliance with government policies, tax rules, production and financial plans, and profit submission schemes and to ensure the safety of state assets and proper use of government funds. There was no need for an independent audit service provided by a third party to provide an independent view as to whether the financial statements were true and fair due to direct control of the government. The financial examination by the MOF and its local offices served as a means of direct supervision and management of the SOEs. Under this system, there were no professional public accountants and auditors and no external markets for accounting services, as the state was the ultimate owner of all entities and resources. 6.5.2.2. Resumption of the Accounting Profession in the Market Economy The accounting profession reemerged following the economic reforms and experienced unique process in moving toward internationally acceptable practices. Particularly, the professionalization process was largely controlled by Chinese government (Yee, 2009). Dual Track of the Accounting and Auditing Professions. Compared to their counterparts in Anglo-American countries, the development process of the accounting and auditing professions is characterized by a “dual track” (Xiao et al., 2000). The open-door policy attracted a large amount of foreign direct investment to China. The revival of the accounting profession was initially driven by foreign investors. In order to meet the information needs of foreign investors, a separate accounting system for the new ownership structure following the international accounting standards was developed. In addition, the Income Tax Law for Sino-Foreign Joint Ventures was

The Corporate Governance and Accounting Environment in China

153

passed by the National People’s Congress in September 1980. In December 1980, the MOF issued the Detailed Principles for Implementation of Income Tax Law for Sino-Foreign Joint Ventures. It was the first to stipulate that an audit report signed by a Chinese CPA is required for a tax return (Hao, 1999). A few days later, the MOF issued Provisional Regulations Regarding the Establishment of Accounting Consultancies. The first accounting firm, Shanghai Accounting Consultants, was set up in January 1981 (Chen, Chen, & Su, 2001). More accounting firms were established in other large cities within the next few years. Demands for independent auditing service were increased by the SOE reform and the establishment of the capital market, which is further discussed in succeeding sections. In addition, under the new economic environment, state audit offices were created largely because of the concern that the MOF and its local offices lacked independence and were unable to discover management problems in SOEs. The financial examination conducted by the MOF might be biased, as the MOF financed the SOEs and had been involved in business decision making. In 1983, the State Administration of Audit under the State Council was officially set up, which signaled the new era of modern state auditing in China. The State Administration of Audit established its local audit offices (also referred to as audit firms in the literature) at province, city, and town levels. Audit offices report to the corresponding level of government and the higher level audit office.34 In accordance with the Article 91 of the 1982 Constitution, audit offices are responsible for auditing “the revenue and expenditure of all departments under the State Council and of the local governments at different levels, and those of state financial and monetary organizations and of state enterprises and institutions.” The establishment of audit offices created conflicts between the accounting profession and the auditing profession as the two professions competed with each other and qualifications for accountants and auditors were governed by different government departments. In accordance with the Regulation of Certified Public Accountants issued in 1986, the CICPA was formed in 1988 and the MOF and its local offices are responsible for managing CPAs and accounting firms. In 1992, in competition with the CICPA, the Chinese Association of Certified Public Auditors was established by the State Administration of Audit to regulate auditors employed in audit offices (Xiao et al., 2000). For many years, auditing offices mainly audited government departments and domestic companies, whereas accounting firms focused on companies using foreign investments. However, along with the economic development their business areas overlapped.

154

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Merger of the Auditing and Accounting Professions. The competition between the accounting profession and the auditing profession with their own rules issued by different government departments caused many problems, such as duplication of audits and abnormal competition (Xiao et al., 2000).35 Repeated audits resulted in excessive burdens on clients. Another issue was the inconsistency between China’s practice and international conventions. Particularly the international accounting firms were confused by the different rules issued by different government agencies. Consequently, steps were taken to merge the two professional bodies. The CICPA took over the Chinese Association of Certified Public Auditors in 1995 and became the sole accounting professional body in China (Sami & Zhou, 2008). According to the CPA law issued in 1993, the MOF was given the power to regulate the CICPA. This change has resulted in the unification of name, institution, and regulations. The merger brought both accounting firms and audit offices under the auspices of the CICPA. While the work of the State Administration of Audit after the merger focuses on government audits and audits of SOEs in compliance with laws and regulations, the performance of the attest functions is restricted to the CPAs. Auditor Disaffiliation Program. Historically, most of the accounting and auditing firms in China were affiliated with government agencies, government-sponsored bodies, or universities and research institutions (Lin, 1998; Xiao et al., 2000). The affiliation between accounting firms and the government was the major threat to auditor independence (DeFond et al., 1999; Yang, Tang, Kilgore, & Jiang, 2001). Affiliated firms were able to obtain a competitive advantage through government agencies’ administrative powers. Government-affiliated firms audited about 70% of listed companies (DeFond et al., 1999). The government affiliation also protected firms from litigation risk (DeFond et al., 1999; Yang et al., 2001) because the ultimate liability was borne by the sponsoring government agencies (Gul, Sami, & Zhou, 2009). High-profile corporate scandals such as the Yuanye scandal in 1991, the Great Wall Fund Raising scandal in 1992, the Wangfujing scandal in 1993, the Jianfeng in 1993, and the Nantong Machine Tool event in 1995, all of which were audited by affiliated auditors (Gul et al., 2009), brought about a credibility crisis for the young accounting profession and revealed the urgency of severing the link between the government and public accounting service (Xiao et al., 2000).36 In order to improve auditor independence and restore public confidence the MOF launched the disaffiliation program in 1997 1998, which was

The Corporate Governance and Accounting Environment in China

155

completed in 2000 and largely severed the relationship between accounting firms and government agencies. The Nature of Auditing Standards. Before 1995, there were no unified auditing standards in China. The CPA law, promulgated in 1993, made auditing standard setting a statutory requirement. It also empowered the CICPA to draft auditing standards subject to the approval of the MOF. The CICPA formed the China Independent Auditing Standards Commission (reorganized as the Chinese Auditing Standards Board in 2005) to develop standards in October 1994, with members from the CICPA, higher education, research institutes, and accounting firms. Two consultative expert groups, the Domestic Advisory Group and the Foreign Advisory Group, were also established in 1995, with members appointed by the MOF. The former consisted of leading Chinese accounting academics and practitioners, while the latter was composed of representatives from international accounting firms active in China (Xiao et al., 2000). Since 1995 the MOF has issued several batches of auditing standards that have been largely modeled on international auditing standards (Chen, 1997; Cooper, Chow, & Wei, 2002; Sami & Zhou, 2008). The implementation of these auditing standards has reduced earnings management and improved accounting disclosure and the information environment of public companies (Sami & Zhou, 2008). Moreover, to achieve continuous and comprehensive convergence with international auditing standards, the revised Chinese Standards on Auditing was released in November 2010, which came into effect in January 2011 (IFAC, 2010). In contrast to the accounting profession in Anglo-American countries, auditing standards development in China is largely government driven. For example, the US auditing profession developed auditing standards on its own, while the CICPA has been heavily dependent on the government through the MOF. Consequently the US auditing standards had professional authority, whereas the Chinese standards have resorted to the authority of the government (Xiao et al., 2000). Audit Services Market. The audit services market grows in parallel with the economic development. Initially enterprises with foreign investment were the main audit clients of Chinese CPAs. Listed companies and companies seeking a listing became important clients with the establishment of the Shanghai Stock Exchange and Shenzhen Stock Exchange in 1990 and 1991, respectively. The auditing market for Chinese CPAs was further expanded in 1998 as a result of a new regulation issued by the MOF,

156

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Provisional Rules for CPA Auditing of Annual Accounting Reports of State-Owned Enterprises, which extended the compulsory auditing requirements to state-owned enterprises except for specified enterprises such as banks and insurance companies. The Chinese government adopts an incremental approach in terms of opening up the audit services market to international accounting firms in order to protect the young Chinese CPA profession from competition with foreign accountancy giants. Entry into China’s market by foreign accounting firms was restricted. Initially only the Big Nine were allowed to enter into China,37 which was followed by the second-level international firms. Among the Big Nine at that time, Coopers & Lybrand was the first accounting firm that established a representative office in China in January 1981. Then other international accounting firms also set up their offices in major cities such as Beijing, Shanghai, Guangzhou, and Fuzhou. Further, the service scope was also controlled in that these international firms could only extend their business gradually (Hao, 1999). Initially, foreign firms mainly served their multinational clients and could provide limited consultancy services to Chinese clients. Other service markets, such as valuation and auditing for any domestic purpose, were not opened up immediately to them. Since 1992, they have been allowed to enter the domestic accounting and audit service market by forming joint ventures with Chinese local accounting firms (Hao, 1999). In 1996, international accounting firms were allowed to develop local member firms. China’s accession to membership in the WTO in 2001 expanded the market for international accounting firms. For example, as a result, foreigners became eligible to be granted Chinese CPA qualification upon passing qualifying examinations, and audit service restrictions imposed on joint venture accounting firms were removed (Ezzamel & Xiao, 2007). To date, all Big Four firms, namely, Ernst & Young, PwC, KPMG, and Deloitte, have set up offices in more than 10 large cities.38 The audit services market in China is relatively small and highly competitive. For example, listed companies are the main targets of accounting firms, but both the number and size of listed companies are small. In China at the end of 2006, there were only approximately 1,400 listed companies, while 73 accounting firms were qualified to audit them, suggesting less than 20 listed clients on average for one qualified firm (Chen, Sun, & Wu, 2010). China ranks 32 in the world in terms of the average size of listed companies (Liebman & Milhaupt, 2008). Further, although in Anglo-American economies the Big 5/4 firms audit the majority of listed companies,39 there is no such concentration in the Chinese audit market for listed companies. For

The Corporate Governance and Accounting Environment in China

157

example, in the UK market during 1998 2003, the level of concentration of Big 5/4 ranged from 68 to 75 based on number of audits, whereas the level measured by audit fees was as high as around 95% over the six-year period (Abidin, Beattie, & Goodacre, 2010). In contrast, the average market share of the then Big 5 auditors in China’s statutory audit market between 1995 and 2003 was 26% (Chen et al., 2007). Low concentration increases competition in the audit market, which in turn weakens the bargaining power of auditors and consequently gives rise to issues of auditor independence. 6.5.2.3. A Government-Regulated Profession In contrast to Anglo-American countries, in which the accounting profession tends to be self-regulated, the accounting profession in China is largely government regulated. The Chinese government imposes its administrative influence over the accounting profession in the licensing of accounting firms, qualifying exams, and firms’ day-to-day operations through agencies such as the MOF, CICPA, and CSRC (Tang, 1999). The CICPA is a government-regulated body rather than a self-regulated professional association, although the Chinese government intends to withdraw from direct intervention in the accounting profession, and the CICPA is recognized as a community organization in the Law of Certified Public Accountants.40 The CICPA was established as a subsidiary unit of the MOF. It is under direct control of the MOF, and its decisions must be ratified by the MOF. MOF delegates to the CICPA have administrative responsibility for the registration of CPAs and CPA firms, the conduct of professional examinations, and the management of training programs. The CICPA is also responsible for formulating and implementing codes of CPA ethics and developing audit standards. Upon approval by the MOF, these codes and standards become authoritative documents that are binding on all CPAs. Thus, essentially the CICPA is a government-regulated body rather than a self-regulated professional association because of its quasigovernmental status. In addition, the CSRC, the regulator of China’s securities markets, also has important political and administrative power over accounting firms and accounting practitioners. It sets up 36 regional bureaus throughout the country in provinces, autonomous regions, municipalities directly under the central government, and cities under separate state planning, as well as two offices for securities regulation in Shanghai and Shenzhen. Laws and regulations concerning listed companies, accounting firms, and accounting practitioners are mainly enforced through CSRC’s administrative system,

158

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

which consists of the Shanghai Securities Exchange, the Shenzhen Securities Exchange, regional bureaus, and offices. Fig. 6.1 shows the accounting regulatory framework in China and illustrates the relationship among the Chinese government, accounting regulators, accounting professional organizations, and accounting practitioners. 6.5.2.4. Relatively Small Size and Lack of Expertise of the Accounting Profession In addition, the Chinese CPA profession is relatively small and lacks the expertise required to handle the auditing issues in the Chinese economy (DeFond et al., 1999; Lin & Chan, 2000; Winkle et al., 1994; Xiang, 1998). The accounting profession experienced rapid growth following the economic reforms. By October 31, 2010, the CICPA had 7,790 group members (accounting firms, including 779 branches) and nearly 180,000 individual members, with 95,378 practicing members and over 83,000 nonpracticing members (CICPA, 2012). However, this is still a small number compared to the increasing demand for independent audit service. Table 6.2 shows a

State Council of China

Ministry of Finance

China Securities Regulatory Commission

Chinese Institute of Certified Public Accountants

Shanghai Securities Exchange Shenzhen Securities Exchange Regional Bureaus and Offices

Accounting Firms Accounting Practitioners

Listed Firms

Fig. 6.1. Accounting Regulatory Framework in China.

159

The Corporate Governance and Accounting Environment in China

Table 6.2.

A Comparison of the Number of Professional Accountants in China and Anglo-American Countries.

Country

Population

Number of Professional Accountantsa

Proportion of Professional Accountants per Million Population

China USA Australia

1.3 billionb 0.3 billiond 20 millionf

171,000c 350,000e CPA Australia 117,000g + Institute of Chartered Accountants in Australia 58,000h = 175,000

131 1167 8750

a

Professional accountants refers to members of professional accounting bodies. Source: http://www.chinapop.gov.cn/wxzl/rkgk/200806/t20080629_157022.htm c Source: http://www.cicpa.org.cn/topnews/201011/t20101109_26387.htm d Source: http://news.xinhuanet.com/ziliao/2002-01/28/content_257426.htm e Source: https://www.aicpa.org/MediaCenter/FAQs.htm#aicpa_answer6 f Source: http://www.immi.gov.au/media/publications/statistics/popflows2003-4/ch1_pt1.pdf g Source: http://www.cpaaustralia.com.au/cps/rde/xchg/SID-3F57FECA-C451F567/cpa/hs.xsl/ 1038_9684_ENA_HTML.htm h Source: http://www.charteredaccountants.com.au/about_the_institute b

brief comparison of the number of professional accountants in China and two Anglo-American countries. The lack of required expertise in accounting and financial reporting is a result of the nonexistence of a commercial audit system from the 1950s to the early 1980s and the suspension of higher education in accounting during the Cultural Revolution. In the 1980s, approximately 80% of CPAs were retired accountants (Abdel-Khalik, Wong, & Wu, 1999; Xiao et al., 2000), 52% of CPAs were over 60 years old, and only 18% of CPAs held university degrees (Tang, 2000). Until 1991, the CPA qualification was obtained by review rather than by examination. Further, the syllabus of the uniform CPA examination and the curriculum of higher education were somewhat narrow in scope (Lin & Chan, 2000). IFAC (2004) states that a program of accounting education and experience should go beyond the traditional approach and place emphasis on a set of knowledge, skills, and professional values broad enough to enable adaptation to changes in the business environment.41 Accounting education in China has been based on a traditional unified accounting system that lacks a conceptual underpinning and an international outlook (Yan & Wang, 2000), and the CPA examination in China largely focuses on accounting techniques (Lin & Chan, 2000). Currently CPA examination subjects comprise accounting,

160

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

financial management, auditing, economic laws, corporate strategy, and risk management and taxation (MOF, 2013). Moreover, unlike in Anglo-American countries, there is a lack of systematic professional training and post-qualification education or professional development programs in China (Lin & Chan, 2000; Xiao et al., 2000). For example, UK auditors could maintain audit quality because the UK professional accounting bodies emphasized professional education, training, and examinations (Chandler, 1997). By contrast, the lack of continuing professional education in China has hindered the development of the profession (Tang, 2000; Xiao et al., 2004a). The Chinese government has endeavored to improve the accounting profession. The unified CPA examination is organized each year, and successful completion of the CPA examination and practical experience are required for CPA qualification (Tang, 2000). In addition, the government has established National Institutes of Accounting in Beijing, Shanghai, and Xiamen to provide executive courses relating to accounting for auditors, preparers, and regulators (Xiao et al., 2004a). However, it is likely that it will take a long time for these measures to produce results.

6.6. CONCLUDING REMARKS This chapter examines China’s corporate governance and accounting environment that shapes the adoption of internationally acceptable principles and standards. Specifically, it examines international influences, including supranational organizations; foreign investors and international accounting firms; domestic institutional influences, including the political system, economic system, legal system, and cultural system; and accounting infrastructure. China’s convergence is driven by desired efficiency of the corporate sector and legitimacy of participating in the global market. Being heavily influenced by international forces in the context of globalization, corporate governance and accounting practices are increasingly becoming in line with internationally acceptable standards and codes. While the convergence assists China in obtaining legitimacy, improving efficiency is likely to be adversely affected given that corporate governance and accounting in China operate in an environment that differs considerably from those of Anglo-American countries. China’s development of a socialist market economy is largely driven by the single-party dominant

The Corporate Governance and Accounting Environment in China

161

government. Although the Chinese government has gradually withdrawn from running enterprises it still maintains a strong influence on the business sector. China’s economy is in transition. Its capital market is newly developed and exhibits speculative behavior. In order to keep the capital market under control, among other things, the CSRC heavily relies on accountingoriented measures, which in turn stimulates accounting manipulation. In the highly concentrated ownership structure, controlling shareholders are able to intervene in company operation. The value of good corporate governance tends to be undermined in the speculative market. Further, the underdeveloped and ineffective legal system in China provides little protection for investors, which has implications for the behaviors of organizational players, including managers, independent directors, and auditors. Chinese culture, stressing relationship harmony in communities, is not compatible with the key concept of independence that underpins the accounting profession in Anglo-American countries. Within China’s institutional settings, information preparers lack an appropriate level of professionalism. Information users lack appreciation of the value of financial statements and audit reports. The accounting profession is still very young and underdeveloped. Particularly, the Chinese government essentially maintains control over the accounting profession, including CPAs, CPA firms, and the CICPA. In conclusion, an examination of the corporate governance and accounting environment in China suggests heavy government involvement within underdeveloped institutions. While the Chinese government has made impressive progress in developing the corporate governance and accounting environment for the market economy, China’s unique institutional setting is likely to affect how the imported concepts are interpreted and implemented.

NOTES 1. Unlike Anglo-American countries, China adopts a two-tier board system. The board of directors is responsible for day-to-day operation, and the supervisory board monitors the board of directors and other senior managers. 2. China Statistical Yearbook 2007, China Statistics Press; Statistical Communique´ of the People’s Republic of China in 2007, Statistical Communique´ of the People’s Republic of China in 2008, Statistical Communique´ of the People’s Republic of China in 2009, and Statistical Communique´ of the People’s Republic of China in 2010, available at http://www.stats.gov.cn 3. The other four countries include Brazil, India, Indonesia, and South Africa.

162

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

4. The World Bank started to commit itself to supporting reform of China’s accounting system in 1992 when China obtained USD 60 million in financial assistance under the title of Financial Sector Technical Assistance Loan. One component (USD 2.4 million) was for accounting standards reform. Acknowledging good progress achieved, the World Bank granted further financial support, particularly under the title of China-Accounting Reform and Development Project (World Bank, 1998). 5. Within foreign Chinese joint accounting ventures, foreign accounting firms are allowed to maintain a majority equity holding and maintain control of staffing decisions. In addition, foreign partners can play a significant role in the design of the internal control system and practical rules for the cooperative accounting firms. Within the membership system, Chinese accounting firms use the name and the practice standards of the international accounting firms. These practices should raise the quality and reputation of Chinese public accounting, as the internationally acceptable auditing standards and practices will eventually prevail in China (Lin, 1998). 6. Modern China was formed following the revolution in 1949. 7. Some Anglo-American accounting concepts, such as conservatism, were prohibited because they were viewed as a tool of capitalist exploitation that was used to protect capitalist interest (Xin & Huang, 1951; Yan, 1951). 8. There are four territorial levels of power in China, which include state, province, city, and town. 9. The United States has developed a series of administrative laws and regulations, including the Administrative Procedure Act (1946), the Freedom of Information Act (1966), the Privacy Act (1974), the Sunshine Act (1976), and the Electronic Freedom of Information Act (1996), making governmental decisions open to the public (Zhang, 2009). 10. A socialist market economy refers to a developing economy based on socialist principles. 11. The government required banks to fund key projects even if they were unprofitable. Most of this policy lending was made to SOEs and the government itself. 12. Currently there are three policy banks, namely, the Agricultural Development Bank of China, Export-Import Bank of China, and China Development Bank. 13. Shanbufeng refers to the situation of no separation of responsibilities between the Communist Party of China and the government, between the government and the enterprises, between the government as the owner and the government as the administrator of the state. 14. It should be noted that although the stock exchanges are growing in size and volume, their scale and importance are still not comparable to that of the banking sector for the entire economy (Allen et al., 2005). 15. SCSC was the highest security regulatory body in the country and determined overall policies related to the securities market, such as approving the formation of new stock exchanges and new securities legislation and regulations and setting the quota of securities issuance at the national and provincial levels. 16. In all past three consecutive years, the company must report profit instead of loss. In addition, the accumulated profit must exceed 30 million RMB, and the accumulated net cash flow must be greater than 50 million RMB/or the accumulated operating revenue greater than 300 million RMB.

The Corporate Governance and Accounting Environment in China

163

17. These documentations are available through the CSRC website: http://www. csrc.gov.cn 18. QFII are defined as overseas fund management institutions, insurance companies, securities companies, and other asset management institutions that have been approved by the CSRC to invest in China’s securities market and granted investment quota by the State Administration of Foreign Exchange. 19. State shares are those owned by the state (i.e., the central government, local governments, or solely state-owned enterprises). Legal person shares may be owned only by domestic legal entities and institutions with formal legal personality, such as other stock companies, state private mixed enterprises, and nonbank financial institutions. State shares and legal person shares were initially prohibited from being traded in the capital market. Employee shares were offered to company employees. They represent accumulated profits retained in a state enterprise under the Contract Responsibility System prior to its initial public offering and are collectively owned by the employees of the company. After a holding period of 6 12 months, the company may file with the CSRC to allow its employees to sell their shares in the open market (Xu & Wang, 1999). 20. Historically, individual shareholders were the dominant shareholder group in the tradable share market. In order to overcome the highly speculative and shortterm investment horizon of individual shareholders, institutional investors have emerged as a result of the promulgation of the Provisional Measures on Administration of Securities Investment Funds by the State Council Securities Commission in November 1997. Provisional Measures on Administration of Domestic Securities Investments of Qualified Foreign Institutional Investors (QFII) came into effect in December 2002, which allows QFII to enter into China’s capital market. Today, shareholders of listed companies comprise securities investment funds, QFII, insurance and social insurance institutions, superannuation funds, and individual shareholders. 21. For example, of 1,088 listed companies on the two stock exchanges at the end of 2000, over 90% were originally transformed from SOEs (Tam, 2002), and 940 of the 1,287 listed companies at the end of 2003 were SOEs (Hua, Miesing, & Li, 2006). 22. Government bailout is a public record in China. Bailout could be conducted by different authorities in different forms. Local governments will bail out their listed companies mainly through restructuring. The CSRC is responsible for the stock market and is expected to bail out the entire market. An official research report states that “in addition, CSRC also takes special duties such as to develop the market, stabilize the market, and bail-out the market” (SZSE, 2008b). 23. These laws include the Accounting Law (passed in 1985, revised in 1993 and 1999), Bankruptcy Law (passed in 1986, revised in 2006), Company Law (passed in 1993, revised in 1999 and 2005), Law of Certified Public Accountants (passed in 1993), Auditing Law (passed in 1994, revised in 2006), and Securities Law (passed in 1998, revised in 2005). 24. This provision is inconsistent with both the old and new Securities Law. The old Securities Law contains a general provision (Article 207) that provides civil compensation liability for violation of the Securities Law. Under the new Securities Law, separate provisions provide civil compensation liability for misrepresentation

164

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

(Article 69), insider trading (Article 76), market manipulation (Article 77), and fraudulent broker conduct (Article 79). 25. It is the CSRC’s sanction, not sanctions issued by the two exchanges, that makes listed companies subject to potential private securities litigation. 26. In the new Securities Law, there are over 30 administrative liability provisions, 18 criminal liability provisions, and only four civil liability provisions on four specific violations (Wang & Chen, 2008). 27. For lesser infractions, the CSRC may issue reprimands called “correction orders,” in which a company or an individual is ordered to correct certain behavior. However, correction orders are not formal administrative sanctions and thus do not constitute the condition for civil lawsuits in accordance with Supreme People’s Court Notice in 2002 and 2003. 28. The CSRC does not make timely public disclosures of its enforcement actions; instead, it leaves it up to the firms to make a public announcement under their general obligation to disclose price-sensitive information. In contrast, the stock exchanges in Shenzhen and Shanghai make their enforcement decisions public promptly through the media and the exchanges’ official websites. 29. Punishment is relatively heavy in the United States. Recent examples of insider trading law enforcement in the United States include Joseph Nacchio of Qwest, who was convicted in 2007 of insider trading and sentenced to six years’ imprisonment, a USD 19 million fine, and the forfeiture of USD 52 million that he gained in illegal stock transactions. Jeffrey Skilling of Enron was convicted in 2006 of fraud, including insider trading, and sentenced to 24 years’ imprisonment and a USD 45 million fine (Statman, 2009). 30. A total of 109 companies have been suit eligible as a result of CSRC administrative sanctions from 2000 to 2006. Approximately 20 additional listed companies are suit eligible as a result of criminal judgments or MOF sanctions. All these cases involved information disclosure. 31. The disruption refers to the situation where old values and norms were thrown into doubt and abandoned while new norms and values had yet to be established to provide that basic guidance for people’s behaviors (Ip, 2009). 32. This issue is further discussed in the information intermediaries section, as it is a common problem facing accountants (as information producers) and auditors (as information intermediaries). 33. A considerable portion of the respondents had rarely relied upon financial statements and audit reports in making business and financial decisions. The majority of those participants were business and financial managers, securities analysts, and credit and loan officers with work experience at relatively senior levels. Their views may reflect the general attitudes of financial statement users in China. 34. Governments at all levels establish their corresponding audit offices. The audit reporting system is of a dual nature in that, for example, an audit office at the city level should report to both the city government and the audit office at the provincial level. 35. A company might be audited several times by an accounting firm, audit office, and tax office. 36. In these cases, managers issued fraudulent financial statements or falsified capital investment accounts to mislead investors, while affiliated CPA firms failed

The Corporate Governance and Accounting Environment in China

165

to either detect or report such managerial misconduct. In some cases, auditors were even found to assist their clients in falsifying accounts. For example, Shenzhen Yuanye Industrial Corporation Limited is a joint venture involving a Hong Kong partner. Shenzhen Special Economic Zone Accounting Firm was the auditor. Although the client made a loss every year from 1989 to 1991, it reported a cumulative profit of RMB 77.4 million in the financial statements during that period, all of which was issued as unqualified opinion by its auditor. The auditor was found guilty of helping the client falsify accounts. It was also found that the auditor provided 10 false certificates on capital contribution verification. In the Great Wall Fund Raising scandal, the company illegally raised RMB 1 billion in a few months between 1992 and 1993 by issuing high coupon securities to over 100,000 private investors in 17 large cities in China. A branch of the Zhongcheng Accounting Firm played a key role in the fraud. Its three CPAs provided an unfounded certificate confirming RMB 0.3 billion capital after just one day’s work with only 25 pages of working papers (Xiao et al., 2000). 37. The Big Nine at that time comprised Coopers & Lybrand, Arthur Andersen, Arthur Young, Ernst & Whinney, Deloitte Haskins & Sells, Touche Ross, Klyneld Main Goerdeler, Peat Marwick Mitchell, and Price Waterhouse. A wave of mergers and the Enron collapse has now reduced the Big Nine to the Big Four (KPMG, Ernst & Young, PricewaterhouseCooper, and Deloitte Touche Tohmatsu). 38. Ernst & Young has offices in 12 cities, namely, Beijing, Chengdu, Dalian, Guangzhou, Hangzhou, Qingdao, Shanghai, Shenzhen, Suzhou, Tianjin, Wuhan, and Xiamen (from http://www.ey.com/OurLocations). PwC has offices in 12 cities, namely, Beijing, Guangzhou, Shanghai, Tianjin, Chongqing, Ningbo, Shenzhen, Xiamen, Dalian, Qingdao, Suzhou, Xian (from http://www.pwccn.com/home/chi/ index_chi.html). KPMG has offices in 11 cities, namely, Beijing, Shenyang, Qingdao, Shanghai, Nanjing, Chengdu, Hangzhou, Fuzhou, Xiamen, Guangzhou, Shenzhen (from http://www.kpmg.com/cn/en/Pages/default.aspx). Deloitte has offices in 12 cities, namely, Beijing, Chongqing, Dalian, Guangzhou, Hangzhou, Nanjing, Shanghai, Shenzhen, Suzhou, Tianjin, Wuhan, and Xiamen (from http:// www.deloitte.com/cn/about). 39. Andersen, one of the Big 5 accounting firms then, merged with PricewaterhouseCoopers (PwC) in 2002. 40. For example, the Regulation of Certified Public Accountants issued in 1986 provided that the MOF and its local offices were responsible for managing CPAs and accounting firms, while the role of the MOF and its local offices was changed to provide oversight and guidance to CPAs, accounting firms, and CICPA in the Law of Certified Public Accountants issued in 1993, which replaced the Regulation of Certified Public Accountants. 41. The traditional approach has emphasized “transfer of knowledge,” with learning defined and measured strictly in terms of knowledge of principles, standards, concepts, facts, and procedures at a point in time (IFAC, 2004).

CHAPTER 7 CORPORATE GOVERNANCE-RELATED FINANCIAL REPORTING ISSUES IN CHINA: EMPIRICAL EVIDENCE

ABSTRACT This chapter analyzes and discusses the empirical results of the study. The discussion is organized under the following themes: independent director, audit committee, auditor independence, corporate code of conduct, adoption of IFRS, and measures for improvement. Three main findings emerge from the analysis. First, the current institutional environment does not yet fully support the Anglo-American practices. Second, in recent years the quality of financial reporting has improved considerably, which is largely attributable to strengthened accounting rules and regulations. However, the imported Anglo-American models of corporate governance and financial reporting, except for enhancing auditor independence, have had only a minor impact on financial reporting quality. Third, although the imported practices are not working as intended, the vast majority of interviewees stated that it was appropriate to move toward internationally acceptable principles and standards. Improving laws and regulations seems to be the main measure for rendering the institutional environment in China more supportive of AngloAmerican models of corporate governance and financial reporting. Keywords: Empirical evidence; symbolic implementation

167

168

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

7.1. INTRODUCTION The Chinese government has reformed corporate governance and financial reporting on the basis of Anglo-American models for both efficiency and legitimacy reasons. While the convergence with international standards facilitates gaining international legitimacy, the enforcement of internationally acceptable ideas is largely influenced by the local context in which those ideas are interpreted and practiced. The discussion in Chapter 6 indicates that China has a different institutional setting from that of AngloAmerican countries, which is likely to cause problems in implementing internationally acceptable standards and practices. Institutional contradictions are reproduced within the intraorganizational context, shaping organizational players’ relationships and their behaviors. Conflicts of interest among organizational players, including managers, independent directors, audit committees, and auditors, are inherent in the workplace relationship because of differentiated functions and divergent interests. Functionally differentiated organizational players tend to mobilize their power to protect the status quo and mitigate conflicts of interest (DiMaggio & Powell, 1983; Meyer & Rowan, 1977). The chapter is organized as follows. The next four sections discuss the associated issues under the titles of independent directors, audit committees, auditor independence, and corporate code of conduct, respectively. As indicated in Chapter 2, these corporate governance elements are considered to be directly related to financial reporting. Section 7.6 examines the adoption of IFRS. Measures for improvement are presented in Section 7.7. Section 7.8 ends the chapter with some concluding remarks.

7.2. INDEPENDENT DIRECTORS 7.2.1. Factors Affecting the Independence of Independent Directors For the purpose of this monograph, the independence of independent directors refers to their ability to resist undue influence from parties such as controlling shareholders and management. The independence of independent directors is influenced by a number of factors in China, including the meaning of independent directors as perceived by key players involved, controlling shareholders, guanxi, a lack of understanding of corporate operations of independent directors, and their minority status on the board. It is worth noting that these factors are interrelated.

Corporate Governance-Related Financial Reporting Issues in China

169

7.2.1.1. Meaning of the Independence of Independent Directors Article 3 of the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies (CSRC, 2001) lists the independence requirements, which mainly prohibit independent directors from having an affiliation with and financial interest in the company. While it is important to comply with the regulatory requirements, the substance of an independent director’s independence is to withstand undue influence of management. However, the interviewees indicated that their understanding of independence largely concerns the legal form rather than the spirit of the concept. For example, when discussing the meaning of independence a number of company directors insisted that the independence of independent directors is not a matter of concern because this quality is automatically ensured by the regulatory requirements of independence. As one company director elaborated, “Actually, there is nothing special with the independence … independent directors must be independent because this is a precondition for becoming an independent director according to the regulation” (CM1). As indicated by later discussion, independent directors in China are largely viewed as lacking independence. However, independent directors themselves disagreed with this view. While they were aware of the fact that they rarely cast a dissenting vote, which is one factor attracting criticism of independent directors, they emphasized that casting a dissenting vote does not necessarily mean independence. They argued that the same situation occurs in Anglo-American countries, implying that they do not believe they are less independent than their foreign counterparts. For example, one independent director elaborated: What does expressing an independent opinion mean? I have different opinion in this regard. I have never cast a dissenting vote in nearly six years as an independent director of a number of companies … No dissenting vote doesn’t necessarily mean I have no opinion and I am not independent … Americans act the same way, you can do your research, how many dissenting votes do you hear about in board meetings in the US? (ID3)

When probing the independence issue further with independent directors, their comments indicate that their understanding of independence is mainly related to communication. They believed that failure to communicate and express opinions is the major reason for the problems many independent directors have with independence. They also argued that issues can be resolved by communicating with management, suggesting the role satisfactory communication with management can play in maintaining the independence of independent directors.

170

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Normally I have sufficient communication with other directors and managers and solve the problems before the board’s meeting. (ID3) What is the major problem with independence in China? It is mainly related to communication before the proposal being submitted to the board for discussion. What is independence? It does not necessarily mean casting a dissenting vote, rather it is the communication before or during the board meeting, making the proposal more complete, this is my understanding of the concept of independence. I believe that most Chinese independent directors have this sort of understanding of independence … they also have opportunities and power to do so (i.e., communicate and express their opinion), but many independent directors haven’t used this power. (ID4)

While thorough communication is important, it is simplistic to believe that independent directors could maintain their independence by relying too heavily on communication to resolve disagreements with managers, given the complexities of corporate governance issues in China. Additionally, the interviewees generally avoided discussing those situations where disagreements cannot be resolved by communication, which is likely to indicate that they have not considered the independence issue thoroughly. In short, in China the meaning of the independence of independent directors seems to be understood in its purely legal form rather than in a substance over form approach. Independence issues are likely to be downplayed by assuming that the independence of independent directors is guaranteed by law and regulation. Further, Chinese independent directors are defensive about the possible allegation of lack of independence. They argue that they are able to maintain their independence through sufficient communication with management. Given the complex corporate governance related financial reporting issues in China, this simplistic understanding is not helpful to ensure the independence of independent directors. 7.2.1.2. Appointment of Independent Directors Controlling shareholders, along with the board of directors and senior management, were identified by all interviewees as the most influential parties in the process of appointing an independent director. The heavy involvement of controlling shareholders and management in the appointment process constrains independent directors’ ability to maintain independence and places them in a dilemma. As discussed in Chapter 6, Chinese listed companies are characterized by a highly concentrated ownership structure and frequent misappropriation of funds by controlling shareholders. According to the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies, independent directors are

Corporate Governance-Related Financial Reporting Issues in China

171

expected to be “especially concerned with protecting the interests of minority shareholders from being infringed” (CSRC, 2001). A number of interviewees pointed out the contradiction between the prevailing way of appointing independent directors and the role expected of independent directors in the regulation. The practice of introducing independent directors creates a paradox. Independent directors are expected to be concerned about minority’s interests, but their appointment is largely determined by controlling shareholders and management. Minority shareholders do not have a say, and probably they don’t care about matters of this kind (because they do not believe that independent directors are able to protect their interests). (AC3)

Chapter 6 also indicates that government is the controlling shareholder in most listed companies and those listed companies as restructured SOEs are continuously expected to accomplish political goals. A number of interviewees suggested that locals are preferred by the government when selecting independent directors, and the major purpose of selecting locals appears to be to impose political influence upon independent directors. Independent directors could come from universities … If the university is governed by local government; the government has considerable influence (over independent directors’ opinion). If the independent director has a divergent opinion to that of the government, his promotion will be affected. Many listed companies always try to get local independent directors. (CM7) … the government favors locals to do this job. Strangers could cause more troubles … they want locals with better social connections … (Consequently) some retired government officials have been introduced into boards. (ID4) Many university professors have good relationship with local government officials. As a result, they have more chances to be appointed as an independent director; they also are more likely subject to government influence. (ID6)

7.2.1.3. Guanxi The vast majority of interviewees admitted that guanxi plays an important role because the most popular way to approach an independent director is by recommendation. Independent directors take their positions through their direct or indirect connection with listed companies, and “no company looks for an independent director blindly” (ID3). Initially, one independent director indicated little influence of guanxi, suggesting that an independent director is appointed mainly on the basis of his or her personal reputation in a certain field. However, upon probing in depth his response still implied the pervasiveness of guanxi: “Companies need to find a financial expert … You are in this circle where everyone

172

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

knows each other. You have been working (in this circle) so many years. Your students you ever taught might recommend you” (ID1). The significant influence of guanxi is likely to cause independence issues. Chinese culture emphasizes harmony and mutual benefits. Hence, maintaining good relationships with referees and showing support to them (or the persons connected to them) come to have the status of rules that independent directors have to keep in mind to survive in China’s business environment. This point was implicit or explicit in a number of interviewees’ elaborations. One listed company approached me through one of my classmates. I knew what this company had done because I have analyzed it in my case study. I told my classmate, look, you want me to do it, probably I need to say something (if anything comes to my attention). I don’t want to destroy your guanxi. You tell them (the company’s management). If they agree, then I will take this job. (ID3) … it is easy to deal with someone who we are familiar with. The communication cost is low. Appointed through guanxi, he won’t express an opposing opinion … it is better to find someone who is easy to communicate with. (CM3) The way Chinese people look at it, when you drink water you remember the person who dug the well. You recommended me so naturally I have a bias in favor of you. I need to be responsible for you, supporting you as much as possible. (CM4) The relationship between management and independent directors is very much a mutual-beneficial one. Besides they know each other very well. Frankly, I believe many independent directors have to take management’s side when it comes to important issues. (ID7)

On the other hand, guanxi could be used by management to deal with an independent director who expresses a divergent opinion. One interviewee elaborated on this point of view: “… the independent director is referred by a person who has a connection with the company management or controlling shareholder. If management can’t convince the independent director to cooperate, then they will ask the referee to talk to the independent director” (AU3). 7.2.1.4. Dominance of Academics Guanxi partly contributes to the unique phenomenon that academics account for the majority of independent directors. The good networks possessed by such groups as university academics, partners in accounting firms and law firms, and retired government officials, coupled with CSRC requirements regarding knowledge and expertise, make these groups the major source of independent directors in listed companies (see also Kakabadse, Yang, & Sanders, 2010; SZSE, 2008a).

Corporate Governance-Related Financial Reporting Issues in China

173

In accordance with the regulation, independent directors shall be industry specialists or financial experts. Listed companies tend to look for professors at universities and experts in accounting and law firms. (CM3) Most independent directors are professors in economics or business administration major … In 2007 I attended a training course for independent directors. Everyone introduced himself (or herself). Two out of three were finance and law academics, and the majority of them are in finance. (ID2)

A high proportion of university academics causes concerns about independent directors’ ability to discharge their duties properly. A number of interviewees pointed out that independent directors with academic backgrounds usually lack practical knowledge about their companies and industries (see also Kakabadse et al., 2010), and their understanding of the companies’ historical backgrounds is limited. Many listed companies are restructured SOEs. Although such companies are technically independent from their parent group, there are still many connections between listed companies and the parent group as the controlling shareholder. In the absence of sufficient understanding of the historical background it is difficult for independent directors to make informed and appropriate judgments about matters such as related party transactions. Thus, because of a lack of practical knowledge and insufficient understanding of the historical backgrounds of their companies, independent directors are likely to be subject to management’s influence. Independent directors don’t know much about the company … lack a thorough understanding … majority of them are university teachers, (some of them) serving in several companies … Independent directors do not have many ideas about company business growth … They normally listen to executive directors who are apparently more experienced and professional. (CM3) In my view, independent directors should not be too independent … an independent director’s understanding of proposals (to be discussed in board meeting) is not as good as management’s. Particularly, for investment proposals, management’s understanding is better than an independent director’s. For related party transactions, management pay attention to historical issues, because related party transactions in China is closely related to historical factors … an independent director’s understanding is not as deep as management’s, so he (or she) can’t be too independent. (ID4)

7.2.1.5. Minority Status The percentage of independent directors on the boards of directors of Chinese listed companies is relatively low compared to Anglo-American countries. In Anglo-American countries, independent directors often dominate boards, whereas independent directors in China are the minority on

174

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

boards. In accordance with the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies (CSRC, 2001), the regulatory requirement is that independent directors shall account for only one third of board membership. It was found that many companies appoint the bare minimum of independent directors to satisfy this requirement and that their consequent minority status is likely to place independent directors in disadvantaged positions in their work relationships with managers. Normally, the number of independent directors of many listed company just meets the regulatory requirement. Senior managers still account for the majority of the board. (AU5) In boards of directors, independent directors are minority. They may make their voice heard, but it is difficult for them to really make a difference. The decision has been made (before the meeting), they can’t change the result. Anyway it will get through. (AC2)

In summary, superficial understanding of the meaning of independent directors, the influence of controlling shareholders, management and guanxi over the appointment, minority status in the board, and lack of understanding of corporate operation would largely impair independent directors’ bargaining power when confronting management. In its report, the Shengzhen Stock Exchange also points out that independent directors lack independence, and their knowledge of business operations and management is very limited (SZSE, 2008a). Kakabadse et al. (2010) indicate that issues pertaining to the independence and competence of independent directors in China need to be addressed thoroughly. Lack of independence from controlling shareholders and management is likely to cause a power imbalance in the work relationship between managers and independent directors, which is further illustrated in the following discussion.

7.2.2. Other Realities of the Position 7.2.2.1. Managerial Resistance The position of independent director was introduced in China in 2001. However, it was found that some company directors still hold negative attitudes toward this policy. While all interviewees emphasized their unconditional compliance with government requirements, their views suggest managerial resistance, as they have not embraced fully the underlying meaning of those requirements.

Corporate Governance-Related Financial Reporting Issues in China

175

Introducing independent directors is required by CSRC, which is a restriction imposed upon companies … For most listed companies, CSRC wants them to do this, they have to do it. In terms of really achieving the expected purpose, it is not essential. (CM3) I feel independent directors are not well supported by managers. For them, it is government regulation, they have to follow it. In terms of whether we can add value to the company, I believe managers have question mark on it. (ID6)

7.2.2.2. Managerial Capture In order to effectively capture independent directors, controlling shareholders and management tend to manipulate the role of independent directors by blurring their outsider status and by downplaying the value of their monitoring, equating monitoring with confrontation and labeling opposing opinion as lack of team spirit and trouble making. It is unrealistic to expect independent directors to fight against managers … why? They are in a dominant position. Also we come to help, not to confront managers. (ID7) First of all he/she (independent director) is a director. It is unreasonable for a director to act against his/her own company. (CM1) If you don’t have any team spirit and cast a dissenting vote, they don’t want you. They don’t want people who will give them trouble. (ID3)

It is worth noting that casting a dissenting vote, if necessary, is considered to be in the normal course of independent directors discharging their duties in Anglo-American countries, although it may not occur often. However, the elaboration by interviewees suggests that company management in China does not share the same view and is unlikely to tolerate opposing opinions. In addition, company management attempts to create a climate that acknowledges only those independent directors who bring economic benefit to the company. … They (independent directors) do have some value, sometimes they looked at the financial reports and tax liability account, (and asked) why the tax liability increased so much, and if there was any way to reduce tax liability. They then made some suggestions. I think this kind of function is quite good. (CM1)

7.2.2.3. Reluctance to Accept a Monitoring Role In an international context contributing valuable insights to a company’s strategic development is an important part of the role of an independent director. However, given the fact that the Chinese government is mainly concerned about excessive influence of controlling shareholders on listed

176

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

companies, the primary role of independent directors should be monitoring these shareholders. In response to careful probing of the role of independent directors, some of them showed reluctance to view their role as monitoring. The elaboration by interviewees suggests that the tendency of independent directors to avoid confrontation explains the unwillingness. I won’t consider my job as monitoring. I believe it is a guard, guard what? Management might need independent directors to look at the matter from a more neutral and different perspective … relatively fair … not departing too much from the regulation. (ID4) … an independent director is also a director. Independent directors and executive directors should have more communication. We need to make management believe that independent directors are useful … Monitoring creates conflicts … I think we should improve our expertise and knowledge, be able to give them more suggestions, then, our value arises. We are useless if we focus on monitoring. (ID2)

7.2.2.4. Reluctance to Express Opposing Opinions Given the deep involvement of controlling shareholders and management in the appointment of independent directors and independent directors’ tendency to avoid conflict with management, they are unlikely to express opposing opinions. For example, one independent director indicated that independent directors normally agree with controlling shareholders and they are flexible over many issues as long as those issues are not critical and there is no apparently bad effect on minority shareholders. Normally we are flexible over many issues. For us (independent directors), these are not key issues. For example, investment, if it is not an obviously bad decision and you can’t see an apparent impact on minority shareholders. (ID4)

Upon probing in depth, this independent director implied that the voice of independent directors tends to be weak when their opinions differ from those of controlling shareholders, and eventually they tend to accede to proposals made by controlling shareholders and management. I guess the possible conflict lies in mergers and acquisitions. From government’s perspective, they want to sell the government’s assets to the listed company (which constitutes a related party transaction) … you can also accept that, the question is how to determine the price … this is directly related to minority shareholders’ interest … we have differing opinion regarding the pricing … in this situation we will ask many things by which controlling shareholders could be moved slightly … Now what the majority of us (independent directors) have done is just stating our opinion, not necessarily forcing management to modify the proposal … normally the wording tends to be tactful, pointing out our concern over the motion. But eventually we normally just give up (arguing with controlling shareholders and management) and approve the proposal when voting.

Corporate Governance-Related Financial Reporting Issues in China

177

There are simply two considerations. First we hope to make the proposal better (rather than rejecting it). Second to have a record which indicates that I ever expressed my (different) opinion … Anyway we know each other well. Normally we do not oppose management proposals. I believe most independent directors have done their job smartly … (ID4)

This perspective was confirmed by another independent director when the first author probed the scenario of auditor client conflict by hypothetically assuming that the auditor’s view is correct and hence expected to be upheld. His response suggests that independent directors are willing to provide support but that the support tends to be weak: “Basically we are able to support an auditor if the conflict really occurs. Of course, it is a kind of art to express independent opinions” (ID2). Further, it was found that independent directors are generally unwilling to clearly state their standpoint of representing minority interests in the presence of managers. In order to have any influence over managers, independent directors need to show that their concern is for managers’ interests (and/or for corporate economic welfare) rather than for those of minority shareholders. Independent directors’ vague standpoint also suggests the weakness of their position in companies. I am here for you … I will tell the controlling shareholder from his perspective that it is inappropriate to do that … There is no doubt that an independent director is there to protect minority interests. However if the proposal is unfavorable to minority shareholders; and I directly tell the controlling shareholder that you are against the legislation, I will reject the proposal. It will not work. I will tell what he risks by doing this … (ID3)

Gendron and Bedard (2006) find that independent directors’ skills in asking difficult and challenging questions are a central element attributable to audit committee effectiveness. The above quotes clearly indicate that independent directors’ subtle ways of expressing opinions, evidenced by being flexible, tactful, and smart, make acting as an independent director a kind of art. Lack of extensive questioning and frank communication is likely to considerably reduce the effectiveness of independent directors. 7.2.2.5. Downplaying the Toughness of Fulfilling Duties Given the acute conflict of interest between controlling and minority shareholders, it is a challenge for independent directors to properly fulfill their role of protecting minority shareholders. However, it was found that some independent directors tend to downplay the complexity and toughness of the situation.

178

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

… particularly with regard to state-owned companies … chair and CEO of state-owned companies have special statuses (being government official as well). If they (directors and management) do that (inappropriate thing), they will risk personal loss while gaining the benefits that are irrelevant to them, why would they do that? They used to do it just because they did not know the consequences. Now if you tell them, normally they accept it … every aspect (of the company) is being monitored (by various government departments). As long as the independent director isn’t too dumb, he/she must be able to explain the benefits and associated risks of proposals to managers. What bad thing can a company do when so many parties are watching? (ID3)

7.2.2.6. Symbolic Role Independent directors are perceived by the public as “vases” to decorate the board of directors with little substantial role in companies.1 This was a view held by many interviewees. Interestingly, some independent directors with backgrounds in finance see others who lack accounting knowledge in the same light. The value of an independent director seems to be symbolic in terms of signaling the company’s compliance with the regulation. It is rare for an independent director to challenge management’s proposals. A number of interviewees corroborated this perspective. Based on my knowledge, only those independent directors with financial and legal knowledge are able to do their job. Others, entering by guanxi, are just vase and decoration. They did not fulfill their duties properly. (ID1) In China, independent directors are just “vases.” Normally their role is more likely to be symbolic … Before a proposal comes to an independent director for consideration it has already been determined. The remaining stuff is just completing the process (obtaining independent directors’ signatures) … Right from the very start the company never thought to get anything from an independent director. Because from the top down, it is a necessity of the system … it is a necessity of the process. For example, the company should seek an independent director’s opinion on related party transactions which need to be disclosed to the public … but the fact is he/she certainly will agree with it. If they refuse to sign they can’t be an independent director. Independent directors are selected by controlling shareholders, if they challenge controlling shareholders, they will be removed. This has to get to the root of the issue. (AU2)

7.2.2.7. Ensuring the Legitimacy of Company Operations The majority of interviewees indicated that independent directors are not performing as expected. While a number of interviewees believed that independent directors have been somewhat effective, they admitted that the effect is mainly limited to ensuring the legitimacy of company operations. They rarely rejected operational decisions. But they might have some good suggestions about major decisions probably (because) they knew more about external

Corporate Governance-Related Financial Reporting Issues in China

179

environment … Independent directors can improve the legality of decision making. (CM7) Independent directors do not have many ideas about company business growth, but in relation to risk management, they need to give opinion on major events which restrain controlling shareholders from doing something illegal or not in line with administrative rules and regulations. They could do something in this regard. (CM3)

Ensuring the legitimacy of company operations does not necessarily mean that independent directors have fulfilled their responsibility for preventing controlling shareholders and management from infringing on minority interests. There are two possible interpretations of this situation. First, the legitimacy of company operations is secured by introducing independent directors in accordance with relevant regulations. Second, ensuring companies’ compliance with law and regulations in legal form becomes the primary objective of independent directors instead of substantially protecting minority interests. Independent directors act more as legal consultants than as monitors, which is consistent with the reluctance of independent directors in acknowledging their monitoring role. In summary, the findings indicate that at present independent directors are not functioning as intended. Managers still hold negative attitude toward this governance mechanism and effectively capture independent directors by downplaying the monitoring role and creating a climate that discourages dissenting opinion. Because of the power dependence in the work relationship, independent directors are reluctant to accept their monitoring role and to express opposing opinions. Their primary objective is ensuring a company’s compliance with laws and regulations instead of upholding minority interests. Therefore, at present the function of independent directors is largely ceremonial in nature. These findings are largely consistent with those of other studies. For example, Tenev et al. (2002) document that in China only 3.1% of independent directors were perceived to have any real degree of independence, compared to 62% in the United States and 34% in the United Kingdom. Further, Yuan (2007) reports that 2% of independent directors admitted they were “decorative directors,” 39% considered their role as consultants, and only 37% regarded themselves as monitors of management behavior. Furthermore, a survey conducted by China Securities Daily reveals that 65% of independent directors never said “no” in board meetings and all of them admitted that they sometimes voted “yes” even though they should have voted “no” on the basis of their knowledge and the merits of the proposals (China Securities Daily, 2005).

180

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

In China independent directors must constitute majorities on audit committees (CSRC, 2002), and most independent directors serve on those committees. The functioning of independent directors acting as audit committee members is discussed further in the next section.

7.3. AUDIT COMMITTEES In accordance with the Code of Corporate Governance for Listed Companies in China, audit committee duties include recommending the engagement or replacement of the company’s external auditing institutions, reviewing the internal audit system and its execution, overseeing the interaction between the company’s internal and external auditing institutions, and monitoring the company’s internal control system (CSRC, 2002). However, a number of interviewees pointed out that audit committees generally lack authority, and the role of audit committees is largely ritualistic. The major themes emerging from the data analysis in regard to the role of audit committees include limited involvement in selecting external auditors, insufficient interaction with external auditors, coalition with management against external auditors, and insufficient interaction with internal auditors.

7.3.1. Involvement in Selecting External Auditors A number of interviewees suggested that it is controlling shareholders and management, rather than audit committees, who effectively determine the selection of external auditors. I believe the controlling shareholders have a big influence in determining who will be the auditor because they control considerable voting power. Also the chair of the board is appointed by the controlling shareholder (which increases controlling shareholder’s influence). (AU1) Although the audit committee has this function, it is still management who recommends an external auditor. Normally the audit committee would agree to engage the auditor who had been recommended if there was no particular problem. Audit committees do not find an external auditor independently. (ID1) I definitely believe independent directors do not have influence, and neither do audit committees. Unless that audit institute is very bad, normally as long as management

Corporate Governance-Related Financial Reporting Issues in China

181

made the recommendation and gave its reasons, the audit committee won’t argue about it. (ID4) Usually, audit firms will approach managers or controlling shareholders. If they had decided to hire one particular firm, we are ok with that as long as all rules and regulations have been followed. (ID7)

These findings are consistent with those of existing studies in China. For example, Lin et al. (2008) report that audit committees in Chinese listed companies are rarely involved in decisions to appoint auditors or determine audit fees. In contrast, in US listed companies audit committees are found to be very active in selecting a new engagement partner to replace one who rotates off the engagement (Beasley et al., 2009). Nevertheless, many interviewees pointed out that the fact of external auditors preexisting independent directors and audit committees is one reason that there is little scope for an audit committee to exercise its function of selecting an auditor. Introducing independent directors is a relatively new regulatory requirement that came about in 2001 and applies to listed companies only. Engaging an auditor normally occurs at the preparation stage of an IPO when the company has not yet appointed any independent director. For various reasons it is rare for independent directors and audit committees to replace an existing auditor after they join the company. The company has already chosen the auditor … before the IPO, before independent directors joined the board. Only after the IPO were independent directors introduced. It is impossible to fire the old auditor and employ a new one. (ID1) When we took over and established the audit committee, the auditor was already there … Normally the audit committee won’t fire the old one and get a new one. Otherwise, others might think that we gain some benefit from this. (ID3)

7.3.2. Interaction with External Auditors Interviewees indicated that interaction among audit committees and external auditors is insufficient. They revealed several issues in this regard. First, formal communication between auditor and auditor committee is a new requirement that came into effect in 2008.2 Both parties lack experience conducting meaningful communication. Second, as indicated in the previous section, independent directors lack practical knowledge, which prohibits them from overseeing the audit process. Although audit committees have been accorded responsibilities for auditing-related affairs, they are perceived to lack the power and authority needed to fulfill the duty.

182

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

Communication between auditors and audit committees tends to be artificial, which results in a rubber-stamping role of audit committees. A number of interviewees expounded on these issues: Since last year, audit firms and audit committees have started to communicate … Chinese auditors are not experienced in communicating with independent directors and audit committees. The communication exists formally, but is insufficient … (ID4) If we have a disagreement with the CFO we will go to the boss (CEO). Up until recently, we, as the auditors, did not have any connection with the audit committee. Since last year, the Shenzhen Stock Exchange required that auditors communicate with audit committees at three stages, i.e. at the beginning, middle and completion of the annual audit and that audit committees must sign on the record. Audit committees are easy to deal with. Sometimes we did communicate. If not, we just ask them to add their signatures. And our communication with audit committees is not open and complete. What we communicate to them is the outcome, not the process … basically we only show audit committees what can be disclosed … Some independent directors teach accounting at university. There are two types of university lecturers, some may know a little about auditing, others don’t understand auditing although they are in the accounting field. Because of lack of practical experience, they don’t talk much. (AU2) In Chinese listed companies, audit committees do not have a substantial role … They do not have real power and authority to discharge their duties. (AU3)

Prior research also documents audit committees’ lack of interaction with external auditors. For example, Lin et al. (2008) indicate that audit committees in Chinese listed companies have little interaction with external auditors, and most audit committees held no or few meetings with a very short meeting duration. In contrast, in the United States it has been found that the external auditor is heavily involved in audit committee meetings. In addition, there is often significant contact between the audit committee chair and the external auditor outside of meetings (Beasley et al., 2009). It is clear that, compared to their counterparts in Anglo-American countries, audit committees in China have much less interaction with external auditors.

7.3.3. Coalition with Management against External Auditors The tendency of management and audit committees to form coalitions against external auditors was indicated in the interviews, providing additional evidence supporting the managerial capture discussed above. When conflict between auditor and client arises, a number of interviewees admitted that the audit committee is likely to take the side of the company

Corporate Governance-Related Financial Reporting Issues in China

183

and convince the auditor to cooperate with management. Acting in line with management’s views is in the best interest of independent directors themselves given their vulnerable position in the company. Two auditors corroborated this perspective: After all, they (audit committees) have close relationship with company management. There are interests involved … convincing the auditor is still very common. (AU3) It is difficult for auditors to obtain support from the audit committee … many reasons for that, such as the committee members do not really know what is going on … more importantly, audit committees tend to back the management in the first place. (AU4)

In order to justify the support to the company, one company director and one independent director alleged that auditors’ excessive conservativeness and overreacting should be blamed for losing support from audit committees. Normally they (the audit committee) stand on the side of the company. For example, since the adoption of new accounting standards, company management and the auditor have had some disagreements with regard to professional judgment. In cases where there is no clear-cut solution, they support the company. On the other hand, I think auditors are too conservative. (CM7) The fact is that there are issues with auditors as well. In order to avoid any responsibility, they overreact … it is not good for the company … if company management can’t convince them, the audit committee can communicate with them. (ID3)

One company director insisted that his company’s audit committee acted on the basis of accounting standards. However, his elaboration implied the audit committee’s propensity to support management. It is not always the case that the audit committee stands on management’s side. For example, in our company, I believe that the audit committee made a judgment based on accounting standards. There are two issues here. First, the auditor’s understanding of accounting standards is not necessarily correct. Second, there are certain grey areas in accounting standards which allow for different explanations. Our audit committee always states that if the regulation clearly prohibits a particular accounting treatment, then we follow the regulation. In the absence of regulatory restriction, the auditor should accommodate company’s requirement … Audit committee members also sit in the board. They represent the company. Convincing the auditor essentially indicates the correctness of company management and the board. (CM2)

Coffee (2006) indicates that, in concentrated ownership settings in which the controlling shareholder controls the board, it is difficult to restructure the relationship among management, external auditor, and audit committee to ensure proper functioning of the audit committee in upholding auditor independence. Given the highly concentrated ownership in Chinese listed

184

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

companies, audit committees are likely to be subject to the influence of controlling shareholders and management. Whether the opinion of the auditor or that of management should be upheld is determined case by case. However, the view shared by audit committee members and management suggests that they tend to believe that the audit committee should support management under the name of company interests, thus casting doubt on the audit committee’s oversight role.

7.3.4. Interaction with Internal Auditors A strong relationship between internal auditors and audit committees benefits both parties (Beasley et al., 2009; Turley & Zaman, 2007). However, it was found that there is a substantial lack of interaction between internal auditors and audit committees. Two factors are likely to contribute to that, namely, a largely neglected internal audit function and underdeveloped internal control systems in companies. Originally internal auditing is charged by the party committee and the discipline committee in the company. And in China, internal auditing is not really emphasized … internal control policies can’t be implemented effectively. Normally people think it is sufficient for a company to have a finance department and external auditing. Internal auditing doesn’t get sufficient attention … without functional internal auditing, it is difficult for an audit committee to do something. (CM7) … In Chinese listed companies, there is basically no communication between internal auditors and audit committees … The lack of communication is directly attributable to the absence of internal controls in Chinese companies. Internal audit is normally related to internal control. In developed countries, internal audit departments have an important role in implementing company’s internal controls which are also the focus of audit committees. So in these countries audit committees have much communication with internal auditors. In China, basically there is no attention to internal controls … Because of the lack of internal control systems in companies, there is no much work relationship between internal auditors and audit committees … normally the communication occurs between audit committees and board secretary offices. Financial departments and internal auditing departments have little communication with audit committees. (ID4)

The above quotes indicate that the internal audit has been long neglected in China and that audit committees are unable to deploy the internal audit in fulfilling their oversight role. In contrast, audit committees’ emphasis on internal audit functions is well documented in the international literature because internal auditors are perceived to be a major source of comfort to audit committees because of their unique knowledge of companies (Sarens,

Corporate Governance-Related Financial Reporting Issues in China

185

De Beelde, & Everaert, 2009). For example, Beasley et al. (2009) find that in the United States, following the introduction of the Sarbanes Oxley Act in 2002, public companies’ audit committees typically meet frequently with internal auditors and are often involved in internal auditor hiring, compensation, and budget decisions with regard to the internal audit. The quotes also indicate that Chinese companies have not fully recognized the importance of internal control systems. The concept of internal control in China is still in its embryonic stage, and enterprises’ internal control systems are largely underdeveloped. Most enterprises in China have not yet accomplished the building up of an effective internal control mechanism (Liu, 2005). The Chinese government has announced the Basic Standard for Enterprise Internal Control, with which listed Chinese companies were initially required to comply from July 2009.3 The effective date for this requirement was postponed to January 2012, suggesting challenges in implementing comprehensive internal control requirements. The existing literature documents that the effectiveness of the audit committee is essentially determined by the interaction between the audit committee, internal auditor, and external auditor through both formal and informal structures and processes (Beasley et al., 2009; Gendron & Bedard, 2006; Turley & Zaman, 2007). The lack of communication between audit committees and internal and external auditors in both formal and informal manners, coupled with little involvement in selecting external auditors and a propensity for supporting management in auditor client conflicts, is likely to impair the effectiveness of audit committees in Chinese listed companies. The findings are largely consistent with existing studies. For example, the Shenzhen Stock Exchange reports that audit committees’ involvement in corporate decision making is low, and only one company’s audit committee issued two negative opinions (SZSE, 2008a). Lin et al. (2008) indicate that while audit committees have a ceremonial role in terms of lifting the image of good corporate governance, they lack substantial roles, such as enhancing audit quality, reducing a company’s illegal acts or irregularities, and preventing fraudulent financial reports.4 In summary, audit committees in Chinese listed companies are not functioning effectively, and actual audit committee operations are far below the standards in Anglo-American countries (see also Lin et al., 2008). They are rarely involved in selecting external auditors. Their communication with external auditors tends to be superficial. They are inclined to support management in the event of a conflict between the auditor and the company. Also, they are perceived to lack authority and unable to deploy an internal

186

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

audit in fulfilling the oversight role. Thus, the audit committee is likely to be a ceremonial decoration rather than an effective oversight function for corporate governance. The establishment of an audit committee in most Chinese listed companies mainly reflects the response to the regulatory requirement and serves merely to create an image of good corporate governance.

7.4. AUDITOR INDEPENDENCE 7.4.1. Factors Affecting Auditor Independence 7.4.1.1. Government Influence The government can have influence over the appointment of an auditor, although the traditional association between the government and audit practitioners was officially severed in the 1990s. The intervention takes different forms, including administrative rules and recommendation concerning the selection of audit institution. For state-owned enterprises, the State-owned Assets Supervisions and Administration Commission requires that listed state-owned companies should engage the auditor who has been engaged by the controlling shareholder (i.e., parent company), that is, the same audit firm for the entire group. (ID4) Government departments make recommendations. Sometimes if the government believes a particular firm provides good quality service, or because of long-term relationship between the government and a particular audit firm, that firm could be recommended to other companies. (AU1)

The government’s influence over auditor appointments is also documented by the existing literature. For example, Lin and Fraser (2008) find that, in addition to normal factors such as changes in management or operations, influences from government agencies have an impact on the difficulty of assessing risk in an audit engagement in China. In addition, the unique tax practices in China could also affect auditor independence. Each year, local tax offices need to complete a certain amount of tax collection that has been prespecified by higher level tax offices. In order to achieve a desirable amount of tax collection, tax offices tend to influence the timing and amount of tax liability that essentially reflect the outcome of the negotiation between tax officers and enterprise management.

Corporate Governance-Related Financial Reporting Issues in China

187

They (tax officers) will tighten it up if they can’t complete the assigned tax collection task … They will relax it in case where they have already got their job done. Every year tax offices are given heavy collection task (by the higher level authorities). It increases each year. Where to get it? Enterprises. … They negotiate with the enterprise managers with regard to how much tax they have to pay. (CD3) Listed companies are under government pressure. There are several situations … one situation is about tax offices. All tax offices have a certain task each year. If the task for the whole year has been accomplished early, say, in November, they (tax officers) tell companies not to issue invoice,5 because if actual tax collection this year exceeds the prescribed amount, the task for next year will increase. This apparently affects listed companies, which are not allowed to issue invoices. That means the company can’t recognize sales revenue. Thus, the reported profit is lower than it actually should be. (CD1)

The above quotes present typical examples that illustrate how taxation affects financial accounting in China. One could argue that the unique tax practices lead a company to breach accounting standards. However, the practices are so prevalent that they have been taken for granted. When this situation is confronted by auditors, they are likely to look the other way. A company director further made comments on this: “… every company faces these situations. That is not caused by company themselves. Auditors fully understand this …” (CD1). 7.4.1.2. Guanxi Guanxi is identified by a number of interviewees as an important factor influencing a company’s decision of selecting an auditor. It is worth noting that guanxi often intertwines with government intervention, as discussed in Chapter 6. Guanxi must be involved in obtaining an audit engagement … In addition to guanxi, the quality and reputation of an accounting firm will also be taken into account. (ID2) … the State-owned Assets Supervisions and Administration Commission issued a document, requiring a five-year rotation (within state-owned enterprises) … several central state owned companies took advantage of this opportunity to remove us (to engage other auditors who had much closer relationship with them) … depends on who has a connection with government. (AU2) I should say basically the link between government and auditing firms has been cut off. It was a successful restructure. There is no longer business relationship. However, due to the historical factor,6 many firm managers have some government connection, which gives them an advantage in obtaining business. (CM4)

A number of interviewees pointed out that tenders are gaining in popularity in state-owned companies. However, even in the case in which a listed

188

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

company does invite bids, guanxi is still significant in the process. First, guanxi is important to ensure that an accounting firm becomes a candidate for bidding. Further, guanxi is still critical in determining final outcomes. One interviewee elaborated on this point of view: … one large central government controlled company wanted four audit firms. They invited bidders on a 3:1 basis (three bidders compete for one project or one client) … auditors who were not familiar with the company, or with State-owned Assets Supervision and Administration Commission, had no chance of being invited … on that day we saw other auditor firms who came to bid as well. Because we were in the same circle, we knew each other. We found they already knew the evaluation criteria, which had not been disclosed in the invitation letter of bidding, because of their guanxi with the government authority. Also the assessment is very subjective … Now we won’t go for any bid invited by centrally controlled enterprises. We know we cannot win such a bid. Other competitors have better relationships with government authorities … Currently in the auditing industry there are lots of complaints about bidding, particularly bids invited by State-owned Assets Supervision and Administration Commission. This (unfair) situation also arises in bids organized by local State-owned Assets Supervision and Administration Commission. (AU3)

The above quotes indicate that the government still intervenes in the audit services market and that guanxi plays an important role in selecting auditors. Auditors who have good connections with government officials, controlling shareholders, and managers are likely to be in an advantaged position in the audit services market. 7.4.1.3. Competitive Audit Services Market While providing nonaudit services is a major concern in Anglo-American countries, it does not seem to be a major issue in China. One interviewee pointed out that “in China, there is not much nonaudit service” (ID1). His view is confirmed by the CICPA 2010 Top 100 Accounting Firms Assessment Report. The report reveals that nonaudit service fees account for only 18% of the total revenue of the top 100 accounting firms (CICPA, 2010a).7 Recall in Chapter 6 it was highlighted that the audit services market in China is highly competitive. In the competitive market auditors are likely to compromise independence because they tend to avoid issuing qualified opinions to retain clients and to reduce audit fees to compete for clients. Strong competition in China may cause threats to auditor independence. They have to reduce the audit fee, or are likely to compromise when negotiating with clients. (AC4) If the auditor gave qualified opinion frequently (i.e., acting independently), other companies would be scared (and walk away from the auditor). (ID4)

Corporate Governance-Related Financial Reporting Issues in China

189

These findings are consistent with the existing literature. For example, Chen et al. (2007) argue that the buyer’s market in China is likely to impose pressure on auditors to compromise their independence and to accord clients more bargaining power. Within highly competitive environments, Chinese auditors are more likely to accede to their clients in an auditor client conflict than are their UK counterparts (Lin & Fraser, 2008). 7.4.1.4. CSRC’s High Level of Skepticism As discussed in Chapter 6, market regulators maintain a high level of skepticism toward listed companies. One listed company director described that “regulatory bodies consider listed companies as mice and they are cats” (CM1). In order to protect auditor independence, the CSRC requires that a listed company explain its reasons for replacing an existing auditor. In addition, there is no regulatory requirement for mandatory auditor rotation in China (Lin & Fraser, 2008).8 These factors collectively result in the unique phenomenon that replacing an auditor is interpreted as a bad signal by the capital market. Consequently, listed companies are unwilling to change an auditor, which partly causes a long-term relationship between companies and auditors. The replacement of an auditor itself sends some messages. If one company changes its auditor suddenly, the public might believe something has gone wrong in the company, sending a bad message. (ID2) You can see in China’s listed companies, the auditing institutions are relatively stable. It is rare to change auditors frequently. If you do change, regulatory bodies place you under observation immediately, and ask the reason for the change … (CM1) It is rare to change the external auditing institution … Some accounting firms have been working for the same clients for more than ten years. (ID1)

7.4.1.5. Provision of Advice and Assistance on Financial Reporting Matters An auditor’s provision of advice on financial reporting matters may cause threats to auditor independence. While auditors are allowed to provide advice to clients on relevant financial reporting matters,9 certain types of service may cause a self-review threat.10 In China, the newly developed Code of Ethics for Chinese CPAs was issued in February 2010 (CICPA, 2010b). According to Article 112, No. 4 (Independence Requirement for Audit and Review), to assess the existence and extent of a self-review threat, among other things, three factors should be taken into account, namely, the materiality of valuation to the financial statement, the degree of the client’s involvement in determining and approving the valuation

190

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

method and other important judgments, and the degree of subjectivity associated with the valuation. The interviewees’ elaborations suggest that a self-review threat is likely to be created because of clients’ heavy dependence on their auditors in determining accounting treatments. In China, the auditor’s advice could be very specific in terms of making adjusting entries, impairment tests, fair value determinations, etc. Because of the close relationship between auditors and clients, auditors offer this kind of assistance very often … In China, it is not enough that you just explain accounting standards, you have to give specific advice on how the accounting standard is applied to the client’s situation. If we don’t give the advice, they don’t know how to determine the accounting treatment, and may also consider us unfriendly and unhelpful. (AU5) I don’t have much argument with my auditor, because in daily operations I consult my auditor if I have any problems. We communicate a lot with our auditor. They have been our auditor for many years. Once I face any problem, I always ask for their advice about how to deal with those issues. (CM3)

The above quotes indicate that the advice provided by auditors in China is likely to create independence threats. The discussion in Chapter 6 suggests that Chinese information preparers’ level of professionalism is low and they are reluctant to make professional judgments. Where their skills and knowledge are limited in applying new accounting standards, they are likely to approach the auditor for advice. The possible outcome of this is that the auditor makes a considerable contribution to determining accounting treatment, which may amount to a management decision. In addition, the close relationship suggested by the above quotes also implies that auditors encounter pressure to frequently provide specific advice to their clients. As a result, while the dialogue between auditors and clients might promote the fair presentation of financial statements, clients’ overreliance on their auditors is likely to cause auditor independence issues. In summary, auditor independence in China is largely shaped by such factors as government influence, guanxi, fierce competition in the audit services market, the CSRC’s high level of skepticism, and provision of advice and assistance on financial reporting matters. These factors are unique to China. The findings provide support to the notion that the meaning and operation of auditor independence is largely influenced by local historical and cultural context (e.g., Hudaib & Haniffa, 2009; MacLullich & Sucher, 2005; Sucher & Kosmala-MacLullich, 2004). 7.4.2. Perceived Improvement Despite the range of issues that could impair auditor independence discussed above, auditor independence is perceived to have improved

Corporate Governance-Related Financial Reporting Issues in China

191

considerably over the past three decades. Institutional theorists accept that institutional fields may have multiple pressures providing inconsistent cues or signals, opening up the possibility for idiosyncratic interpretation (Oliver, 1991; Scott, 2008). While factors such as guanxi and the competitive audit market may indicate the likelihood that auditors compromise their independence, the improvement achieved in the institutional environment is expected to enhance auditor independence and remedy the inequalities in dependence. The majority of interviewees agreed that auditor independence has improved significantly over the past decades and that auditing can add credibility to financial reporting. I feel auditor independence is much better than before. I have been in this industry more than ten years, and I find IPO audit quality has been improved considerably, probably because the capital market was not closely monitored before … now the market regulation has been considerably strengthened. For example, the IPO application is a real and substantial check by CSRC. If you fake too much, they will find out, you can’t get through … before, there were little rules and we didn’t know how to do our job. Now many rules have been made and we have also learned what to do. (AU2) Definitely auditing is important for financial reporting, because accounting regulation has improved a lot. China’s accounting practices are converging towards international practices. Chinese accounting professionals have also improved their skill and knowledge. (CM3) They (auditors) won’t compromise on major issues although they have flexibility on trivial matters. Now the monitoring agencies impose greater penalties, which has big effects on auditors’ career. (CM4)

The above quotes indicate that the improved regulatory environment has considerably contributed to enhanced auditor independence and that the value of auditing is increasingly acknowledged in China. This view is consistent with extant literature that has documented improvement in the institutional environment in the past two decades and its positive impact on auditor independence. For example, Chen (2003) states that the regulatory enforcement and litigation risk faced by Chinese auditors was relatively low in the 1990s but that the Chinese government has taken steps to improve the institutional environment of the stock market since 1996. These steps include the disaffiliation program; the development of accounting and auditing standards; and legislative measures, such as allowing investors to initiate private securities cases under the revised Securities Law. The improvement in the institutional environment largely drives the increase in auditor independence. Among other things, researchers have found that implementing the new auditing standards in 1995 (DeFond et al., 1999) and the auditor disaffiliation program from 1997 to 1998 (Gul

192

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

et al., 2009; Yang et al., 2001) have had a positive effect on auditor independence. Lin and Chen (2004) indicate that the role and benefits of independent audits have been positively recognized by Chinese audit beneficiaries and auditors and that there are increasing demands for audit services. Audit information is valued by the capital market in China, and large auditing firms have been able to product-differentiate themselves within the Chinese stock market (Lin & Liu, 2009). In summary, despite a range of issues that could impair auditor independence in China, such as government influence, guanxi, and fierce competition in the audit services market, auditor independence has been enhanced considerably over recent decades largely because of the improved regulatory environment.

7.5. CORPORATE CODE OF CONDUCT In modern enterprises, a corporate code of conduct is considered to be an important mechanism for encouraging ethical behavior. Most interviewees indicated that usually listed companies have a corporate code of conduct. Upon further probing, it was found that those codes mainly concern disciplinary measures and administrative rules instead of broad ethical issues. This was explicit or implicit in a number of interviewees’ responses: All new employees will get a booklet about employee behavior, it is basically about the penalties for breaching company rules and the rewards for complying with them. (AU3) They are more about discipline and rules, not much about ethical issues … Normally listed companies have this document and new employees are required to study it. (CM3) We have a code of conduct for employees … it states basic rules, a series of policies … all new employees must study company’s rules and policies … If they don’t study company policies, they will suffer loss (of being penalized) … no rules means no efficiency. (CM1)

The researcher found difficulties in communicating the meaning of corporate code of conduct. A possible explanation for this is that these companies do not have a corporate code of conduct that has the same meaning as in Anglo-American countries. The interviewees simply equated the disciplinary measures and administrative rules to the corporate code of conduct. In order to clarify this issue, the researcher requested copies of the corporate codes of conduct from the interviewees and subsequently searched for

Corporate Governance-Related Financial Reporting Issues in China

193

relevant material on the websites of the participants’ companies but was unable to find any formal document guiding ethical behavior. However, the researcher did find some content relevant to ethics presented in the form of poetry or slogans. When discussing the effectiveness of the corporate code of conduct in improving employee ethical behavior, a mixed response was received. Some interviewees believed that there is some sort of effect. Some indicated that the effect varies from company to company. However, a number of interviewees doubted that any effect could flow from the existence of such a code. Every company is different. Some companies treat it as an important part of corporate culture and it works. But in other companies, it is just a matter of form. It really depends on corporate culture. (CM3) If the code is in relation to ethics, I believe it is more likely to be merely a decoration for the company. (ID4) In most companies, the code is primarily for showing to other parties, it doesn’t have much real effect. (AU2)

In China, little research effort has been directed to studying the impact of a corporate code of conduct. Further, there is no regulatory requirement for a listed company to establish a corporate code of conduct. The Code of Corporate Governance for Listed Companies in China does not explicitly state ethical requirements of the board, management, and employees, nor does it require the establishment of a corporate code of conduct. In summary, it seems that corporate codes of conduct and related ethical issues have not received adequate attention in China. Three factors account for this lack of focus on ethical issues, namely, interviewees’ tendency to equate disciplinary measures to a corporate code of conduct, the absence of an ethical component in the Code of Corporate Governance for Listed Companies in China, and the paucity of research in this regard.

7.6. ADOPTION OF IFRS 7.6.1. Professional Judgment While there are some restrictions imposed on the use of fair value in new Chinese accounting standards, as discussed in Chapter 3, it is reasonably

194

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

expected that the adoption of IFRS in China would result in a considerable increase in the use of fair value and professional judgment in accounting practices. However, it was found that Chinese managers and accountants are reluctant to exercise professional judgment and that historical cost is still favored by most listed companies where both historical cost and fair value are allowed by the new accounting standards, suggesting difficulties in promoting professional judgment in China’s context.11 After the accounting system has been changed, they (listed companies) still use conservative methods. For example, there are two measurement methods available for investment property, but the majority of listed companies are still using historical cost rather than market price … (AC3) Today company accountants’ skills and knowledge have improved a lot, but their professional judgment hasn’t. They may not exercise judgment at all, although it is required by the new accounting standards. For example, some particular situations arise, which may indicate that assets have been impaired, but they (accountants) rarely make professional judgments in these circumstances … they don’t think it is a problem. But from an auditing perspective, the decline in value might cause a going concern issue. Then we (as auditors) question the accountants and they will give us relevant information and ask for our suggestions, but normally they don’t actively make judgments. (AU1) After new accounting standards were released, some persons predicted that there would be big changes in accounting reports due to judgments about fair value. I said no big change would happen. The subsequent facts proved my prediction. Because professional judgment is a difficult job, the majority accountants are quite conservative, avoid using judgment, still use historical cost … You have to accept responsibility if you make a mistake in exercising judgment about fair value, but if you get it right, nobody will appreciate you. (ID2)

One company manager insisted that Chinese accountants have sufficient technical knowledge to exercise professional judgment, but he admitted the limitations imposed by China’s immature market. I don’t think professional judgment is big problem, my friends and other CPAs working in listed companies think the same. Particularly the young generation is more capable of learning new knowledge. Of course, there are some practical issues; it is difficult to determine fair value for particular types of assets. For example, in an active market, the price of a house can be determined by comparing a similar house in a similar area. For a factory building, or a warehouse, in rural areas, the price is difficult to determine … in China, such markets as the finance market, capital market, and property market are underdeveloped, so there are many difficulties in determining fair value. (CM6)

Ren (2009) argues that the spirit of “professional autonomy” is not necessarily encouraged by the existing institutional structure in China.

Corporate Governance-Related Financial Reporting Issues in China

195

As indicated in Chapter 6, company managers and accountants in China exhibit a low level of professionalism. Further, the use of fair value is considerably constrained in the new Chinese GAAP, suggesting Chinese regulators’ caution regarding the fair value approach, which is likely to discourage the exercise of professional judgment in practice.

7.6.2. Improvement in Financial Reporting Regardless of the issues discussed above, the majority of interviewees believed that financial reporting quality, including disclosure and transparency, has improved considerably. Strengthened rules and regulations were identified as the major factor contributing to the improvement. In particular, increased disclosure requirements, enhanced auditing regulation, the growing accounting profession, and direct involvement of independent directors in areas such as related party transactions were well acknowledged. … after all, for so many years the CSRC, including its local offices, has been checking the auditing quality of listed companies. Since the Yinguangxia Scandal several years ago, the CSRC, the CICPA and the MOF have been emphasizing the auditing quality of listed companies … the improvement of financial reporting quality is also related to the transformation of accounting standards. For example, new accounting standards require more mandatory information disclosure … In addition, auditing standards have also been updated. The new auditing standards have improved auditing procedures and risk evaluation … (AU3) Certainly the financial reporting quality is improving gradually, more information is being disclosed, there are more severe penalties; the legal system has been improved; the accounting profession is getting bigger, and professional training and incoming foreign-owned enterprises have all helped to improve financial reporting quality. (CM4) Disclosure of related party transaction has been improved in the last two years. Following relevant regulations, independent directors must issue independent opinions, then the company needs to make full disclosure about the price, etc. (ID1)

The extant literature documents the value of independent directors in helping constrain management’s opportunistic behavior in terms of related party transactions. For example, with a focus on related party sales transactions, Lo et al. (2010) find that firms with a board that has a higher percentage of independent directors are less likely to engage in transfer pricing manipulations.

196

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

7.6.3. Increasing Acceptance of International Accounting Practice Many interviewees indicated that moving toward international accounting standards is appropriate although there are concerns that the adoption of new accounting standards could lead to increases in accounting manipulation: You can’t discount international accounting standards just because of the concerns of accounting manipulation. I believe the new standards can improve disclosure and are more likely to achieve accounting objective of providing useful information for decision making … we are directly involved in business and accounting practices (so we understand the reality). I believe that the new accounting standards are more in line with economic events, economic regulation and public demands … (AU2) Converging with international accounting standards is necessary; we can’t still stay with old rigid rules. In terms of fair value, people might be concerned about manipulation. I don’t think the use of fair value is the main cause for accounting manipulation. There are lots of other areas in which people can do earnings management, such as provision and income recognition … to solve these issues corporate governance should be strengthened rather than fair value discarded. (AU3)

In summary, while China is moving toward internationally acceptable practices at the technical level, the changes at the institutional level have been largely superficial. IFRS has been implemented in a market that is still governed mainly by regulators rather than by market mechanisms (see also Ding & Su, 2008). Specifically, Chinese markets are relatively unsophisticated, and Chinese regulators are cautious regarding the use of fair value. It was found that Chinese managers and accountants are reluctant to exercise professional judgment. The mismatch between the imported IFRS and the Chinese institutional environment is likely to continue in the foreseeable future. Further, financial reporting quality, including disclosure and transparency, has improved considerably, which is largely attributable to strengthened rules and regulations rather than to the adoption of IFRS. Nevertheless, the internationally acceptable accounting standards are increasingly appreciated in China despite a range of issues involved currently.

7.7. MEASURES FOR IMPROVEMENT Given the considerable gaps between China and Anglo-American countries in the areas of institutional environments and corporate governance and

Corporate Governance-Related Financial Reporting Issues in China

197

financial reporting practices, it is unwise to expect the imported practices to function well without any problems. Nevertheless, China has made significant institutional improvements in the three-decade transition process from a planned economy to a market economy. The internationally acceptablecorporate governance and financial reporting practices are increasingly acknowledged and embraced by Chinese regulators, academics, firm management, professional practitioners, shareholders, creditors, market analysts, and the public as a whole. Independent audit sets a good example in this regard. Thus, it can be reasonably expected that Anglo-American ideas will play an increasingly important role in China and that the Chinese accounting profession will eventually speak “a global language understandable to external parties” (Ding & Su, 2008). One broad implication emerging from this study is that improving institutions is an effective way to enhance the successful adoption of AngloAmerican corporate governance and financial reporting in China. This view is consistent with the existing literature. For example, Wang et al. (2008) find that in regions with more developed institutions, SOEs have less of a tendency to hire small auditors within the same region. Local auditors in institutionally weak regions are more likely to issue unqualified opinions to listed companies controlled by local governments than their counterparts in institutionally strong regions (Chan, Lin, & Wong, 2010). The varying institutional influences across regions were also elaborated on by a number of interviewees. They indicated that government officials in less developed regions are more likely to influence independent directors than their counterparts in developed regions, suggesting the important role of institutional development in constraining government intervention. In my personal experience, there might be little influence being exerted in Guangzhou (with regard to the appointment of independent directors). But in lower level cities and counties (less developed regions), I believe it must happen. (ID4) Particularly in underdeveloped regions … listed companies are more closely linked to the officials’ achievements and advancements in their political careers. In these circumstances the independence of independent directors is likely to be affected by government pressure. (AC1) In less developed regions, independent directors are more likely subject to government influence because in such regions there are only a few listed companies and government finance heavily relies on them. (ID6)

Additionally, although the gap between imported practices and the institutional environment is examined from political, economic, cultural, and legal perspectives, it is unwise to expect significant changes in the political

198

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

system (e.g., government intervention and control), the economic structure (e.g., concentrated ownership), and the value system (e.g., the influence of guanxi). Thus, in the short term, a relatively effective way is to improve laws and regulations. A number of interviewees corroborated this viewpoint: The improvement of business ethics needs support from the external environment. The key is the legal environment. Only when the legal environment gets improved will we see some improvement in the business environment … China is in a rapid transition. The old moral system has broken down and a new one has not yet been set up. Meanwhile, people get lost. Just relying upon values and beliefs is unreal and impractical … (CM5) Education doesn’t work, only punishment does … punishment doesn’t necessarily mean fines, I am talking about punishment from the legal perspective. (ID3) Government needs to strengthen regulations so as to hold people accountable for their wrongdoings. We are not short of intelligent people; but we are short of rules to oversee them. (AC3)

7.8. CONCLUDING REMARKS This chapter provides empirical evidence of the effectiveness of AngloAmerican models of corporate governance and financial reporting in China. Specifically, informed by the theoretical framework for this monograph, this chapter provides insights into how the process and outcome of implementing internationally acceptable principles and standards intertwine with organizational players’ conflict of interest and power dependence within China’s institutional setting. The call by the Chinese government for greater efficiency and accountability through the adoption of Anglo-American ideas in listed companies has resulted in tensions and conflicts. The organizational players’ relationships and behaviors are largely shaped by institutional contradictions. The interplay of conflicts of interest and power dependence gives rise to many issues associated with implementing internationally acceptable principles and standards and makes the implementation largely symbolic rather than instrumental. Three main themes emerge from the analysis. First, the current institutional environment does not yet fully support the Anglo-American practices. Second, in recent years the quality of financial reporting has improved considerably, which is largely attributable to strengthened

Corporate Governance-Related Financial Reporting Issues in China

199

accounting rules and regulations. However, the imported Anglo-American models of corporate governance and financial reporting, except for enhancing auditor independence, have had only a minor impact on financial reporting quality. Third, although the imported practices are not working as intended, the vast majority of interviewees stated that it was appropriate to move toward internationally acceptable principles and standards. Improving laws and regulations seems to be the main measure for rendering the institutional environment in China more supportive of AngloAmerican models of corporate governance and financial reporting.

NOTES 1. “Vase” is used to describe an independent director who tends to be merely a “decoration” on the board, serving to demonstrate the company’s compliance with the regulation and commitment to good corporate governance; his (or her) function is symbolic instead of being substantial. 2. This requirement was first put forward in CSRC Document No. 235 (2007), which was reinforced in CSRC Announcement No. 48 (2008) (accessed through http://www.csrc.gov.cn). 3. The Basic Standard for Enterprise Internal Control was launched on June 28, 2008, jointly by the MOF, the National Audit Office, and all three major industry regulators: the CSRC, the China Banking Regulatory Commission, and the China Insurance Regulatory Commission. 4. Lin et al. (2008) investigate the perceived role of audit committees in China from the perspectives of investors/creditors, independent directors, company officers, and auditors. They find that company management respondents held greater reservations of audit committee roles in contrast to other groups of respondents. A majority of respondents agreed to the ceremonial roles of audit committees in terms of lifting the image of good corporate governance. However, the respondents, overall, have not fully recognized other more substantial audit committee roles, such as enhancing audit quality, reducing a company’s illegal acts or irregularities, and preventing fraudulent financial reports. 5. In China, a company needs to pay VAT (value-added tax) for all sales transaction. All companies must buy blank tax invoices from tax offices. When a company makes a sales transaction, a tax invoice is issued to the customer and relevant sales information is transmitted to the local tax office via computer system simultaneously. In this way tax offices are able to monitor a company’s sales and associated tax liability at any time. 6. Many firm managers are former government officials or have extensive connections with the government because many audit firms were transformed from former government entities. 7. The total revenue is RMB 20.61 billion (approximately USD 3.17 billion). Total revenue from audit services is RMB 16.99 billion (approximately USD 2.61 billion).

200

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

8. Relative to Anglo-American countries, auditor rotation in China is a new requirement and its application is largely limited. In 2002, the CICPA required auditor rotation in the Guideline of Ethics for Chinese CPAs, but with no specific requirement regarding the maximum auditor tenure (CICPA, 2002). The newly issued Code of Ethics for Chinese Certified Public Accountants states that an auditor partner must rotate off the audit of a listed company after five successive years (CICPA, 2010b). The effect of implementation is yet to be seen. The earliest auditor rotation requirement was implemented in 2005 by the State Asset Supervision and Administration Commission, which requires a 5-year audit firm rotation for all central state owned enterprises, including central state owned listed companies (SASAC, 2005). As a result, to date, auditor rotation is mainly practiced in listed companies owned by the central government. 9. For example, in Australia, the Accounting Professional and Ethical Standards (APESB) 110, titled Code of Ethics for Professional Accountants, allows audit and accounting firms to provide technical advice on such matters as accounting principles and financial statement disclosure, the appropriateness of controls, and the methods used in determining the stated amounts of assets and liabilities to their audit clients without it being considered a threat to their independence, under normal circumstances (refer to APES 110, Paragraph 290.168). 10. For example, in Australia, the APESB 110 indicates that a self-review threat may be created when the external auditor provides assets valuation services (refer to APES 110, Paragraph 290.175 176). 11. A number of interviewees admitted that new accounting standards do have significant effects on the finance industry, as financial instruments are required to be measured by fair value.

CHAPTER 8 SUMMARY AND CONCLUSION

ABSTRACT This chapter concludes the monograph. It summarizes the findings and contributions of the study, acknowledges the limitations of the study, and provides suggestions for further research. Keywords: Findings; contributions; limitations; further research

8.1. INTRODUCTION This monograph has examined the adoption of Anglo-American models of corporate governance and financial reporting in China. More specifically, it examines whether the measures taken by the Chinese government, including the adoption of IFRS, the introduction of independent directors and audit committees, and the strengthening of auditor independence, are likely to improve the quality of financial reporting of Chinese listed companies. A comprehensive framework was developed, and this framework was applied in analyzing the data and summarizing the key findings of this monograph. The findings show that the internationally acceptable principles and standards are not functioning in China as intended. The regulations become loosely coupled with actual operations over time. The loose coupling has occurred through the dynamic interplay of conflicts of interest and power dependence among organizational players, including the government, controlling shareholders, management, independent directors, and auditors, within China’s institutional setting.

201

202

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

The remainder of the chapter is organized as follows. Section 8.2 provides a summary of the study. Main findings are presented in Section 8.3. Section 8.4 illustrates the contribution of the study. Section 8.5 discusses the implications of the study. The limitations of the study and suggestions for future research are outlined in the final section.

8.2. SUMMARY OF THE STUDY The underperforming corporate sector creates endogenous pressure upon the Chinese government to reform corporate governance and financial reporting regulations and practices. The adoption of Anglo-American models in this reform process is justified by the perceived superiority of the Anglo-American models in achieving efficiency improvement and international legitimacy. In the context of globalization, supranational organizations, including the World Bank, WTO, IASB, OECD, IOSCO, and IFAC, provide mutual support to one another to reinforce the legitimizing power of Anglo-American corporate governance and financial reporting. These supranational organizations, together with international accounting firms and foreign investors, imposed exogenous pressures upon China to move toward Anglo-American models to secure legitimacy in the global market. However, the findings of this monograph demonstrate that the actual effectiveness of the Anglo-American models is largely determined by the way in which organizational players respond to, interpret, and implement the imported ideas in China’s context. This study reveals that the loose coupling between the regulations and actual operations is a process and an outcome of the interplay of conflicts of interest and power dependence among organizational players within China’s institutional setting. It provides insights into the issues involved in achieving the objective of adopting internationally acceptable principles and standards in China. This monograph was motivated mainly by two factors. First, there is relatively limited empirical evidence available on the adoption of internationally acceptable principles and standards in developing and emerging economies in general and in China in particular. Second, the existing literature has largely neglected the institutional influences on corporate governance and financial reporting practices and the dynamic nature of those practices. In addition, the issues related to corporate governance and financial reporting in China are becoming increasingly important in view of China’s growing influence in the global economy. By studying issues

203

Summary and Conclusion

associated with the adoption of internationally acceptable standards and principles in China, and providing empirical evidence related to those issues, this monograph fills the gaps in the literature and makes an original contribution to the relevant literature. This monograph also recognizes that a holistic and comprehensive theoretical perspective is needed in order to provide richer insights into the complex issues associated with the adoption of internationally acceptable practices in China. As a result, an integrated theoretical framework on the basis of institutional theory was developed that incorporates international influences, domestic influences, and intraorganizational dynamics. It shows that the institutional influences largely shape the process and outcome of loose coupling, which deeply intertwine with conflicts of interest and power dependence among organizational players. An institutional perspective is adopted to inform the study, mainly because of its perceived appropriateness for the issues under investigation. The integrated institutional framework enabled not only a holistic examination of China’s adoption of Anglo-American models of corporate governance and financial reporting by incorporating both global and domestic contexts but also an in-depth examination of the issues of implementation related to the process and outcome involved. Using a field study approach, data for the study were collected from interviewing 23 selected key individuals, comprising 7 company managers, 7 independent directors, 4 academics, and 5 auditors. In addition, data were also collected from public documents, including corporate governance guidelines and accounting regulations issued by government agencies, government reports, reports issued by supranational organizations such as the OECD and the WTO, rating agencies’ reports, official statistics, firms’ websites, and media and analysts’ reports. Furthermore, additional and corroborative information was obtained by surveying the existing literature that has examined corporate governance and financial reporting issues in China. The use of multiple sources of data was useful in validating the findings and generating fruitful insights from exposure to different perspectives.

8.3. FINDINGS 8.3.1. Independent Directors Not Functioning as Intended The findings of this monograph reveal that although independent directors have been introduced into Chinese listed companies specifically to protect

204

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

minority shareholders’ interests, at present they are not functioning as intended. Their role is largely ceremonial in nature, with the primary objective of ensuring companies’ compliance with laws and regulations, which in itself is viewed as evidence of a symbolic role. Lack of independence from controlling shareholders and management is attributable to several factors, including a superficial understanding of the meaning of independence of directors; the influence of controlling shareholders, management, and guanxi over appointments; minority status on boards; and lack of understanding of corporate operation. The power imbalance in the work relationship, coupled with managerial resistance to and capture of independent directors, has largely shaped the way in which independent directors deal with management. The findings show that to avoid conflicts with management, independent directors are reluctant to accept a monitoring role and to express opposing opinions where it is necessary to protect minority interests, suggesting their failure in discharging their duties substantially.

8.3.2. Ineffective Audit Committees The study suggests that while audit committees in China are accorded the duty of recommending the engagement or replacement of external company auditors, there are several impediments to discharging this duty. They include the influence of controlling shareholders and management, the absence of experience in meaningful interaction with external auditors, having to support management in the event of a conflict between the auditor and the company, lack of tradition of valuing the internal audit function, and lack of real authority.

8.3.3. Limited Auditor Independence The findings show that there are several unique factors affecting auditor independence in China, namely, the influence of government and guanxi in determining audit institutions, auditors’ concerns over issuing audit opinions in the competitive audit services market, long-term auditor client relationships resulting from the CSRC’s high-level skepticism, and provision of advice and assistance on financial reporting matters. Despite the existence of such issues, which could compromise auditor independence, this monograph reveals that the Chinese government’s efforts to improve

Summary and Conclusion

205

auditing regulation over the past three decades have considerably raised the reputation of the profession and the quality of audit services. 8.3.4. Lack of Focus on Ethics in Corporate Codes of Conduct While the corporate code of conduct is an important part of corporate governance in Anglo-American countries, this monograph reveals that ethical issues related to corporate governance are not explicitly discussed in the Code of Corporate Governance for Listed Companies in China issued in 2002. In addition, a lack of proper understanding of the meaning of corporate codes of conduct and scant research in this regard also support the view that ethical issues have received little attention in China. The findings of this monograph indicate that the importance of corporate codes of conduct in promoting high ethical standards and assisting company directors and senior managers in fulfilling their responsibilities is largely neglected in China. 8.3.5. China’s Own Approach to Convergence with IFRS The findings reveal that China has its own approach to convergence with IFRS. For example, the convergence process has been heavily driven by the government. While IFRS requires extensive application of professional judgment and promotes the use of fair value, the Chinese government has been cautious with regard to valuation based on the fair value method. Chinese managers and accountants seem to be reluctant to exercise professional judgment and tend to favor historical cost, as both historical cost and fair value are allowed under the new accounting standards. However, this monograph also reveals that the quality of financial reporting, including disclosure and transparency, has improved considerably as a result of introducing internationally acceptable mechanisms for accounting regulations. The major reasons include improved disclosure requirements, enhanced auditing regulations, and independent directors’ involvement in areas such as approving related party transactions.

8.3.6. Loosely Coupled Regulations Concerning Corporate Governance and Financial Reporting This study reveals that there is a mismatch between the imported ideas of corporate governance and financial reporting and actual operations. Most

206

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

of the changes introduced by the Chinese government do not get fully embedded in corporate practices. The Chinese government enforces the internationally acceptable principles and standards by way of regulations, which were intended to improve, among other things, the accountability of organizational players and quality of financial reporting. The findings of this monograph support the view that the effectiveness of the Anglo-American models is largely determined by how organizational players respond to, interpret, and practice the imported ideas in China’s context. Discussion in Chapter 6 shows that China has a different institutional setting from that of Anglo-American countries. The imported ideas are likely to encounter resistance due to the mismatch between those ideas and China’s context. The monograph shows that although formal rules have changed rapidly as a result of the decisions of the Chinese government, informal constraints embedded in customs and traditions are much more persistent to the political efforts. In their day-to-day practices the powerful players tend to mobilize their power to neutralize the proposed changes and to maintain the status quo. 8.3.6.1. Gap between the Institutional Environments Discussion in Chapter 6 indicates that being highly regulated is a prominent feature of the Chinese market, although the extent of government involvement is gradually decreasing. After three decades of economic reforms, the Chinese government is still the principal player in the economy. Nevertheless, it should be recognized that the government’s involvement has both positive and negative impacts rather than simply presuming that the government’s intervention necessarily undermines corporate efficiency. In China the economic reforms, including corporate governance and accounting innovation, have been driven by the government and achieved remarkable success. The findings also show that the improvement in the quality of financial reporting is largely attributable to enhanced regulations. However, the government’s excessive involvement, coupled with the underdeveloped legal system and the penetration of guanxi culture into the corporate sector, is likely to create problems in the relations among organizational players, exacerbate conflicts of interest, and eventually compromise the effectiveness of Anglo-American models in China’s context. The introduction of Anglo-American models of corporate governance and financial reporting is regarded as legitimate, as the innovation calls for greater efficiency. However, the innovation does not necessarily change the underlying contradictions, which are rooted in China’s institutional setting. The majority of listed companies are restructured SOEs, with the state

Summary and Conclusion

207

being the controlling shareholder. Chinese listed companies have been reorganized in a commercial business-like manner but are continually expected to achieve a range of social and political objectives. The government has incentives and the capability to make use of listed companies to achieve its multiple objectives. Furthermore, the concentrated ownership structure creates acute conflicts of interest between controlling and minority shareholders in addition to those between shareholders and managers. Controlling shareholders frequently use measures including related party transactions to expropriate assets of listed companies and minority shareholders. Independent directors are assigned to protect minority interests. However, the considerable influence of controlling shareholders and management in selecting independent directors makes them feel accountable to controlling shareholders instead of to minority shareholders. The Chinese stock market is immature and volatile, and the value of good corporate governance is not yet fully recognized. In addition, the legal system in China is underdeveloped and offers little protection to shareholders. Low risk of litigation is unlikely to help make controlling shareholders, managers, directors, and auditors accountable for their misconduct. Chinese culture has been heavily influenced by Confucian philosophy, which seeks to cultivate a harmonious climate and is incompatible with the value of independence emphasized in Anglo-American practices. It is, therefore, concluded that the current institutional environment in China is not yet fully supportive of implementing Anglo-American corporate governance and financial reporting practices in general. 8.3.6.2. Resistance to Anglo-American Models This monograph shows that the institutional context acts to configure the power and status of groups within an organization (see also Greenwood & Hinings, 1996). The power imbalance and diverging interests among such organizational players as controlling shareholders, minority shareholders, management, independent directors, audit committees, and auditors are deeply rooted in the institutional setting and reflect the institutional contradictions in China. The fundamental agency problem within Chinese listed companies is conflict between controlling and minority shareholders. The major purpose of introducing independent directors is to protect minority interests by monitoring controlling shareholders and management so as to hold them accountable. The task of auditors is to ensure the credibility of financial reporting prepared by management. The conflicts of interest are unavoidable and determined by the different roles played by various

208

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

organizational players. Furthermore, the findings of this monograph reveal that managers, backed by controlling shareholders, are the dominant group in Chinese listed companies compared to independent directors, audit committees, and auditors. This monograph also shows that the interplay between power relations and conflicts of interest in organizations largely determines the way in which organizational players interpret and practice the imported ideas to accommodate institutional contradictions in organizations. In the process of enforcing internationally acceptable principles and standards, the functionally differentiated groups with different interests tend to compete for influence and dominance. As Greenwood and Hinings (1996) point out, effective change would not be the likely outcome, unless those in positions of privilege and power were in favor of the proposed change. The adoption of Anglo-American models is the Chinese government’s attempt at constructing rational organizations in which the role of corporate governance and financial reporting would make corporate management responsible and accountable for corporate performance, as it is in mature economies. However, the regulations threaten management’s autonomy and power, and their implementation is likely to encounter substantial resistance. Corporate management, as the dominant group, is capable of shaping the change process. The findings illustrate the difficulty of mobilizing internal support to secure effective organizational changes because of the normative embeddedness of organizations within their institutional context (see also Baum & Oliver, 1991; North, 1990). Corporate management refuses to accept the Anglo-American practices in the way that was intended because of the embedded controlling shareholders oriented norms. The corporate governance and accounting innovation challenged the prevailing ways of thinking and evoked resistance (Burns & Scapens, 2000). The multiple and probably conflicting goals of listed companies create difficulties in building a common understanding of how to improve corporate efficiency, although the importance of improving efficiency may be unanimously held by all organizational players. Further, it is in the interests of the corporate management to preserve the status quo. An important consequence of introducing the AngloAmerican practices, with the aim of seeking to promote responsible conduct, was the increased monitoring and controlling of the behavior of corporate managers, suggesting potential restrictions on their autonomy and power. Management’s dominant position enables them to make use of favorable power dependencies to promote their interests. The findings show

Summary and Conclusion

209

that managers tend to neutralize the function of audit committees, manipulate the role of independent directors, and build up coalitions with audit committees against auditors by using their strengths over operational knowledge and exercising their influence in the selection of independent directors and auditors. The resistance and manipulation of management result in compromises made by other organizational players. For example, independent directors and audit committees are required to protect minority interests, and auditors are expected to add credibility to financial reports. However, it is not in the interest of these players to confront management where conflicts arise. Further, the legal system is unable to impose pressure on independent directors and auditors, as the current litigation risk and administrative discipline are not sufficient to make these organizational players observe the spirit of their duties as expected by law and regulations. The findings reveal that because of the lack of acceptance of and the resistance to the use of imported practices as a means of improving accountability, corporate managers tend to mobilize their existing power to ensure that decision making in operations is not threatened by a shift of power to independent directors and auditors. Consequently, although there have been changes to corporate governance and accounting, in the sense that Anglo-American procedures have been implemented, they have become loosely coupled and generally have little substantive impact on the day-to-day activities of the corporate managers. The established routines, such as a controlling shareholders orientation and management domination of decision making, have largely persisted. The findings of this monograph demonstrate that the notion of loose coupling largely reflects the adoption of internationally acceptable principles and standards in China. First, the study reveals that Chinese regulators made modifications to Anglo-American models. For example, the Chinese government has restricted the use of fair value and has incorporated a unique method into the accounting standard in relation to business combinations to reflect China’s context. In addition, there is no ethical component in the Code of Corporate Governance for Listed Companies in China. The modifications, to some extent, signify the loose coupling between the imported ideas and actual operations within the local context. Second, the imported corporate governance mechanisms remain largely separate from actual operations. Independent directors are subject to managerial influence. They have a propensity to ignore the fundamental role of monitoring and to favor taking a consultative role that is more likely to be appreciated by managers. They are reluctant to oppose management.

210

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

On the other hand, partly because of the CSRC’s requirement, listed companies tend to seek independent directors with academic backgrounds. Lack of operational knowledge and industry expertise not only leads to independent directors being perceived as the “decoration” of boards but also substantially weakens their ability to challenge management. Furthermore, the roles of audit committees are marginalized. For example, audit committees are rarely involved in appointing external auditors. They are unable to establish effective relationship with both external and internal auditors because of lack of communication, which in turn impairs the power and legitimacy of audit committees. Also, audit committees tend to cooperate with management against external auditors, which imposes additional pressure on auditors rather than supporting them in cases of client auditor conflict. Nevertheless, the loose coupling does not necessarily preclude substantial changes in operations. The findings indicate that the value of audits in adding credibility to financial reports is increasingly acknowledged. Auditor independence has been strengthened considerably because of the disaffiliation program and increased regulatory requirements. Disclosure and transparency have improved owing largely to the increasing disclosure requirements and independent directors’ involvement in approving related party transactions. This monograph provides an example of how loose coupling interacts with and results from the interplay between power dependence and conflicts of interest and how it is used to accommodate the institutional contradictions in organizations. The innovation was introduced to manage conflicting institutional pressures, for example, conflict between controlling and minority shareholders. However, the implementation has created new institutional contradictions among independent directors, management, and auditors. In this monograph, loose coupling can be seen as an ongoing process that accompanies the continuing interplay between conflicts of interest and power dependence to accommodate the institutional contradictions. In addition, loose coupling is also seen as an outcome, as the imported AngloAmerican arrangements are not substantially used to make corporate managers accountable for their decision making. The loose coupling maintains the autonomy and dominance of corporate managers and eases the tensions between managers, independent directors, and auditors by reducing the need for interaction and coordination and by avoiding confrontation. It mediates the conflict in the decision-making process and reduces the costs and time involved in organizational players’ coordination and negotiation. The findings of this monograph demonstrate that loose coupling is a

211

Summary and Conclusion

process and an outcome of competition, negotiation, coordination, and compromise among organizational players and helps maintain the stability of work-related meanings, values, and norms (see also Nor-Aziah & Scapens, 2007). However, loosely coupling leads to behavioral patterns that tend to be dysfunctional and is incapable of being used as a means of change (see also Weick, 1976). It makes the impact of the Anglo-American models on the behavior of such organizational players as controlling shareholders, corporate management, independent directors, and audit committees largely ceremonial. The effectiveness of the innovation to corporate governance and accounting is considerably impaired by negotiation and compromise among organizational players.

8.4. CONTRIBUTION This monograph presents an understanding of the process and the outcome of adopting Anglo-American ideas in China’s context. It contributes to both the corporate governance and financial reporting literature and corporate governance and accounting innovation.

8.4.1. Contribution to the Literature This monograph makes original and significant contributions to the literature on corporate governance and financial reporting in general and to the relevant literature in China in particular. It contributes to the literature mainly in three ways. First, by providing empirical evidence in relation to corporate governance and financial reporting practices in an emerging economy this monograph expands the existing literature, which is largely dominated by studies conducted in industrialized countries. Second, by using an institutional perspective this monograph makes a theoretical contribution to the literature. In particular, by using a holistic and comprehensive framework that has drawn concepts from various institutional perspectives and incorporated international influences, domestic influences, and intraorganizational dynamics this monograph provides an in-depth institutional analysis of the process and outcome of adopting AngloAmerican ideas in China’s context. Third, the field study method used in this monograph adds to the increasing body of corporate governance and

212

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

financial reporting literature in an institutional setting in which corporate governance and accounting operate. The research method adopted in this monograph enabled the provision of insights into the complexities involved in the phenomena under investigation. This monograph contributes to the relevant literature in China in particular mainly in two ways. First, by examining China’s institutional environment, comprising the political, economic, legal, and cultural systems and accounting infrastructure, and its impact on the implementation of AngloAmerican ideas, this monograph contributes to the body of literature that has examined the relation between corporate governance and financial reporting but has largely failed to take into account the unique features of China’s institutional context and associated influences in shaping corporate governance and accounting practices. Second, the existing research conducted in China has predominantly concentrated on one or two corporate governance elements. By examining relevant and important corporate governance elements that are considered to have a direct impact on financial reporting this monograph extends the existing literature. While some of the findings (e.g., the ineffectiveness of independent directors and audit committees) in the current study are consistent with those of existing literature, this monograph provides a comprehensive understanding of the issues under investigation within an integrative institutional framework. It highlights the way in which corporate governance and accounting practices are shaped by the institutional environment. It also provides valuable insights into the process of and the underlying reasons for loose coupling. It shows how corporate governance and accounting innovation introduced by way of regulations became loosely coupled with actual practices and how loose coupling has interplayed with the organizational processes of change to accommodate contradictory institutional pressures within organizations.

8.4.2. Contribution to Corporate Governance and Financial Reporting Innovation The monograph provides insights into the influence of an institutional environment upon the adoption of Anglo-American models of corporate governance and financial reporting in an emerging economy. It reveals the unique features of the institutional environments in China and the inherent contradictions between existing institutions and the imported ideas. It also illustrates the complexities associated with the implementation of imported ideas. This monograph highlights that the level of effectiveness of

213

Summary and Conclusion

Anglo-American models is largely determined by the institutional environment. Issues arising from implementing internationally acceptable principles should be analyzed and understood in the institutional setting where those principles are interpreted and practiced. Thus, the findings of the monograph contribute to understanding and potentially improving corporate governance and financial reporting innovation in China. Other countries that are adopting, or considering adopting, Anglo-American models may also find the findings of this monograph useful.

8.5. IMPLICATIONS This monograph has implications for policy makers, professional practitioners, company managers, creditors, investors, and researchers. First, the findings of the monograph suggest that internationally acceptable principles and standards are not functioning in China as intended because of the country’s unique environment. It will be helpful for creditors and investors, international investors in particular, to take into account the findings when assessing the corporate governance and accounting practices of Chinese listed companies. Furthermore, the monograph suggests that to achieve the expected objectives of corporate governance and financial reporting innovation, the fundamental issue is to develop a supportive institutional environment, though this will be a long-term challenge. Policy makers and regulators may find such understanding useful for the effective introduction of innovation. This monograph provides empirical evidence in relation to the problems associated with the implementation of internationally acceptable principles and standards, particularly those associated with interaction among organizational players. An understanding of such problems could assist policy makers and innovation participants in implementing innovation more effectively. The general failure to materialize Anglo-American models of corporate governance and financial reporting highlights a number of factors that may require careful consideration when implementing imported ideas in organizations. First, it emphasizes the importance of clarifying the function and objectives expected of newly introduced positions (e.g., independent directors, audit committees) in regulation to avoid ambiguity and manipulation. Second, it highlights the importance of ensuring that key people within organizations who will be involved in and affected by the innovation are aware of the significance of the innovation, their important role in securing

214

CORPORATE GOVERNANCE & FINANCIAL REPORTING IN CHINA

its success, how the innovation works, and how it adds value to company operation and performance. Third, it highlights the importance of ensuring that people who take the newly introduced roles (e.g., independent directors and audit committee members) understand their functions and responsibilities. Such measures may be useful in overcoming, to some degree, the resistance of parties affected by the innovation and in cultivating an innovation-supportive culture within organizations (e.g., open discussion in boardrooms). However, the relative success in strengthening auditor independence achieved by improving the regulatory environment and the wellacknowledged role of auditing point to the possibility of introducing Anglo-American ideas in an environment that is considerably different from that of Anglo-American countries.

8.6. LIMITATIONS AND SUGGESTIONS FOR FUTURE RESEARCH The limitations of this monograph relate to the sources of data and the period investigated. First, this monograph is based on the perceptions of key people and on publicly available information. No in-depth analysis of internal records, such as company organizational structure, meeting minutes, company policy documents, or internal control documents, was conducted for the study. Further analysis of internal records could have provided additional insights into and enhanced the understanding of the process of implementing Anglo-American models of corporate governance and financial reporting and interactions among organizational players. Furthermore, although measures were taken to ensure the validity and reliability of the data, for example, by using data triangulation and selecting interviewees on the basis of their perceived knowledge of corporate governance and financial reporting and from different interest groups, there is still potential for bias in the data. In particular, it is possible that the interviewees selectively addressed or avoided aspects of issues under investigation and that their interpretations were colored by their interests and preferences. Moreover, this study was unsuccessful in seeking insights from the perspective of government agencies. Government officials were considered to be an important group of interviewees, as corporate governance and financial reporting have been largely driven by the government. However, this study was unable to secure their insights because of the difficulties of approaching appropriate government officials. Additionally, the interviews were mainly conducted in Guangdong Province. Therefore, the findings may not be

215

Summary and Conclusion

representative of the other provinces in China. However, Guangdong is one of the most developed regions in China,1 which makes it an ideal research field to investigate the effectiveness of corporate governance and financial reporting innovation. Second, while this monograph reveals that most changes in relation to the adoption of Anglo-American models of corporate governance and financial reporting did not have a substantial effect on company operations, it should be noted that it has been only a short period since the Anglo-American ideas were introduced. For example, the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies and the Code of Corporate Governance for Listed Companies in China were promulgated by the CSRC in 2001 and 2002, respectively. It was not until 2007 that Chinese listed companies were required to adopt new ASBE. Over time, the Anglo-American ideas could gradually become embedded within company practices, particularly as a result of continuously improving the institutional setting, which is likely to be the case in China. Hence, the conclusions provided should be interpreted as reflecting the situation related to a phase of a continuing process. This monograph has adopted a holistic and comprehensive institutional framework that incorporates international influences, domestic influences, and intraorganizational dynamics to provide an understanding of the adoption of Anglo-American models of corporate governance and financial reporting in China. The framework can also be useful for researchers who are interested in obtaining insights into the introduction of AngloAmerican ideas in other developing and emerging economies. Furthermore, case study is an appropriate approach to obtain understanding about the process and the outcome of corporate governance and financial reporting innovation. Also, the case study approach can extend the sources of data to provide an in-depth analysis of internal records. Future research can replicate this study in China and obtain participants from various regions, which will improve the generalizability of the research findings. Future research may also extend the current study by examining the implementation of Anglo-American models of corporate governance and financial reporting in other emerging countries.

NOTE 1. Guangdong is the first province that experimented on reform and the opendoor policy in China. It reported the largest GDP in 2010.

APPENDIX: INTERVIEW GUIDE ADOPTION OF ANGLO-AMERICAN MODELS OF CORPORATE GOVERNANCE AND FINANCIAL REPORTING IN CHINA Thank you for agreeing to take part in this interview. It will take approximately one hour. The discussion is intended to obtain your views about the corporate governance and financial reporting practices in China. This study focuses on listed companies and it proposes to examine the environmental context in which listed companies operate in China. Topics covered in this interview include independent directors, audit committee, auditor independence, corporate code of conduct, and disclosure and measurement of accounting information. These topics, which are of concern to both corporate governance and accounting, are particularly important in view of China’s decision to adopt IFRS in 2007. The Code of Corporate Governance for Listed Companies in China and the Guidelines for Introducing Independent Directors to the Board of Directors of Listed Companies issued in 2001 are referred as the Code and the Guidelines respectively in the interview questions. 1. Independent Director In accordance with the Guideline, board of directors, supervisory board and shareholders (owning more than 1% outstanding shares) are eligible to nominate independent directors, who will be voted at the shareholders’ meeting. (1) How is an independent director nominated in your company? Is the process of obtaining approval from the shareholders’ meeting followed? (for company managers, independent directors) How is an independent director nominated in listed companies? Is the process of obtaining approval from the shareholders’ meeting followed?

217

218

APPENDIX

(2) Based on your experience with other listed companies, did they follow the same process? (for company managers, independent directors) (3) In your opinion, who is the most influential party in the process of appointing an independent director? Can you elaborate? (4) Does the influential party affect the independence of independent director? How?

Chapter 2 of the Code specifically discusses the relation between a listed company and its controlling shareholders. (5) In your opinion, are controlling shareholders able to influence the independence of independent directors? Can you elaborate on how they affect the independence? (6) Most listed companies are restructured SOEs and state ownership still counts for a major part. Is the government still exerting significant influence on the appointment of independent directors? (7) Is the government able to influence the independence of independent directors? Can you elaborate? (8) In your opinion is guangxi likely to affect the appointment of independent directors? How? How does the culture of guangxi influence the independence of independent directors?

For the purpose of performing the duties effectively, the Guidelines state that listed companies shall ensure that the independent director has the same right to be kept informed as the other directors in the companies. (9) As an independent director, are you provided with sufficient information by the company that you serve in order to express an independent opinion on major events? (for independent directors) In your opinion, are other independent directors provided with sufficient information in order to express an independent opinion on major events? (for independent directors) It is not unusual that managers might refuse to provide necessary information or deliberately hide material information from independent directors. What is your experience on this issue? (for independent directors) If it happened to you, how did you deal with it? (for independent directors) How do other independent directors deal with this issue? (for independent directors) In your opinion, are independent directors provided with sufficient information in order to express the independent opinion on the major events? It is not unusually that managers might refuse to provide necessary information or deliberately hide material information from independent directors. How serious is the situation in China? How do independent directors deal with this issue?

In accordance with the Code and the Guidelines, at least one independent director shall be accounting professional (or if there is an audit committee, at least one independent director from the audit committee shall be an accounting professional).

Appendix

219

(10) Do you believe independent directors with accounting background are able to add value to financial reporting quality? Why? (11) In your opinion, generally do independent directors understand company’s business? Do they have sufficient knowledge to discharge their duties properly? Can you elaborate? (12) In your opinion, are independent directors diligent in fulfilling their duties? Can you elaborate? (13) In your opinion, are Chinese independent directors likely to possess all the qualities of independence, expertise and diligence? (14) To your knowledge, do independent directors play an active role in financial reporting? Can you elaborate? (15) If an independent director failed to discharge his or her duties, will he or she suffer loss in his or her reputation? Do any consequences follow in his or her future career? Can you elaborate? (16) Does CSRC impose any enforcement actions against misconduct of independent directors? In your opinion, are CSRC enforcement actions effective in disciplining misconduct of independent directors? (17) Except for enforcement actions, could any other legal consequence follow? (18) Can you give some suggestions for improving the effectiveness of independent directors in safeguarding the quality of financial reporting?

2. Audit Committee In accordance with the Code and Guidelines, independent directors shall constitute the majority of the audit committee. (19) What would be the effect of this requirement in ensuring independence of audit committees? (20) What are the impediments to audit committee independence in China? Can you elaborate?

In accordance with the Code, the duty of supervisory board includes supervising and examining the company’s financial matters. Audit committee is also charged with inspecting the company’s financial information and its disclosure. (21) How is the confusion caused by this duplication of duties resolved in practice? Can you elaborate? (22) Do audit committee members have sufficient knowledge to discharge the duties, particularly in terms of protecting integrity of financial reporting? Can you elaborate? (23) In your opinion, are audit committees diligent in fulfilling their duties? Can you elaborate? (24) In your opinion, among independence, expertise and diligence, which quality are audit committee members not likely to possess?

220

APPENDIX

Audit committees are responsible for audit related affairs and aim to enhance auditor independence. (25) How often does the audit committee of your company meet external auditors? Is it usual for the audit committees of other companies to meet their external auditor regularly? (for independent directors) How often do the audit committees of your clients meet you? How about other listed companies? (for auditors) How often do the audit committees of listed companies meet their external auditor? In case of conflict between managers and external auditors, do you think there is a role for the audit committee as a mediator? In your opinion, are audit committees really able to enhance auditor independence? Can you elaborate? (26) Do you think the audit committee plays an active role in improving the quality of accounting information? How? (27) Can you give some suggestions for improving the effectiveness of audit committee in safeguarding the quality of financial reporting?

3. Auditor Independence In accordance with the Code and Guideline, the audit committee should recommend the engagement and replacement of the auditing firm. (28) How was your firm appointed as an auditor? (for auditors) In reality, could any other party manipulate the audit committee’s recommendation? If yes, how? (29) Also, how would the manipulation affect auditor independence? (30) Normally audit fee, non-audit fee and long association between auditor and client are major concerns for auditor independence. In your opinion, do these factors result in auditor independence issues in China? Can you elaborate? (31) In your opinion, how important is the guangxi in the auditor appointment? (32) How important is the guangxi in obtaining audit and non-audit service? (33) How does the guangxi affect auditor independence? In your professional career, have you ever faced any pressure which threatened your independence? Can you elaborate? How did you deal with it? (for auditors) (34) We know historically audit firms were affiliated with government. Is government still important in the auditing and non-auditing service market? How does the government affect the market share? (35) Is an auditor likely to be sued if he or she failed to detect material misstatement? Why? (36) Overall, do you think Chinese auditors are independent? Why do you think so? What are the major factors that should be considered in evaluating independence issues? (37) In your opinion, to what extent is an auditor able to add credibility to financial reporting in China? Can you explain? (38) Can you give some suggestion for enhancing auditor independence?

Appendix

221

4. Corporate Code of Conduct (39) How important is ethical behaviour in Chinese business? (40) Does your company have a code of conduct? If yes, what does it emphasize? (for company managers and independent directors) (41) How is the code of conduct communicated in your company? (for company managers and independent directors) (42) Do you think directors and managers in your company commit themselves to the code and set good example for other employees? Can you give some examples? (for company managers and independent directors) (43) Is it common for a listed company in China to establish a corporate code of conduct? (44) Do you think directors and managers of listed companies commit themselves to the code and set good examples for other employees? Can you give some examples? (45) Is the information about corporate code of conduct widely known and available? (46) Do listed companies provide courses concerning the code to employees? Can you give some examples? (47) In your experience, do employees take the code seriously and value those courses? Can you elaborate? (48) Are these courses effective in terms of improving employees’ ethical awareness? Can you explain? (49) In your opinion, what role can the code of conduct play in improving quality of financial reporting? (50) In your opinion, what purpose has the code of conduct actually achieved? (51) Can you give some suggestions for improving the effectiveness of corporate code of conduct in safeguarding the quality of financial reporting?

5. Disclosure and Transparency In accordance with the Code, a listed company shall truthfully, accurately, completely and timely disclose information as required by laws and regulations. In addition, a company shall also voluntarily and timely disclose all other information that may have a material effect on the decisions of shareholders and stakeholders. These requirements suggest the importance of transparency is emphasized in the new corporate governance framework in China. (52) The new corporate governance framework including the Code and the Guideline has been in place for eight years. In your opinion, has transparency improved since the new framework was introduced? What are the factors that have affected transparency by companies over the period? (53) Have listed companies made improvements in disclosure in the areas of related party transactions and management remuneration? What other areas need further improvement? In your opinion, what are potential reasons for inadequate disclosure?

The Guideline specifically requires that major related party transactions should be approved by independent directors before being submitted to the

222

APPENDIX

board of directors for discussion. In addition, the disclosure of the contents of related party transactions is stipulated in the Code. (54) Did your company follow the requirement of obtaining approval of independent directors? (for company managers and independent directors) Did you have sufficient information to evaluate those related party transactions to make proper judgment? (for independent directors) Did your company fully disclose related party transactions? (for company managers and independent directors) Have you ever found that your company failed to make full disclosure? How did you deal with that? (for independent directors) (55) In your opinion, are related party transactions prevailing in China? What are the most common types of related party transactions? Why do you think they need independent director’s approval to proceed? Do independent directors have sufficient information to evaluate those related party transactions and make proper judgment? Do you think that related party transactions in Chinese companies are fully disclosed as required? Can you elaborate? To what extent that the involvement of independent directors improves the disclosure of related party transactions? (56) ASBE 36 (Related Party Disclosures) acknowledges state-controlled entities are not regarded as related parties simply because they are state-controlled. However, state-controlled entities are not exempted under IAS 24 (Related Party Disclosures). Given the extensive existence of state-ownership, how does this departure from IFRS affect information disclosure?

Financial reporting basically emphasizes two aspects namely accurate information and sufficient disclosure. (57) In your opinion, is one of the two aspects obtaining relatively more attention from independent directors and audit committee? Can you elaborate? Comparing disclosure failure and information misstatement, which issue is more likely to attract CSRC enforcement action? Can you elaborate? (58) Do you think independent directors and audit committees are able to improve transparency? Can you elaborate? (59) Do you believe Chinese culture has an impact on the disclosure practices? Can you elaborate on how Chinese culture affects disclosure? (60) Can you give some suggestions for improving transparency by companies in China?

6. Adoption of IFRS 2007 saw the adoption of IFRS which represents a milestone of the harmonization process in China. Now let’s talk about how the adoption of international accounting standards affects financial reporting quality in China.

Appendix

223

Traditionally Chinese accounting standards are rule-based. However IFRS is principle-based accounting standards and more professional judgment is required. (61) Do you think Chinese managers and accountants are capable of making professional judgment on technical issues such as impairment test for goodwill, depreciation of fixed assets and classification of research and development costs? (62) In your opinion, what factors might impede professional judgment of professional accountants?

The new Chinese accounting standards require greater use of fair values compared to old Chinese GAAP. For example, Fair value is allowed to measure equity investments, investment properties, biological assets, exchange of non-monetary assets, assets or equity interests in debt restructuring. Such measurement will lead to increased volatility in results (Deloitte 2006). (63) In your opinion, is the increasing use of fair value a big challenge to managers and accountants in China? Why? (64) Is the increasing use of fair value improving the quality of financial reporting in China? (65) In your opinion, are independent directors, audit committees and external auditors able to ensure the proper implementation of fair values?

On the other hand, the new Chinese accounting standards still impose restriction over the use of fair values. For example, with regards to fixed assets and intangible assets, IFRS allows both the cost model and the revaluation model (relying on fair values). The new Chinese accounting standards only allows the cost model. (66) In your opinion, how does the restrictive use of fair values affect the quality of financial reporting? (67) There are some concerns that professional judgement might create opportunity for accounting manipulation. Given that China has decided to adopt IFRS, do you think this could aggravate the problem of accounting manipulation by Chinese companies? (68) Does the IFRS-based financial reporting provide more reliable information to users compared to old Chinese standards? Can you elaborate? Does the IFRS-based financial reporting provide higher quality information to users compared to old Chinese standards? Can you elaborate? Does the IFRS-based financial reporting lead to more transparency? Can you elaborate? (69) If managers and accountants are involved in the accounting manipulation, is any action likely to be taken against them? By whom?

End of the interview

224

APPENDIX

INTERVIEW GUIDE

CHINESE VERSION

Appendix

225

226

APPENDIX

Appendix

227

REFERENCES AASB. (2007). Framework for the preparation and presentation of financial statements. Australian Accounting Standards Board, Australia. Abbott, L. J., Parker, S., & Peters, G. F. (2004). Audit committee characteristics and restatements. Auditing: A Journal of Practice & Theory, 23(1), 69 87. Abdel-Khalik, A. R., Wong, K. A., & Wu, A. (1999). The information environment of China’s A and B shares: Can we make sense of the numbers? The International Journal of Accounting, 34(4), 467 489. Abidin, S., Beattie, V., & Goodacre, A. (2010). Audit market structure, fees and choice in a period of structural change: Evidence from the UK 1998 2003. The British Accounting Review, 42(3), 187 206. Adhikari, A., & Wang, S. Z. (1995). Accounting for China: In 1978, the leaders in China, to the world’s surprise, embarked on a dramatic reform program designed to move the country toward a market-oriented economy. Management Accounting-New York, 76, 27. Aggarwal, R., Erel, I., Stulz, R., & Williamson, R. (2010). Differences in governance practices between US and foreign firms: Measurement, causes, and consequences. Review of Financial Studies, 23(3), 3131 3169. Agrawal, A., & Chadha, S. (2005). Corporate governance and accounting scandals. Journal of Law and Economics, 48(2), 371 406. Aguilera, R. V., & Jackson, G. (2003). The cross-national diversity of corporate governance: Dimensions and determinants. Academy of Management Review, 28(3), 447 465. Aharony, J., Wang, J., & Yuan, H. (2010). Tunneling as an incentive for earnings management during the IPO process in China. Journal of Accounting and Public Policy, 29(1), 1 26. Ahmed, E., Li, H., & Rosser, J. B. (2006). Nonlinear bubbles in Chinese stock markets in the 1990s. Eastern Economic Journal, 32(1), 1 18. Ahrens, T., & Chapman, C. S. (2006). Doing qualitative field research in management accounting: Positioning data to contribute to theory. Accounting, Organizations and Society, 31(8), 819 841. Ahrens, T., & Dent, J. (1998). Accounting and organizations: Realizing the richness of field research. Journal of Management Accounting Research, 10, 1 39. AICD/KPMG. (1998). Boardroom report: Board performance evaluation. Institute of Company Directors, Sydney. Aiken, M., & Lu, W. (1998). The evolution of bookkeeping in China: Integrating historical trends with western influences. Abacus, 34(1), 140 162. Alexander, D., & Archer, S. (2000). On the myth of “Anglo-Saxon” financial accounting. The International Journal of Accounting, 35(4), 539 557. Allen, F., Qian, J., & Qian, M. (2005). Law, finance, and economic growth in China. Journal of Financial Economics, 77(1), 57 116. Allmon, D. E., & Grant, J. (1990). Real estate sales agents and the code of ethics: A voice stress analysis. Journal of Business Ethics, 9(10), 807 812.

229

230

REFERENCES

American Institute of CPAs. (2013). IFRS FAQs: International Financial Reporting Standards. Retrieved from http://www.ifrs.com/ifrs_faqs.html. Accessed on December 27, 2013. Anderson, D. M. (2000). Taking stock in China: Company disclosure and information in China’s stock markets. Georgetown Law Journal, 88, 1919. Aoki, M. (1994). The Japanese firm as a system of attributes: A survey and research agenda. In M. Aoki & R. Dore (Eds.), The Japanese firm: Sources of competitive strength (pp. 11 40). Oxford: Oxford University Press. APESB. (2010). APES 110 code of ethics for professional accountants. Accounting Professional and Ethical Standards Board, Australia. Armstrong, C. S., Barth, M. E., Jagolinzer, A. D., & Riedl, E. J. (2010). Market reaction to the adoption of IFRS in Europe. The Accounting Review, 85(1), 31 61. Armstrong, C. S., Guay, W. R., & Weber, J. P. (2010). The role of information and financial reporting in corporate governance and debt contracting. Journal of Accounting and Economics, 50(2), 179 234. Ashbaugh, H., LaFond, R., & Mayhew, B. W. (2003). Do nonaudit services compromise auditor independence? Further evidence. The Accounting Review, 78(3), 611 639. ASX. (2010). Corporate governance principles and recommendations with 2010 amendments. Australian Securities Exchange, Australia. Atkinson, P., & Silverman, D. (1997). Kundera’s immortality: The interview society and the invention of the self. Qualitative Inquiry, 3(3), 304 325. Babbie, E. (2001). The practice of social research. Belmont, CA: Wadsworth Publishing. Bai, Z. L. (1988). Accounting in the People’s Republic of China Contemporary situations and issues. In Recent accounting and economic developments in the Far East (pp. 27 50). Springfield, MA: Center for International Education and Research in Accounting, University of Illinois. Baker, C. R., Biondi, Y., & Zhang, Q. (2010). Disharmony in international accounting standards setting: The Chinese approach to accounting for business combinations. Critical Perspectives on Accounting, 21(2), 107 117. Balachandran, K. R., Dossi, A., & Van Der Stede, W. A. (2010). Corporate governance research in “The Rest of the World”. Journal of Accounting, Auditing & Finance, 25(4), 523 529. Ball, R., Robin, A., & Wu, J. S. (2003). Incentives versus standards: Properties of accounting income in four East Asian countries. Journal of Accounting and Economics, 36(1), 235 270. Ball, R., & Shivakumar, L. (2005). Earnings quality in UK private firms: Comparative loss recognition timeliness. Journal of Accounting and Economics, 39(1), 83 128. Basioudis, I. G., Papakonstantinou, E., & Geiger, M. A. (2008). Audit fees, non-audit fees and auditor going-concern reporting decisions in the United Kingdom. Abacus, 44(3), 284 309. Baum, J. A., & Oliver, C. (1991). Institutional linkages and organizational mortality. Administrative Science Quarterly, 36(2), 187 218. Beasley, M. S., Carcello, J. V., Hermanson, D. R., & Lapides, P. D. (2000). Fraudulent financial reporting: Consideration of industry traits and corporate governance mechanisms. Accounting Horizons, 14(4), 441 454. Beasley, M. S., Carcello, J. V., Hermanson, D. R., & Neal, T. L. (2009). The audit committee oversight process. Contemporary Accounting Research, 26(1), 65 122.

References

231

Beatty, R. P. (1989). Auditor reputation and the pricing of initial public offerings. Accounting Review, 64, 693 709. Bedard, J., Chtourou, S. M., & Courteau, L. (2004). The effect of audit committee expertise, independence, and activity on aggressive earnings management. Auditing: A Journal of Practice & Theory, 23(2), 13 35. Bedard, J. C., Deis, D. R., Curtis, M. B., & Jenkins, J. G. (2008). Risk monitoring and control in audit firms: A research synthesis. Auditing: A Journal of Practice & Theory, 27(1), 187 218. Bell, D. A. (2010). China’s new Confucianism: Politics and everyday life in a changing society. Princeton, NJ: Princeton University Press. Berg, B. L. (2004). Qualitative research methods for the social sciences (Vol. 5). Boston, MA: Pearson. Berle, A. A. (2004). The impact of the corporation on classical theory. In T. Clarke (Ed.), Theories of corporate governance: The philosophical foundations of corporate governance. New York, NY: Routledge. Berle, A. A., & Means, G. G. C. (1932). The modern corporation and private property. New York, NY: Transaction Books. Bhabra, H. S., Liu, T., & Tirtiroglu, D. (2008). Capital structure choice in a nascent market: Evidence from listed firms in China. Financial Management, 37(2), 341 364. Biondi, Y., & Zhang, Q. (2007). Accounting for the Chinese context: A comparative analysis of international and Chinese accounting standards focusing on business combinations. Socio-Economic Review, 5(4), 695 724. Black, B. S., De Carvalho, A. G., & Gorga, E´. (2012). What matters and for which firms for corporate governance in emerging markets? Evidence from Brazil (and other BRIK countries). Journal of Corporate Finance, 18(4), 934 952. Blismas, N. G., & Dainty, A. R. (2003). Computer-aided qualitative data analysis: Panacea or paradox? Building Research & Information, 31(6), 455 463. Bloom, R., & Naciri, M. A. (1989). Accounting standard setting and culture: A comparative analysis of the United States, Canada, England, West Germany, Australia, New Zealand, Sweden, Japan and Switzerland. The International Journal of Accounting, 24(1), 70 97. Bloomberg News. (2010). China overtakes Japan as world’s second-biggest economy. Bloomberg News, August 16. Retrieved from http://www.bloomberg.com/news Blouin, J., Grein, B. M., & Rountree, B. R. (2007). An analysis of forced auditor change: The case of former Arthur Andersen clients. The Accounting Review, 82(3), 621 650. Boland, L. A. (1979). Knowledge and the role of institutions in economic theory. Journal of Economic Issues, 13, 957 972. Bond, M. H., & Hwang, K. (1986). The social psychology of Chinese people. In M. H. Bond (Ed.), The psychology of the Chinese people (pp. 213 266). New York, NY: Oxford University Press. Boone, J. P., Khurana, I. K., & Raman, K. K. (2008). Audit firm tenure and the equity risk premium. Journal of Accounting, Auditing & Finance, 23(1), 115 140. Borman, K. M., LeCompte, M. D., & Goetz, J. P. (1986). Ethnographic and qualitative research design and why it doesn’t work. American Behavioral Scientist, 30(1), 42 57. Bosch, H. (1993). Corporate practices and conduct. Melbourne: Information Australia. Bosch, H. (1995). Corporate practices and conduct. Melbourne: Pitman.

232

REFERENCES

Botzem, S., & Quack, S. (2009). (No) limits to Anglo-American accounting? Reconstructing the history of the international accounting standards committee: A review article. Accounting, Organizations and Society, 34(8), 988 998. Bowen, R. M., Rajgopal, S., & Venkatachalam, M. (2008). Accounting discretion, corporate governance, and firm performance. Contemporary Accounting Research, 25(2), 351 405. Braendle, U. C., Gasser, T., & Noll, J. (2005). Corporate governance in China Is economic growth potential hindered by Guanxi? Business and Society Review, 110(4), 389 405. Brandt, L., & Li, H. (2003). Bank discrimination in transition economies: Ideology, information, or incentives? Journal of Comparative Economics, 31(3), 387 413. Braun, G. P., & Rodriguez, R. P., Jr. (2008). Earnings management and accounting values: A test of Gray (1988). Journal of International Accounting Research, 7(2), 1 23. Brignall, S., & Modell, S. (2000). An institutional perspective on performance measurement and management in the ‘new public sector’. Management Accounting Research, 11(3), 281 306. Bryman, A. (2012). Social research methods. Oxford: Oxford University Press. Buck, T. (2003). Modern Russian corporate governance: Convergent forces or product of Russia’s history? Journal of World Business, 38(4), 299 313. Burchell, S., Clubb, C., Hopwood, A., Hughes, J., & Nahapiet, J. (1980). The roles of accounting in organizations and society. Accounting, Organizations and Society, 5(1), 5 27. Burgstahler, D. C., Hail, L., & Leuz, C. (2006). The importance of reporting incentives: Earnings management in European private and public firms. The Accounting Review, 81(5), 983 1016. Burns, J. (2000). The dynamics of accounting change inter-play between new practices, routines, institutions, power and politics. Accounting, Auditing & Accountability Journal, 13(5), 566 596. Burns, J., & Scapens, R. W. (2000). Conceptualizing management accounting change: An institutional framework. Management Accounting Research, 11(1), 3 25. Bushman, R. M., Indjejikian, R. J., & Smith, A. (1996). CEO compensation: The role of individual performance evaluation. Journal of Accounting and Economics, 21(2), 161 193. Bushman, R. M., & Piotroski, J. D. (2006). Financial reporting incentives for conservative accounting: The influence of legal and political institutions. Journal of Accounting and Economics, 42(1), 107 148. Bushman, R. M., & Smith, A. J. (2001). Financial accounting information and corporate governance. Journal of Accounting and Economics, 32(1), 237 333. Cadbury, A. (1992). Report of the committee on the financial aspects of corporate governance. London: Gee Publishing. Cadbury, A. (2006). The rise of corporate governance. In M. J. Epstein & K. O. Hanson (Eds.), The accountable corporation: Corporate governance (Vol. 1, pp. 15 43). Westport, CT: Praeger Publishers. Cahan, S., Emanuel, D., Hay, D., & Wong, N. (2008). Non-audit fees, long-term auditor client relationships and earnings management. Accounting & Finance, 48(2), 181 207. Cai, H. (2007). Bonding, law enforcement and corporate governance in China. Stanford Journal of Law, Business, and Finance, 13, 82. CalPERS. (1999). The CalPERS corporate governance guidelines. Corporate Governance: An International Review, 7(2), 218 223. Carcello, J. V., & Nagy, A. L. (2004). Audit firm tenure and fraudulent financial reporting. Auditing: A Journal of Practice & Theory, 23(2), 55 69.

References

233

Carcello, J. V., & Neal, T. L. (2000). Audit committee composition and auditor reporting. The Accounting Review, 75(4), 453 467. Carcello, J. V., & Neal, T. L. (2003). Audit committee characteristics and auditor dismissals following “new” going-concern reports. The Accounting Review, 78(1), 95 117. Carey, P., & Simnett, R. (2006). Audit partner tenure and audit quality. The Accounting Review, 81(3), 653 676. Chan, K. H., Lin, K. Z., & Mo, P. L. L. (2003). An empirical study on the impact of culture on audit-detected accounting errors. Auditing: A Journal of Practice & Theory, 22(2), 281 295. Chan, K. H., Lin, K. Z., & Wong, B. (2010). The impact of government ownership and institutions on the reporting behavior of local auditors in China. Journal of International Accounting Research, 9(2), 1 20. Chand, P. (2005). Impetus to the success of harmonization: The case of South Pacific Island nations. Critical Perspectives on Accounting, 16(3), 209 226. Chandler, R. A. (1997). Taking responsibility: The early demand for institutional action to define an auditor’s duties. International Journal of Auditing, 1(3), 165 174. Chen, A. (2009). Corporate governance in Russia and some points of comparison with China. Chinese Economy, 42(3), 41 59. Chen, C. J., Chen, S., & Su, X. (2001). Is accounting information value-relevant in the emerging Chinese stock market? Journal of International Accounting, Auditing and Taxation, 10(1), 1 22. Chen, C. J., Su, X., & Wu, X. (2007). Market competitiveness and big 5 pricing: Evidence from China’s binary market. The International Journal of Accounting, 42(1), 1 24. Chen, C. Y., Lin, C. J., & Lin, Y. C. (2008). Audit partner tenure, audit firm tenure, and discretionary accruals: Does long auditor tenure impair earnings quality? Contemporary Accounting Research, 25(2), 415 445. Chen, G., Firth, M., Gao, D. N., & Rui, O. M. (2005). Is China’s securities regulatory agency a toothless tiger? Evidence from enforcement actions. Journal of Accounting and Public Policy, 24(6), 451 488. Chen, G., Firth, M., Gao, D. N., & Rui, O. M. (2006). Ownership structure, corporate governance, and fraud: Evidence from China. Journal of Corporate Finance, 12(3), 424 448. Chen, J. (2001). Ownership structure as corporate governance mechanism: Evidence from Chinese listed companies. Economics of Planning, 34(1 2), 53 72. Chen, J. J. (2005). Corporatisation of China’s state-owned enterprises and corporate governance. In D. Brown & A. MacBean (Eds.), Challenges for China’s development: An enterprise perspective (pp. 58 71). Abingdon, UK: Routledge. Chen, J. J., & Cheng, P. (2007). Corporate governance and the harmonisation of Chinese accounting practices with IFRS practices. Corporate Governance: An International Review, 15(2), 284 293. Chen, J. J., & Zhang, H. (2010). The impact of regulatory enforcement and audit upon IFRS compliance Evidence from China. European Accounting Review, 19(4), 665 692. Chen, J. M. (1997). Drawing on experiences of international practices in setting China’s independent auditing standards. Accounting Research, 6, 6 15. Chen, K. C., & Yuan, H. (2004). Earnings management and capital resource allocation: Evidence from China’s accounting-based regulation of rights issues. The Accounting Review, 79(3), 645 665.

234

REFERENCES

Chen, S., Sun, S. Y., & Wu, D. (2010). Client importance, institutional improvements, and audit quality in China: An office and individual auditor level analysis. The Accounting Review, 85(1), 127 158. Chen, S., Sun, Z., & Wang, Y. (2002). Evidence from China on whether harmonized accounting standards harmonize accounting practices. Accounting Horizons, 16(3), 183 197. Chen, S., Wang, Y., & Zhao, Z. (2009). Regulatory incentives for earnings management through asset impairment reversals in China. Journal of Accounting, Auditing & Finance, 24(4), 589 620. Chen, Y., Chen, C., & Chen, W. (2009). The impact of related party transactions on the operational performance of listed companies in China. Journal of Economic Policy Reform, 12(4), 285 297. Chen, Y., Jubb, P., & Tran, A. (1997). Problems of accounting reform in the People’s Republic of China. The International Journal of Accounting, 32(2), 139 153. Chen, Z. (2003). Capital markets and legal development: The China case. China Economic Review, 14(4), 451 472. Cheng, H. (2008). Insider trading in China: The case for the Chinese securities regulatory commission. Journal of Financial Crime, 15(2), 165 178. Cheng, S. S., & Guo, Y. X. (2001). Recalling the bookkeeping method debate in the 20th century (in Chinese). Shanghai Accounting, 12, 3 6. Cheng, Y. (2008). Liberalism in contemporary China: Ten years after its ‘Resurface’. Journal of Contemporary China, 17(55), 383 400. Cheung, Y.-L., Jiang, P., Limpaphayom, P., & Lu, T. (2008). Does corporate governance matter in China? China Economic Review, 19(3), 460 479. Cheung, Y.-L., Jing, L., Lu, T., Rau, P. R., & Stouraitis, A. (2009). Tunneling and propping up: An analysis of related party transactions by Chinese listed companies. Pacific-Basin Finance Journal, 17(3), 372 393. China Securities Daily. (2005). A survey and reflection on China’s independent director system (in Chinese). China Securities Daily, July 28. China Securities Journal. (2007). Three listed companies financial fraud uncovered. China Securities Journal, December 8. Chinese Reform and Development Report Expert Group. (1995). Chinese reform and development report (in Chinese). Beijing: China Financial & Economic Publishing House. Chizema, A., & Buck, T. (2006). Neo-institutional theory and institutional change: Towards empirical tests on the “Americanization” of German executive pay. International Business Review, 15(5), 488 504. Choi, C. J., Raman, M., Usoltseva, O., & Lee, S. H. (1999). Political embeddedness in the new triad: Implications for emerging economies. MIR: Management International Review, 39, 257 275. Choi, J. H., Kim, J. B., Liu, X., & Simunic, D. A. (2008). Audit pricing, legal liability regimes, and big 4 premiums: Theory and cross-country evidence. Contemporary Accounting Research, 25(1), 55 99. Chow, L. M.-y., Chau, G. K.-k., & Gray, S. J. (1995). Accounting reforms in China: Cultural constraints on implementation and development. Accounting and Business Research, 26(1), 29 49. Chua, W. F. (1986). Radical developments in accounting thought. Accounting Review, 61, 601 632.

References

235

Chua, W. F. (1996). Issues in substantive areas of research: Field research in accounting. Melbourne: Victoria University of Technology, Department of Accountancy and Law. Chua, W. F., & Taylor, S. L. (2008). The rise and rise of IFRS: An examination of IFRS diffusion. Journal of Accounting and Public Policy, 27(6), 462 473. CICPA. (2002). Guideline of ethics for Chinese certified public accountants. Beijing: Chinese Institute of Certified Public Accountants. CICPA. (2010a). 2010 top 100 accounting firms assessment report (in Chinese). Beijing: Chinese Institute of Certified Public Accountants. CICPA. (2010b). Code of ethics for Chinese certified public accountants. Beijing: Chinese Institute of Certified Public Accountants. CICPA. (2012). CICPA overview. Retrieved from http://www.cicpa.org.cn/introcicpa/about/ 201210/t20121021_35705.html. Accessed on December, 29 2012. Clark, B. R. (1960). The open door college: A case study. New York, NY: McGraw-Hill. Clark, B. R. (1972). The organizational saga in higher education. Administrative Science Quarterly, 17, 178 184. Clarke, D. (2006). The independent director in Chinese corporate governance. Delaware Journal of Corporate Law, 31(1), 125 228. CLERP. (1997). Director’s duties and corporate governance: Facilitating innovation and protecting investors. Proposals for Reform: Paper No. 3. Canberra: Australian Government Publishing Service. Coffee, J. C., Jr. (2000). Do norms matter A cross-country evaluation. University of Pennsylvania Law Review, 149, 2151. Coffee, J. C., Jr. (2006). Gatekeepers: The professions and corporate governance. New York, NY: Oxford University Press. Collier, P. M. (2001). The power of accounting: A field study of local financial management in a police force. Management Accounting Research, 12(4), 465 486. Cooper, B. J., Chow, L., & Wei, T. Y. (2002). The development of auditing standards and the certified public accounting profession in China. Managerial Auditing Journal, 17(7), 383 389. Corbin, J., & Strauss, A. (2008). Basics of qualitative research: Techniques and procedures for developing grounded theory. Thousand Oaks, CA: Sage. Covaleski, M. A., & Dirsmith, M. W. (1990). Dialectic tension, double reflexivity and the everyday accounting researcher: On using qualitative methods. Accounting, Organizations and Society, 15(6), 543 573. Crotty, M. (1998). The foundations of social research: Meaning and perspective in the research process. London: Sage. Crutchley, C. E., Jensen, M. R., & Marshall, B. B. (2007). Climate for scandal: Corporate environments that contribute to accounting fraud. Financial Review, 42(1), 53 73. CSRC. (2001). Guidelines for introducing independent directors to the board of directors of listed companies. China Securities Regulatory Commission, China. CSRC. (2002). Code of corporate governance for listed companies in China. China Securities Regulatory Commission, China. Cuervo, A. (2002). Corporate governance mechanisms: A plea for less code of good governance and more market control. Corporate Governance: An International Review, 10(2), 84 93. Cuijpers, R., & Buijink, W. (2005). Voluntary adoption of non-local GAAP in the European Union: A study of determinants and consequences. European Accounting Review, 14(3), 487 524.

236

REFERENCES

Cumming, D., & Hou, W. (2014). Valuation of restricted shares by conflicting shareholders in the split share structure reform. The European Journal of Finance, 20, 778 802. Dane, F. C. (1990). Research methods. Thomson Brooks. Davis, S. M., & Hollie, D. (2008). The impact of nonaudit service fee levels on investors’ perception of auditor independence. Behavioral Research in Accounting, 20(1), 31 44. DeAngelo, L. E. (1988). Managerial competition, information costs, and corporate governance: The use of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10(1), 3 36. Dee, C. C., Lulseged, A., & Nowlin, T. S. (2006). Prominent audit clients and the relation between discretionary accruals and non-audit service fees. Advances in Accounting, 22, 123 148. Dees, S. (1998). Foreign direct investment in China: Determinants and effects. Economics of Planning, 31(2 3), 175 194. DeFond, M. L., Wong, T. J., & Li, S. (1999). The impact of improved auditor independence on audit market concentration in China. Journal of Accounting and Economics, 28(3), 269 305. Denis, D. K., & McConnell, J. J. (2003). International corporate governance. Journal of Financial and Quantitative Analysis, 38(1), 1 36. Dent, J. F. (1991). Accounting and organizational cultures: A field study of the emergence of a new organizational reality. Accounting, Organizations and Society, 16(8), 705 732. Denzin, N. K. (2009). The research act: A theoretical introduction to sociological methods. Transaction Publishers. Denzin, N. K., & Lincoln, Y. S. (1994). Handbook of qualitative research. London: Sage. Denzin, N. K., & Lincoln, Y. S. (2008). Collecting and interpreting qualitative materials (Vol. 3). London: Sage. DeZoort, F. T., & Salterio, S. E. (2001). The effects of corporate governance experience and financial-reporting and audit knowledge on audit committee members’ judgments. Auditing: A Journal of Practice & Theory, 20(2), 31 47. DiMaggio, P. J., & Powell, W. (1983). The iron cage revisited: Institutional isomorphism and collective rationality in organizational fields. American Sociological Review, 48(2), 147 160. DiMaggio, P. J., & Powell, W. (1991). Introduction. In W. Powell & P. J. DiMaggio (Eds.), The new institutionalism in organizational analysis (pp. 1 38). London: The University of Chicago Press. Ding, Y., & Su, X. (2008). Implementation of IFRS in a regulated market. Journal of Accounting and Public Policy, 27(6), 474 479. Diplock Ao, J. (2006). IOSCO emerging markets committee luncheon address. Shanghai: Securities Commission. Djankov, S., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2008). The law and economics of self-dealing. Journal of Financial Economics, 88(3), 430 465. Djankov, S., McLiesh, C., & Shleifer, A. (2007). Private credit in 129 countries. Journal of Financial Economics, 84(2), 299 329. Doidge, C., Andrew Karolyi, G., & Stulz, R. M. (2007). Why do countries matter so much for corporate governance? Journal of Financial Economics, 86(1), 1 39. Doupnik, T. S. (2008). Influence of culture on earnings management: A note. Abacus, 44(3), 317 340. Doupnik, T. S., & Perera, H. (2011). International accounting. New York, NY: McGraw-Hill.

References

237

Du Plessis, J., Hargovan, A., & Bagaric, M. (2011). Principles of contemporary corporate governance. New York: Cambridge University Press. Dunfee, T. W., & Warren, D. E. (2001). Is guanxi ethical? A normative analysis of doing business in China. Journal of Business Ethics, 32(3), 191 204. El’fred, H., & Koh, H. C. (2001). The influence of organizational and code-supporting variables on the effectiveness of a code of ethics. Teaching Business Ethics, 5(4), 357 373. Emerson, R. (1972). Exchange theory, Part I: A psychological basis for social exchange. Part II: Exchange relations and networks. In J. Berger, M. Zelditch, & B. Henderson (Eds.), Sociological theories in progress (pp. 38 87). Boston, MA: Houghton Mifflin. Epstein, M. J. (2012). Governing globally: Convergence, differentiation, or bridging. Studies in Managerial and Financial Accounting, 25, 3 39. Epstein, M. J., & Roy, M. (2005). Evaluating and monitoring CEO performance: Evidence from US compensation committee reports. Corporate Governance, 5(4), 75 87. Epstein, M. J., & Roy, M. (2007). The strategic management of information for boards. Mississauga: Society of Management Accountants of Canada, American Institute of Certified Public Accountants, and Chartered Institute of Management Accountants. Erchinger, H., & Melcher, W. (2007). Convergence between US GAAP and IFRS: Acceptance of IFRS by the US Securities and Exchange Commission (SEC). Accounting in Europe, 4(2), 123 139. Ezzamel, M., & Xiao, J. Z. (2007). Regulating accounting in foreign invested firms in China: From Mao to Deng. Edinburgh: The Institute of Chartered Accountants of Scotland. Ezzamel, M., Xiao, J. Z., & Pan, A. (2007). Political ideology and accounting regulation in China. Accounting, Organizations and Society, 32(7), 669 700. Fan, J. P., Wong, T. J., & Zhang, T. (2007). Politically connected CEOs, corporate governance, and post-IPO performance of China’s newly partially privatized firms. Journal of Financial Economics, 84(2), 330 357. Fan, Y. (2002). Ganxi’s consequences: Personal gains at social cost. Journal of Business Ethics, 38(4), 371 380. Fan, Y. (2004). The transfer of western management to China: Context, content and constraints. In C. Grey & E. Antonacopoulou (Eds.), Essential readings in management learning (pp. 321 342). London: Sage. Fanto, J. A. (1996). Absence of cross-cultural communication: SEC mandatory disclosure and foreign corporate governance. Northwestern Journal of International Law & Business, 17, 119. Farber, D. B. (2005). Restoring trust after fraud: Does corporate governance matter? The Accounting Review, 80(2), 539 561. Fay, B. (1987). Critical social science: Liberation and its limits. New York, NY: Cornell University Press. Fei, X. (1992). From the soil: The foundations of Chinese society. Berkeley, CA: University of California Press. Feinerman, J. V. (2007). New hope for corporate governance in China? China Quarterly, 191, 590 612. Felix, W. L., Gramling, A. A., & Maletta, M. J. (2005). The influence of nonaudit service revenues and client pressure on external auditors’ decisions to rely on internal audit. Contemporary Accounting Research, 22(1), 31 53. Fetterman, D. M. (2010). Ethnography: Step-by-step. Thousand Oaks, CA: Sage.

238

REFERENCES

Firth, M., Fung, P. M., & Rui, O. M. (2007a). How ownership and corporate governance influence chief executive pay in China’s listed firms. Journal of Business Research, 60(7), 776 785. Firth, M., Fung, P. M., & Rui, O. M. (2007b). Ownership, two-tier board structure, and the informativeness of earnings Evidence from China. Journal of Accounting and Public Policy, 26(4), 463 496. Firth, M., Rui, O. M., & Wu, X. (2009). The timeliness and consequences of disseminating public information by regulators. Journal of Accounting and Public Policy, 28(2), 118 132. Fontana, A., & Frey, J. H. (1994). Interviewing: The art of science. In N. K. Denzin & Y. S. Lincoln (Eds.), Handbook of qualitative research (pp. 361 376). London: Sage. Fontana, A., & Frey, J. H. (2003). The interview: From structured questions to negotiated text. In N. K. Denzin & Y. Lincoln (Eds.), Collecting and interpreting qualitative materials (pp. 61 106). Thousand Oaks, CA: Sage. Francis, J., Schipper, K., & Vincent, L. (2005). Earnings and dividend informativeness when cash flow rights are separated from voting rights. Journal of Accounting and Economics, 39(2), 329 360. Francis, J. R., & Wang, D. (2008). The joint effect of investor protection and big 4 audits on earnings quality around the world. Contemporary Accounting Research, 25(1), 157 191. Franks, J., & Mayer, C. (1997). Corporate ownership and control in the UK, Germany, and France. Journal of Applied Corporate Finance, 9(4), 30 45. FRC. (2008). The combined code on corporate governance. Financial Reporting Council, United Kingdom. Freeman, R. E. (2010). Strategic management: A stakeholder approach. Cambridge: Cambridge University Press. Friedman, M. (2009). Capitalism and freedom. Chicago, IL: University of Chicago Press. Fukao, M. (1995). Financial integration, corporate governance, and the performance of multinational companies. Washington, DC: Brookings Institution Press. Gabrielsen, G., Gramlich, J. D., & Plenborg, T. (2002). Managerial ownership, information content of earnings, and discretionary accruals in a non-US setting. Journal of Business Finance & Accounting, 29(7 8), 967 988. Gallhofer, S., & Haslam, J. (2007). Exploring social, political and economic dimensions of accounting in the global context: The international accounting standards board and accounting disaggregation. Socio-Economic Review, 5(4), 633 664. Gallhofer, S., Haslam, J., & Kamla, R. (2011). The accountancy profession and the ambiguities of globalisation in a post-colonial, Middle Eastern and Islamic context: Perceptions of accountants in Syria. Critical Perspectives on Accounting, 22(4), 376 395. Garcı´ a-Herrero, A., Gavila´, S., & Santaba´rbara, D. (2009). What explains the low profitability of Chinese banks? Journal of Banking & Finance, 33(11), 2080 2092. Ge, J. S. (1980). How to understand the main attitude of accounting (in Chinese). Economic Issues in China, 5, 42 45. Ge, J. S. (1981). On the continuation of accounting (in Chinese). Journal of Xiamen University, 3, 76 86. Geiger, M. A., O’Connell, B. T., Clikeman, P. M., Ochoa, E., Witkowski, K., & Basioudis, I. (2006). Perceptions of earnings management: The effects of national culture. Advances in International Accounting, 19, 175 199. Gendron, Y. (2009). Discussion of “The audit committee oversight process”: Advocating openness in accounting research. Contemporary Accounting Research, 26(1), 123 134.

References

239

Gendron, Y., & Bedard, J. (2006). On the constitution of audit committee effectiveness. Accounting, Organizations and Society, 31(3), 211 239. Ghosh, A., & Moon, D. (2005). Auditor tenure and perceptions of audit quality. The Accounting Review, 80(2), 585 612. Glendon, M. A., Gordon, M. W., & Osakwe, C. (1994). Comparative legal traditions: Text, materials and cases on the civil and common law traditions, with special references to French, German and English. St. Paul, MN: West Publishing. Goergen, M., Martynova, M., & Renneboog, L. (2005). Corporate governance convergence: Evidence from takeover regulation reforms in Europe. Oxford Review of Economic Policy, 21(2), 243 268. Goldman, M. (2005). From comrade to citizen: The struggle for political rights in China. Washington, DC: Harvard University Press. Goodwin, J., & Seow, J. L. (2000). Corporate governance in Singapore: Perceptions of investors, directors, and auditors. Accounting and Business Review, 7(1), 39 68. Gourevitch, P., Carney, R., & Hawes, M. (2003). Testing political explanations of corporate governance patterns. Paper presented at the Conference on Economics, Political Institutions, and Financial Markets, Social Science History Institute, Stanford University. Graves, W. B. (1924). Codes of ethics for business and commercial organization. International Journal of Ethics, 35(1), 41 59. Gray, S. J. (1988). Towards a theory of cultural influence on the development of accounting systems internationally. Abacus, 24(1), 1 15. Greenwood, R., & Hinings, C. R. (1996). Understanding radical organizational change: Bringing together the old and the new institutionalism. Academy of Management Review, 21(4), 1022 1054. Gregory, H. (2006). International corporate governance: A gradual if incomplete convergence. In M. J. Epstein & K. O. Hanson (Eds.), The accountable corporation: Corporate governance (Vol. 1, pp. 183 200). Westport, CT: Praeger Publishers. Gruchy, A. G. (1967). Modern economic thought: The American contribution. New York, NY: AM Kelley. Guba, E. G., & Lincoln, Y. S. (1994). Competing paradigms in qualitative research. In N. K. Denzin & Y. S. Lincoln (Eds.), Handbook of qualitative research (pp. 105 117). Thousand Oaks, CA: Sage. Gul, F. A., Jaggi, B. L., & Krishnan, G. V. (2007). Auditor independence: Evidence on the joint effects of auditor tenure and nonaudit fees. Auditing: A Journal of Practice & Theory, 26(2), 117 142. Gul, F. A., Kim, J.-B., & Qiu, A. A. (2010). Ownership concentration, foreign shareholding, audit quality, and stock price synchronicity: Evidence from China. Journal of Financial Economics, 95(3), 425 442. Gul, F. A., Sami, H., & Zhou, H. (2009). Auditor disaffiliation program in China and auditor independence. Auditing: A Journal of Practice & Theory, 28(1), 29 51. Guo, D. Y. (1986). The history of accounting development (in Chinese). Beijing: Chinese Broadcasting and Television University Press. Guo, D. Y. (1988). Chinese accounting history (in Chinese). Beijing: China Finance and Economics Publishing House. Guo, D. Y. (1999). A review of major accounting events in the 20th century (in Chinese). Communication of Finance and Accounting, 2, 1 4.

240

REFERENCES

Guo, X., & Zhang, P. (2008). The debate of economic reform for 30 years in China: Review and reflections (in Chinese). Wuhan: Wuhan University. Hackethal, A., Schmidt, R. H., & Tyrell, M. (2005). Banks and German corporate governance: On the way to a capital market-based system? Corporate Governance: An International Review, 13(3), 397 407. Hanafin, J. J. (2002). Morality and the market in China: Some contemporary views. Business Ethics Quarterly, 12, 1 18. Hansmann, H., & Kraakman, R. (2000). End of history for corporate law. Georgetown Law Journal, 89, 439. Hao, Z. P. (1999). Regulation and organisation of accountants in China. Accounting, Auditing & Accountability Journal, 12(3), 286 302. Haskins, C. W. (1904). Business education and accountancy. New York, NY: Harper & brothers. Haw, I. M., Qi, D., & Wu, W. (2000). Timeliness of annual report releases and market reaction to earnings announcements in an emerging capital market: The case of China. Journal of International Financial Management & Accounting, 11(2), 108 131. Hay, D., Knechel, R., & Li, V. (2006). Non-audit services and auditor independence: New Zealand evidence. Journal of Business Finance & Accounting, 33(5 6), 715 734. Heidhues, E., & Patel, C. (Eds.). (2012). Globalisation and contextual factors in accounting: The case of Germany (Vol. 23). Studies in Managerial and Financial Accounting. Bingley, UK: Emerald Group Publishing Limited. Hillier, D., & McColgan, P. (2008). An analysis of majority owner-managed companies in the UK. Accounting & Finance, 48(4), 603 623. Hilmer, F. G. (1998). Strictly boardroom: Improving governance to enhance company performance. Melbourne: Information Australia. Hirsch, P. M., & Lounsbury, M. (1997). Ending the family quarrel toward a reconciliation of “Old” and “New” institutionalisms. American Behavioral Scientist, 40(4), 406 418. Hodder, I. (1994). The interpretation of documents and material culture. In N. K. Denzin & Y. S. Lincoln (Eds.), Handbook of qualitative research (pp. 393 402). London: Sage. Hofstede, G. (1980). Culture’s consequences: International differences in work-related values. Beverly Hills, CA: Sage. Hofstede, G. (1991). Cultures and organizations: Software of the mind. London: McGraw-Hill. Hofstede, G. (2001). Culture’s consequences: Comparing values, behaviors, institutions and organizations across nations. Thousand Oaks, CA: Sage. Hogdson, G. (1988). Economics and institutions: A manifesto for a modern institutional economics. Cambridge: Polity. Holloway, I. (1997). Basic concepts for qualitative research. Oxford: Blackwell Science. Hong, F., Wu, P., & Xiong, H. (2005). Beijing ambitions: An analysis of the Chinese elite sports system and its Olympic strategy for the 2008 Olympic games. The International Journal of the History of Sport, 22(4), 510 529. Hoogervorst, H. (2011). China and IFRS An opportunity for leadership in global financial reporting. Beijing: The International Financial Reporting Standards (IFRS) Foundation and the International Accounting Standards Board (IASB). Hope, O.-K., Kang, T., Thomas, W., & Yoo, Y. K. (2008). Culture and auditor choice: A test of the secrecy hypothesis. Journal of Accounting and Public Policy, 27(5), 357 373. Hopper, T., & Hoque, Z. (2006). Triangulation approaches to accounting research. In Z. Hoque (Ed.), Methodological issues in accounting research: Theories and methods (pp. 477 486). London: Spiramus Press.

References

241

Hopper, T., Storey, J., & Willmott, H. (1987). Accounting for accounting: Towards the development of a dialectical view. Accounting, Organizations and Society, 12(5), 437 456. Hopwood, A. G. (1983). On trying to study accounting in the contexts in which it operates. Accounting, Organizations and Society, 8(2), 287 305. Hopwood, A. G. (1987). The archeology of accounting systems. Accounting, Organizations and Society, 12(3), 207 234. Hopwood, A. G. (2000). Understanding financial accounting practice. Accounting, Organizations and Society, 25(8), 763 766. Hopwood, A. G., & Miller, P. (1994). Accounting as social and institutional practice (Vol. 24). Cambridge: Cambridge University Press. Hoque, Z., & Hopper, T. (1997). Political and industrial relations turbulence, competition and budgeting in the nationalised jute mills of Bangladesh. Accounting and Business Research, 27(2), 125 143. Hoskisson, R. E., Eden, L., Lau, C. M., & Wright, M. (2000). Strategy in emerging economies. Academy of Management Journal, 43(3), 249 267. Hu, H. W., Tam, O. K., & Tan, M. G.-S. (2010). Internal governance mechanisms and firm performance in China. Asia Pacific Journal of Management, 27(4), 727 749. Hua, J., Miesing, P., & Li, M. (2006). An empirical taxonomy of SOE governance in transitional China. Journal of Management & Governance, 10(4), 401 433. Huang, H. (2007). An empirical study of the incidence of insider trading in china. Working Paper. University of New South Wales. Huang, Y. (1998). Agricultural reform in China: Getting institutions right’. Canadian Journal of Agricultural Economics, 46, 257 258. Hudaib, M., & Haniffa, R. (2009). Exploring auditor independence: An interpretive approach. Accounting, Auditing & Accountability Journal, 22(2), 221 246. Hughes, S. B., Sander, J. F., Higgs, S. D., & Cullinan, C. P. (2009). The impact of cultural environment on entry-level auditors’ abilities to perform analytical procedures. Journal of International Accounting, Auditing and Taxation, 18(1), 29 43. Hui, C. H., & Triandis, H. C. (1985). Measurement in cross-cultural psychology a review and comparison of strategies. Journal of Cross-cultural Psychology, 16(2), 131 152. Hussain, M. M., & Gunasekaran, A. (2002). An institutional perspective of non-financial management accounting measures: A review of the financial services industry. Managerial Auditing Journal, 17(9), 518 536. Hussain, M. M., & Hoque, Z. (2002). Understanding non-financial performance measurement practices in Japanese banks: A new institutional sociology perspective. Accounting, Auditing & Accountability Journal, 15(2), 162 183. Hwang, D., Staley, B., Chen, Y. T., & Lan, J. S. (2008). Confucian culture and whistleblowing by professional accountants: An exploratory study. Managerial Auditing Journal, 23(5), 504 526. IASB. (2010). Conceptual framework for financial reporting 2010. London: International Accounting Standards Board. IFAC. (2004). Prequalification education, assessment of professional competence and experience requirements of professional accountants. New York, NY: International Federation of Accountants. IFAC. (2006). Code of ethics for professional accountants. Retrieved From http://www.ifac.org/ Members/DownLoads/2005_Code_of_Ethics.pdf. Accessed on January 21, 2009.

242

REFERENCES

IFAC. (2010). Chinese auditing standards board and international auditing and assurance standards board issue joint statement regarding convergence of international standards. Retrieved from http://www.ifac.org/news-events/2010-11/chinese-auditing-standardsboard-and-international-auditing-and-assurance-standa. Accessed on April 22, 2011. International Monetary Fund and World Bank. (2005). The standards and codes initiative – Is it effective? And how can it be improved? Retrieved from http://www.worldbank.org/ifa/ ROSC%20review%202005.pdf. Accessed on March 25, 2010. Ip, P. K. (2009). The challenge of developing a business ethics in China. Journal of Business Ethics, 88(1), 211 224. Irvine, H. (2008). The global institutionalization of financial reporting: The case of the United Arab Emirates. Paper presented at the Accounting Forum. Iyer, V. M., & Rama, D. V. (2004). Clients’ expectations on audit judgments: A note. Behavioral Research in Accounting, 16(1), 63 74. Janesick, V. J. (1994). The dance of qualitative research design. In N. K. Denzin & Y. S. Lincoln (Eds.), Handbook of qualitative research. Thousand Oaks, CA: Sage. Jeanjean, T., & Stolowy, H. (2009). Determinants of board members’ financial expertise Empirical evidence from France. The International Journal of Accounting, 44(4), 378 402. Jenkins, D. S., & Velury, U. (2008). Does auditor tenure influence the reporting of conservative earnings? Journal of Accounting and Public Policy, 27(2), 115 132. Jensen, M. C. (2002). Value maximization, stakeholder theory, and the corporate objective function. Business Ethics Quarterly, 12(2), 235 256. Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305 360. Jesover, F., & Kirkpatrick, G. (2005). The revised OECD principles of corporate governance and their relevance to non-OECD countries. Corporate Governance: An International Review, 13(2), 127 136. Ji, X.-D. (2003). Concepts of cost and profit in Chinese agricultural treatises: With special reference to Shengshi Nongshu and Pu Nongshu in the seventeenth century. Accounting, Business & Financial History, 13(1), 69 81. Jian, M., & Wong, T. J. (2010). Propping through related party transactions. Review of Accounting Studies, 15(1), 70 105. Jiang, G., Yue, H., & Zhao, L. (2009). A re-examination of China’s share issue privatization. Journal of Banking & Finance, 33(12), 2322 2332. Joe, J. R., & Vandervelde, S. D. (2007). Do auditor-provided nonaudit services improve audit effectiveness? Contemporary Accounting Research, 24(2), 467 487. Judge, W., & Naoumova, I. (2004). Corporate governance in Russia: What model will it follow? Corporate Governance: An International Review, 12(3), 302 313. Jun Lin, Z., & Chen, F. (2005). Value relevance of international accounting standards harmonization: Evidence from A- and B-share markets in China. Journal of International Accounting, Auditing and Taxation, 14(2), 79 103. Kakabadse, N. K., Kakabadse, A. P., & Yang, C. (2009). The Chinese boardroom: Roles, dynamics, and relationships. In A. P. Kakabadse & N. K. Kakabadse (Eds.), Global boards: One desire, many realities. Basingstoke, UK: Palgrave Macmillan Ltd. Kakabadse, N. K., Tsvetkov, O., Uldatsov, V., & Kakabadse, A. P. (2009). Boards of steel: The role and contribution of the Non-Executive Director (NED). In A. P. Kakabadse & N. K. Kakabadse (Eds.), Global boards: One desire, many realities (pp. 170 196). Basingstoke, UK: Palgrave Macmillan Ltd.

References

243

Kakabadse, N. K., Yang, H., & Sanders, R. (2010). The effectiveness of non-executive directors in Chinese state-owned enterprises. Management Decision, 48(7), 1063 1079. Kang, J. (2007). Chinese bookkeeping development in the ancient time (in Chinese). Retrieved from http://lib.cnki.net/cjfd/CKXX200707027.html. Accessed on December 29, 2013. Kao, J. L., Wu, D., & Yang, Z. (2009). Regulations, earnings management, and post-IPO performance: The Chinese evidence. Journal of Banking & Finance, 33(1), 63 76. Kaplan, S. N. (1997). Corporate governance and corporate performance: A comparison of Germany, Japan, and the US. Journal of Applied Corporate Finance, 9(4), 86 93. Kaptein, M. (2004). Business codes of multinational firms: What do they say? Journal of Business Ethics, 50(1), 13 31. Kealey, B. T., Lee, H. Y., & Stein, M. T. (2007). The association between audit-firm tenure and audit fees paid to successor auditors: Evidence from Arthur Andersen. Auditing: A Journal of Practice & Theory, 26(2), 95 116. Kehoe, J. A. (1995). Exporting insider trading laws: The enforcement of US insider trading laws internationally. Emory International Law Review, 9, 345. Kent, P., Routledge, J., & Stewart, J. (2010). Innate and discretionary accruals quality and corporate governance. Accounting & Finance, 50(1), 171 195. Khanna, T., Kogan, J., & Palepu, K. (2006). Globalization and similarities in corporate governance: A cross-country analysis. Review of Economics and Statistics, 88(1), 69 90. Khurana, I. K., & Raman, K. K. (2006). Do investors care about the auditor’s economic dependence on the client? Contemporary Accounting Research, 23(4), 977 1016. Kinney, W. R., Palmrose, Z. V., & Scholz, S. (2004). Auditor independence, non-audit services, and restatements: Was the US government right? Journal of Accounting Research, 42(3), 561 588. Klein, A. (2002). Audit committee, board of director characteristics, and earnings management. Journal of Accounting and Economics, 33(3), 375 400. Koh, P. S., Laplante, S. K., & Tong, Y. H. (2007). Accountability and value enhancement roles of corporate governance. Accounting & Finance, 47(2), 305 333. Kolk, A., & Van Tulder, R. (2002). The effectiveness of self-regulation: Corporate codes of conduct and child labour. European Management Journal, 20(3), 260 271. Krishnan, J. (2005). Audit committee quality and internal control: An empirical analysis. The Accounting Review, 80(2), 649 675. La Porta, R., Lopez-De-Silanes, F., & Shleifer, A. (1999). Corporate ownership around the world. The Journal of Finance, 54(2), 471 517. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. (2000). Investor protection and corporate governance. Journal of Financial Economics, 58(1), 3 27. La Porta, R., Lopez-de-Silanes, F., Shleifer, A., & Vishny, R. W. (2001). Law and finance. Berlin: Springer. Lai, K.-W. (2009). Audit opinion and disclosure of audit fees. Journal of Accounting, Auditing & Finance, 24(1), 91 114. Lam, W. (2009). China’s political feet of clay. Far Eastern Economic Review, 172(8), 10 14. Langer, F. (2005). China at the OECD. OECD Observer, 251, 41. Larcker, D., & Tayan, B. (2011). Corporate governance matters: A closer look at organizational choices and their consequences. Upper Saddle River, NJ: FT Press. Lau, A. H., & Yang, J. (1990). Auditing in China: Historical perspective and current developments. The International Journal of Accounting, 25(1), 53 62. Lau, C.-M., Fan, D. K., Young, M. N., & Wu, S. (2007). Corporate governance effectiveness during institutional transition. International Business Review, 16(4), 425 448.

244

REFERENCES

Leblanc, R., & Schwartz, M. S. (2007). The black box of board process: Gaining access to a difficult subject. Corporate Governance: An International Review, 15(5), 843 851. LeCompte, M. D., Preissle, J., & Tesch, R. (1993). Ethnography and qualitative design in educational research. San Diego, CA: Academic Press. Lee, B., & Humphrey, C. (2006). More than a numbers game: Qualitative research in accounting. Management Decision, 44(2), 180 197. Lee, C.-W. J. (1987). Accounting infrastructure and economic development. Journal of Accounting and Public Policy, 6(2), 75 85. Lee, S. H., & Yoo, T. (2008). Competing rationales for corporate governance in France: Institutional complementarities between financial markets and innovation systems. Corporate Governance: An International Review, 16(2), 63 76. Leedy, P. D., & Ormrod, J. E. (2001). Practical research: Planning and design. Upper Saddle River, NJ: Pearson Education International. Lehman, G. (2005). A critical perspective on the harmonisation of accounting in a globalising world. Critical Perspectives on Accounting, 16(7), 975 992. Letza, S., Sun, X., & Kirkbride, J. (2004). Shareholding versus stakeholding: A critical review of corporate governance. Corporate Governance: An International Review, 12(3), 242 262. Leung, K. (2008). Chinese culture, modernization, and international business. International Business Review, 17(2), 184 187. Leuz, C., Nanda, D., & Wysocki, P. D. (2003). Earnings management and investor protection: An international comparison. Journal of Financial Economics, 69(3), 505 527. Leuz, C., & Oberholzer-Gee, F. (2006). Political relationships, global financing, and corporate transparency: Evidence from Indonesia. Journal of Financial Economics, 81(2), 411 439. Li, B. Z., & Wang, J. Z. (1989). Chinese accounting history (in Chinese). Beijing: Economic Science Press. Li, C. M. (1982). The accounting system of native banks in Peking and Tientsin. New York, NY: Garland. Li, H., Meng, L., Wang, Q., & Zhou, L.-A. (2008). Political connections, financing and firm performance: Evidence from Chinese private firms. Journal of Development Economics, 87(2), 283 299. Li, J. (2002). Picking up accounting history in China (in Chinese). Journal of Guangxi Financial College, 2, 36 41. Li, L., & Ma, Y. (2010). Adjudication and legal reforms in contemporary China. Journal of Contemporary Criminal Justice, 26(1), 36 52. Li, Z. (1992). The vigor in exemplary Sino-Foreign joint ventures and lessons to be learned (in Chinese). The Journal of World Economy, 6, 44 50. Liebman, B., & Milhaupt, C. J. (2008). Reputational sanctions in China’s securities market. Columbia Law Review, 108(4), 929 983. Lillis, A. M. (1999). A framework for the analysis of interview data from multiple field research sites. Accounting & Finance, 39(1), 79 105. Lin, C. X. (2003). A quiet revolution: An overview of China’s judicial reform. Asian-Pacific Law & Policy Journal, 4(2), 255 319. Lin, J. W., Li, J. F., & Yang, J. S. (2006). The effect of audit committee performance on earnings quality. Managerial Auditing Journal, 21(9), 921 933. Lin, J. Y., & Tan, G. (1999). Policy burdens, accountability, and the soft budget constraint. The American Economic Review, 89(2), 426 431.

References

245

Lin, K. Z., & Chan, K. H. (2000). Auditing standards in China A comparative analysis with relevant international standards and guidelines. The International Journal of Accounting, 35(4), 559 577. Lin, K. Z., & Fraser, I. A. (2008). Auditors’ ability to resist client pressure and culture: Perceptions in China and the United Kingdom. Journal of International Financial Management & Accounting, 19(2), 161 183. Lin, L.-H., & Ho, Y.-L. (2009). Confucian dynamism, culture and ethical changes in Chinese societies A comparative study of China, Taiwan, and Hong Kong. The International Journal of Human Resource Management, 20(11), 2402 2417. Lin, Z. J. (1992). Chinese double-entry bookkeeping before the nineteenth century. The Accounting Historians Journal, 19, 103 122. Lin, Z. J. (1998). Internationalization of public accounting: Chinese experience. Managerial Auditing Journal, 13(2), 84 94. Lin, Z. J., & Chen, F. (2004). An empirical study of audit ‘expectation gap’ in the People’s Republic of China. International Journal of Auditing, 8(2), 93 115. Lin, Z. J., Chen, F., & Tang, Q. (2001). An empirical evaluation of the new system of business accounting in China. Journal of International Accounting, Auditing and Taxation, 10(1), 23 49. Lin, Z. J., & Liu, M. (2009). The impact of corporate governance on auditor choice: Evidence from China. Journal of International Accounting, Auditing and Taxation, 18(1), 44 59. Lin, Z. J., Tang, Q., & Xiao, J. (2003). An experimental study of users’ responses to qualified audit reports in China. Journal of International Accounting, Auditing and Taxation, 12(1), 1 22. Lin, Z. J., Xiao, J. Z., & Tang, Q. (2008). The roles, responsibilities and characteristics of audit committee in China. Accounting, Auditing & Accountability Journal, 21(5), 721 751. Lincoln, Y. S., & Guba, E. G. (1985). Naturalistic inquiry (Vol. 75). Beverly Hills, CA: Sage. Liu, G. S., & Sun, P. (2005). The class of shareholdings and its impacts on corporate performance: A case of state shareholding composition in Chinese public corporations. Corporate Governance: An International Review, 13(1), 46 59. Liu, Q. (2006). Corporate governance in China: Current practices, economic effects and institutional determinants. CESifo Economic Studies, 52(2), 415 453. Liu, Q., & Lu, Z. J. (2007). Corporate governance and earnings management in the Chinese listed companies: A tunneling perspective. Journal of Corporate Finance, 13(5), 881 906. Liu, T.-M. (2005). The case analysis on failures of enterprise internal control in mainland China. Journal of American Academy of Business, Cambridge, 7(1), 92 98. Lo, A. W., Wong, R. M., & Firth, M. (2010). Can corporate governance deter management from manipulating earnings? Evidence from related-party sales transactions in China. Journal of Corporate Finance, 16(2), 225 235. Lo´pez de Silanes, F., La Porta, R., Shleifer, A., & Vishny, R. (1998). Law and finance. Journal of Political Economy, 106, 1113 1155. Lovett, S., Simmons, L. C., & Kali, R. (1999). Guanxi versus the market: Ethics and efficiency. Journal of International Business Studies, 30, 231 247. Lu, W., Ji, X.-d., & Aiken, M. (2009). Governmental influences in the development of Chinese accounting during the modern era. Accounting, Business & Financial History, 19(3), 305 326.

246

REFERENCES

Lu, X., & Enderle, G. (2006). Developing business ethics in China. New York, NY: Palgrave Macmillan. Lubatkin, M., Lane, P. J., Collin, S., & Very, P. (2007). An embeddedness framing of governance and opportunism: Towards a cross-nationally accommodating theory of agency. Journal of Organizational Behavior, 28(1), 43 58. Luo, J.-H., Wan, D.-F., & Cai, D. (2012). The private benefits of control in Chinese listed firms: Do cash flow rights always reduce controlling shareholders’ tunneling? Asia Pacific Journal of Management, 29(2), 499 518. Luo, Y. (1997). Guanxi and performance of foreign-invested enterprises in China: An empirical inquiry. MIR: Management International Review, 37, 51 70. Luo, Y. (2008). The changing Chinese culture and business behavior: The perspective of intertwinement between guanxi and corruption. International Business Review, 17(2), 188 193. Lye, J., Perera, H., & Rahman, A. (2006). Grounded theory: A theory discovery method for accounting research. In Z. Hoque (Ed.), Methodological issues in accounting research: Theories, methods and issues (pp. 129 160). London: Spiramus Press Ltd. Machuga, S., & Teitel, K. (2009). Board of director characteristics and earnings quality surrounding implementation of a corporate governance code in Mexico. Journal of International Accounting, Auditing and Taxation, 18(1), 1 13. MacLullich, K. K., & Sucher, P. (2005). A local realisation of auditor independence construct in Poland: Counteracting ‘iron curtain’ syndrome in academic writing. Critical Perspectives on Accounting, 16(5), 593 612. Maijoor, S. (2012). Public statement at the 2012 IOSCO annual conference. Paris: European Securities and Markets Authority. Manry, D. L., Mock, T. J., & Turner, J. L. (2008). Does increased audit partner tenure reduce audit quality? Journal of Accounting, Auditing & Finance, 23(4), 553 572. Mar, P., & Richter, F. (2003). China: Enabling a new era of changes. Singapore: Wiley. Matoussi, H., & Jardak, M. K. (2012). International corporate governance and finance: Legal, cultural and political explanations. The International Journal of Accounting, 47(1), 1 43. McKendall, M., DeMarr, B., & Jones-Rikkers, C. (2002). Ethical compliance programs and corporate illegality: Testing the assumptions of the corporate sentencing guidelines. Journal of Business Ethics, 37(4), 367 383. McKinnon, J. (1988). Reliability and validity in field research: Some strategies and tactics. Accounting, Auditing & Accountability Journal, 1(1), 34 54. Merriam, S. B. (2009). Qualitative research: A guide to design and implementation. Milton: Wiley. Meyer, J. W., & Rowan, B. (1977). Institutionalized organizations: Formal structure as myth and ceremony. American Journal of Sociology, 83, 340 363. Meyer, J. W., & Scott, W. R. (1983). Organizational environments: Ritual and rationality. Beverly Hills, CA: Sage. Miles, L. (2006). The application of Anglo-American corporate practices in societies influenced by Confucian values. Business and Society Review, 111(3), 305 321. Mir, M. Z., & Rahaman, A. S. (2005). The adoption of international accounting standards in Bangladesh: An exploration of rationale and process. Accounting, Auditing & Accountability Journal, 18(6), 816 841. Modell, S. (2002). Institutional perspectives on cost allocations: Integration and extension. European Accounting Review, 11(4), 653 679.

References

247

MOF. (2006). Accounting standards for business enterprises. Retrieved from http://www.mof. gov.cn/lm2261_1.htm. Accessed on June 30, 2009. MOF. (2013). 2013 syllabus on national examination of certified public accountants Professional level (in Chinese). Beijing: Ministry of Finance. Moll, J., Burns, J., & Major, M. (2006). Institutional theory. In Z. Hoque (Ed.), Methodological issues in accounting research (pp. 183 205). London: Spiramus Press Ltd. Moll, J., & Hoque, Z. (2000). Rationality, new public management and changes in management control system: A study of managing change in an Australian local government setting. Paper presented at the 6th Interdisciplinary Perspectives on Accounting conference, Manchester. Molm, L. D. (1988). The structure and use of power: A comparison of reward and punishment power. Social Psychology Quarterly, 51, 108 122. Morgan, G. (1983). Beyond method: Strategies for social research. London: Sage. Myrdal, G. (1978). Institutional economics. Journal of Economic Issues, 12, 771 783. Nabar, S., & Boonlert-U-Thai, K. (2007). Earnings management, investor protection, and national culture. Journal of International Accounting Research, 6(2), 35 54. Nobes, C. (1984). The development of double entry: Selected essays. New York, NY: Taylor & Francis. Nobes, C. (1998). Towards a general model of the reasons for international differences in financial reporting. Abacus, 34(2), 162 187. Nobes, C., & Parker, R. R. H. (2008). Comparative international accounting. Essex: Pearson Education. Nor-Aziah, A. K., & Scapens, R. W. (2007). Corporatisation and accounting change: The role of accounting and accountants in a Malaysian public utility. Management Accounting Research, 18(2), 209 247. Noronha, C., Zeng, Y., & Vinten, G. (2008). Earnings management in China: An exploratory study. Managerial Auditing Journal, 23(4), 367 385. North, D. C. (1990). Institutions, institutional change and economic performance. Cambridge: Cambridge University Press. NYSE. (2003). Final NYSE corporate governance rules. New York, NY: New York Stock Exchange. NYSE. (2011). Listed company manual. New York, NY: New York Stock Exchange. O’Dwyer, B. (2004). Qualitative data analysis: Illuminating a process for transforming a ‘messy’ but ‘attractive’ ‘nuisance’. In C. Humphrey & B. Lee (Eds.), The real life guide to accounting research: A behind the scenes view of using qualitative research methods (pp. 391 407). London: Elsevier. OECD. (1999). OECD principles of corporate governance. Paris: Organisation for Economic Co-operation and Development. OECD. (2004). OECD principles of corporate governance. Paris: Organisation for Economic Co-operation and Development. OECD. (2005). OECD-China co-operation the first ten years. Paris: Organization for Economic Co-operation and Development. OECD. (2008). Using the OECD principles of corporate governance: A boardroom guideline. Paris: Organization for Economic Co-operation and Development. Oliver, C. (1991). Strategic responses to institutional processes. Academy of Management Review, 16(1), 145 179.

248

REFERENCES

Oliver, C. (1992). The antecedents of deinstitutionalization. Organization Studies, 13(4), 563 588. Orton, J. D., & Weick, K. E. (1990). Loosely coupled systems: A reconceptualization. Academy of Management Review, 15(2), 203 223. Osma, B. G., & Noguer, B. G. d. A. (2007). The effect of the board composition and its monitoring committees on earnings management: Evidence from Spain. Corporate Governance: An International Review, 15(6), 1413 1428. Palepu, K. G. (1986). Predicting takeover targets: A methodological and empirical analysis. Journal of Accounting and Economics, 8(1), 3 35. Pan, X. L. (1934). The comparison between Chinese bookkeeping and western bookkeeping (in Chinese). Accounting Journal, 3(1), 1 3. Parker, L. D., & Roffey, B. H. (1997). Methodological themes: Back to the drawing board: Revisiting grounded theory and the everyday accountant’s and manager’s reality. Accounting, Auditing & Accountability Journal, 10(2), 212 247. Patel, C. (2003). Some cross-cultural evidence on whistle-blowing as an internal control mechanism. Journal of International Accounting Research, 2(1), 69 96. Patel, C., Harrison, G. L., & McKinnon, J. L. (2002). Cultural influences on judgments of professional accountants in auditor client conflict resolution. Journal of International Financial Management & Accounting, 13(1), 1 31. Patton, M. Q. (2005). Qualitative research Encyclopedia of statistics in behavioral science. Chichester: Wiley. Peasnell, K. V., Pope, P. F., & Young, S. (2005). Board monitoring and earnings management: Do outside directors influence abnormal accruals? Journal of Business Finance & Accounting, 32(7 8), 1311 1346. Peerenboom, R. (2002). China’s long march toward rule of law. Cambridge: Cambridge University Press. Peng, M. W., Lu, Y., Shenkar, O., & Wang, D. Y. (2001). Treasures in the China house: A review of management and organizational research on Greater China. Journal of Business Research, 52(2), 95 110. Peragallo, E. (1983). Development of the compound entry in the 15th century ledger of Jachomo Badoer, a Venetian merchant. Accounting Review, 58(1), 98–104. Perera, H. B. (1989). Towards a framework to analyze the impact of culture on accounting. The International Journal of Accounting, 24(1), 42 56. Perera, H. B., Rahman, A. R., & Cahan, S. F. (2003). Globalisation and the major accounting firms. Australian Accounting Review, 13(29), 27 37. Perera, S. (2005). Sharing an experience: Field study methods to understand management accounting practices in a changing environment. Management Accounting Review, 4(1), 93 115. Piot, C., & Janin, R. (2007). External auditors, audit committees and earnings management in France. European Accounting Review, 16(2), 429 454. Post, J. E., Preston, L. E., & Sauter-Sachs, S. (2002). Redefining the corporation: Stakeholder management and organizational wealth. Stanford, CA: Stanford University Press. Potter, B. N. (2005). Accounting as a social and institutional practice: Perspectives to enrich our understanding of accounting change. Abacus, 41(3), 265 289. Powell, W. W. (1991). Expanding the scope of institutional analysis. In W. W. Powell & P. J. DiMaggio (Eds.), The new institutionalism in organizational analysis (pp. 183 203). Chicago, IL: University of Chicago Press.

References

249

Previts, G. J., Parker, L. D., & Coffman, E. N. (1990). Accounting history: Definition and relevance. Abacus, 26(1), 1 16. Pucheta-Martı´ nez, M. C., & De Fuentes, C. (2007). The impact of audit committee characteristics on the enhancement of the quality of financial reporting: An empirical study in the Spanish context. Corporate Governance: An International Review, 15(6), 1394 1412. Purdy, M. (2013). China’s economy, in six charts. Harvard Business Review Blog Network. Qi, B. (2007). Non-tradable share reform in China’s capital market. Beijing: China Securities Regulatory Commission. Qi, D., Wu, W., & Zhang, H. (2000). Shareholding structure and corporate performance of partially privatized firms: Evidence from listed Chinese companies. Pacific-Basin Finance Journal, 8(5), 587 610. Qian, X. (2002). Zhou Li (in Chinese). Changsha: Yuelu Publishing. Qiang, Q. (2003). Corporate governance and state-owned shares in China listed companies. Journal of Asian Economics, 14(5), 771 783. Quinn, J. B. (1969). Technology transfer by multinational companies. Harvard University Review, 47(6), 147 161. Rahman, A., Yammeesri, J., & Perera, H. (2010). Financial reporting quality in international settings: A comparative study of the USA, Japan, Thailand, France and Germany. The International Journal of Accounting, 45(1), 1 34. Rahman, R. A., & Ali, F. H. M. (2006). Board, audit committee, culture and earnings management: Malaysian evidence. Managerial Auditing Journal, 21(7), 783 804. Reed, A. M. (2002). Corporate governance reforms in India. Journal of Business Ethics, 37(3), 249 268. Reed, D. (2002). Corporate governance reforms in developing countries. Journal of Business Ethics, 37(3), 223 247. Ren, M. (2009). Chinese accountants and the spirit of professionalism. Retrieved from http:// accountingeducation.com/index.cfm?page=newsdetails&id=150288. Accessed on March 1, 2010. Ren, M. (2010). Summary of 2009 audit reports of listed companies in China. Beijing: Chinese Institute of Certified Public Accountants. Rezaee, Z. (2005). Causes, consequences, and deterrence of financial statement fraud. Critical Perspectives on Accounting, 16(3), 277 298. Rezaee, Z., Smith, L. M., & Szendi, J. Z. (2010). Convergence in accounting standards: Insights from academicians and practitioners. Advances in Accounting, 26(1), 142 154. Robson, C. (2002). Real world research: A resource for social scientists and practitionerresearchers (Vol. 2). Oxford: Blackwell Oxford. Roe, M. J. (2003). Political determinants of corporate governance: Political context, corporate impact. New York, NY: Oxford University Press. Roth, K., & Kostova, T. (2003). Organizational coping with institutional upheaval in transition economies. Journal of World Business, 38(4), 314 330. Ruddock, C., Taylor, S. J., & Taylor, S. L. (2006). Nonaudit services and earnings conservatism: Is auditor independence impaired? Contemporary Accounting Research, 23(3), 701 746. Sami, H., & Zhou, H. (2008). Do auditing standards improve the accounting disclosure and information environment of public companies? Evidence from the emerging markets in China. The International Journal of Accounting, 43(2), 139 169.

250

REFERENCES

Sa´nchez-Ballesta, J. P., & Garcı´ a-Meca, E. (2007). Ownership structure, discretionary accruals and the informativeness of earnings. Corporate Governance: An International Review, 15(4), 677 691. Sarens, G., De Beelde, I., & Everaert, P. (2009). Internal audit: A comfort provider to the audit committee. The British Accounting Review, 41(2), 90 106. SASAC. (2005). Announcement regarding enhancing financial report audit in central state owned enterprises. China: State Asset Supervision and Administration Commission. Schipper, K. (2005). The introduction of international accounting standards in Europe: Implications for international convergence. European Accounting Review, 14(1), 101 126. Schlevogt, K. A. (2000). Doing business in China Part I: The business environment in China Getting to know the next century’s superpower. Thunderbird International Business Review, 42(1), 85 111. Schwartz, M. (2001). The nature of the relationship between corporate codes of ethics and behaviour. Journal of Business Ethics, 32(3), 247 262. Scott, W. (2001). Institutions and organizations. Thousand Oaks, CA: Sage. Scott, W. (2004). Institutional theory. In G. Ritzer (Ed.), Encyclopedia of social theory (pp. 408 414). Thousand Oaks, CA: Sage. Scott, W. (2008). Approaching adulthood: The maturing of institutional theory. Theory and Society, 37(5), 427 442. Securities Commission New Zealand. (2007). Review of financial reporting by issues Cycle 5. Retrieved from http://www.seccom.govt.nz/publications. Accessed on December 27, 2009. Selznick, P. (1949). TVA and the grass roots: A study of politics and organization (Vol. 3). Berkeley, CA: University of California Press. Selznick, P. (1996). Institutionalism “old” and “new” 40th anniversary issue. Administrative Science Quarterly, 41(June), 270 277. Shi, C. (2005). The international corporate governance developments: The path for China. Australian Journal of Asian Law, 71(1), 60 94. Shih, V. (2004). Dealing with non-performing loans: Political constraints and financial policies in China. The China Quarterly, 180, 922 944. Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737 783. Short, H., Keasey, K., Hull, A., & Wright, M. (1998). Corporate governance, accountability and enterprise. Corporate Governance: An International Review, 6(3), 151 165. Siddiqui, J. (2010). Development of corporate governance regulations: The case of an emerging economy. Journal of Business Ethics, 91(2), 253 274. Siregar, S. V., & Utama, S. (2008). Type of earnings management and the effect of ownership structure, firm size, and corporate-governance practices: Evidence from Indonesia. The International Journal of Accounting, 43(1), 1 27. Smith, M. (2011). Research methods in accounting. London: Sage. Soderstrom, N. S., & Sun, K. J. (2007). IFRS adoption and accounting quality: A review. European Accounting Review, 16(4), 675 702. Solomon, J. (2010). Corporate governance and accountability. West Sussex, UK: Wiley. Somers, M. J. (2001). Ethical codes of conduct and organizational context: A study of the relationship between codes of conduct, employee behavior and organizational values. Journal of Business Ethics, 30(2), 185 195.

References

251

Srinidhi, B., & Gul, F. A. (2007). The differential effects of auditors’ non-audit and audit fees on accrual quality. Contemporary Accounting Research, 24(2), 595 629. Standen, D. J. (1995). Insider trading reforms sweep across Germany: Bracing for the cold winds of change. Harvard International Law Journal, 36, 177. Statman, M. (2009). The cultures of insider trading. Journal of Business Ethics, 89(1), 51 58. Su, C., & Littlefield, J. E. (2001). Entering guanxi: A business ethical dilemma in mainland China? Journal of Business Ethics, 33(3), 199 210. Su, K. (1985). Modern China: A topical history (in Chinese). Beijing: New World Press. Su, Y., Xu, D., & Phan, P. H. (2008). Principal principal conflict in the governance of the Chinese public corporation. Management and Organization Review, 4(1), 17 38. Sucher, P., & Kosmala-MacLullich, K. (2004). A construction of auditor independence in the Czech Republic: Local insights. Accounting, Auditing & Accountability Journal, 17(2), 276 305. Sundaram, A. K., & Inkpen, A. C. (2004). The corporate objective revisited. Organization Science, 15(3), 350 363. Sweeney, A. P. (1994). Debt-covenant violations and managers’ accounting responses. Journal of Accounting and Economics, 17(3), 281 308. SZSE. (2008a). An analysis of performance of independent directors, audit committees and remuneration committees (in Chinese). Shenzhen, China: Shenzhen Stock Exchange. SZSE. (2008b). A report on market participants’ violation of law and regulations in 2007 (in Chinese). Shengzhen, China: Shengzhen Stock Exchange. Tam, O. K. (2002). Ethical issues in the evolution of corporate governance in China. Journal of Business Ethics, 37(3), 303 320. Tang, Q., Chow, C. W., & Lau, A. (1999). Auditing of state-owned enterprises in China: Historic development, current practice and emerging issues. The International Journal of Accounting, 34(2), 173 187. Tang, Y. (1999). Issues in the development of the accounting profession in China. China Accounting and Finance Review, 1(1), 21 36. Tang, Y. (2000). Bumpy road leading to internationalization: A review of accounting development in China. Accounting Horizons, 14(1), 93 102. Tang, Y., Chow, L., & Cooper, B. J. (2003). Accounting and finance in China: A review of current practice. Hong Kong: Sweet & Maxwell Asia. Taylor, S., & Bogdan, R. (1998). Introduction to qualitative methods: A guidebook and resource. New York, NY: Wiley. Tenev, S., Zhang, C., & Brefort, L. (2002). Corporate governance and enterprise reform in China: Building the institutions of modern markets. Washington, DC: World Bank. Thorelli, H. B. (1966). The multinational corporation as a change agent. Southern Journal of Business, 1(3), 1 9. Tolbert, P. S. (1985). Institutional environments and resource dependence: Sources of administrative structure in institutions of higher education. Administrative Science Quarterly, 30, 1 13. Tong, W. H., Zhang, S., & Zhu, Y. (2012). Trading on inside information: Evidence from the share-structure reform in China. Journal of Banking & Finance, 37, 1422 1436. Touron, P. (2005). The adoption of US GAAP by French firms before the creation of the international accounting standard committee: An institutional explanation. Critical Perspectives on Accounting, 16(6), 851 873.

252

REFERENCES

Treadway, J. C. (1987). Report of the national commission on fraudulent financial reporting. Washington, DC: National Commission on Fraudulent Financial Reporting. Tsamenyi, M., Cullen, J., & Gonza´lez, J. M. G. (2006). Changes in accounting and financial information system in a Spanish electricity company: A new institutional theory analysis. Management Accounting Research, 17(4), 409 432. Turley, S., & Zaman, M. (2004). The corporate governance effects of audit committees. Journal of Management and Governance, 8(3), 305 332. Turley, S., & Zaman, M. (2007). Audit committee effectiveness: Informal processes and behavioural effects. Accounting, Auditing & Accountability Journal, 20(5), 765 788. Uddin, S., & Choudhury, J. (2008). Rationality, traditionalism and the state of corporate governance mechanisms: Illustrations from a less-developed country. Accounting, Auditing & Accountability Journal, 21(7), 1026 1051. United Nations Conference on Trade and Development. (2006). Guidance on good practices in corporate governance disclosure. New York, NY: United Nations. United States Congress. (2002). Sarbanes-Oxley Act. United States. Uzun, H., Szewczyk, S. H., & Varma, R. (2004). Board composition and corporate fraud. Financial Analysts Journal, 60, 33 43. Velayutham, S., & Perera, M. (2004). The influence of emotions and culture on accountability and governance. Corporate Governance, 4(1), 52 64. Wahlen, J. M., Boatsman, J. R., Herz, R. H., Jonas, G. J., Palepu, K. G., Ryan, S. G., … Skinner, D. J. (2000). Response to the SEC concepts release on international accounting standards. Accounting Horizons, 14(4), 489 499. Wallace, J. S. (1997). Adopting residual income-based compensation plans: Do you get what you pay for? Journal of Accounting and Economics, 24(3), 275 300. Walter, C., Fraser, G., & Howie, F. (2003). Privatizing China: A guide to China’s stock markets and their role in corporate reform. Singapore: Wiley. Wang, H. (2003). China’s new order: Society, politics, and economy in transition. Cambridge: Harvard University Press. Wang, J., & Tweedie, D. (2005). Joint statement of the Secretary-General of the China Accounting Standards Committee and the Chairman of the International Accounting Standards Board. Beijing: China Accounting Standards Committee and International Accounting Standards Board. Wang, Q., Wong, T.-J., & Xia, L. (2008). State ownership, the institutional environment, and auditor choice: Evidence from China. Journal of Accounting and Economics, 46(1), 112 134. Wang, W., & Chen, J. (2008). Reforming China’s securities civil actions: Lessons from PSLRA reform in the US and government-sanctioned non-profit enforcement in Taiwan. Columbia Journal of Asian Law, 21, 115 160. Wang, X. L., Shi, K., & Fan, H. X. (2006). Psychological mechanisms of investors in Chinese stock markets. Journal of Economic Psychology, 27(6), 762 780. Wang, Z.-J., & Deng, X.-L. (2006). Corporate governance and financial distress: Evidence from Chinese listed companies. Chinese Economy, 39(5), 5 27. Wanyama, S., Burton, B., & Helliar, C. (2009). Frameworks underpinning corporate governance: Evidence on Ugandan perceptions. Corporate Governance: An International Review, 17(2), 159 175. Warren, D. E., Dunfee, T. W., & Li, N. (2004). Social exchange in China: The double-edged sword of guanxi. Journal of Business Ethics, 55(4), 353 370.

References

253

Wei, Z. X. (1984). Chinese bookkeeping methods (in Chinese). Beijing: Chinese Financial and Economic Press. Weick, K. E. (1976). Educational organizations as loosely coupled systems. Administrative Science Quarterly, 21, 1 19. White, R. T., & Gunstone, R. F. (1992). Probing understanding. London: Routledge. Whittington, G. (2005). The adoption of international accounting standards in the European Union. European Accounting Review, 14(1), 127 153. Winkle, G. M., Huss, H. F., & Chen, X.-Z. (1994). Accounting standards in the People’s Republic of China: Responding to economic reforms. Accounting Horizons, 8, 48. Wong, M. (2010). Guanxi management as complex adaptive systems: A case study of Taiwanese ODI in China. Journal of Business Ethics, 91(3), 419 432. World Bank. (1998). China – Accounting reform and development project. Retrieved from http://documents.worldbank.org/curated/en/1998/11/442571/china-accounting-reformdevelopment-project. Accessed on December 29, 2013. World Bank. (2009). Report on the Observance of Standards and Codes (ROSC)-Accounting and auditing, People’s Republic of China. Washington, DC: World Bank. World Bank. (2013). China projects & programs. Retrieved from http://www.worldbank.org/ en/country/china/projects. Accessed on December 29, 2013. Wright, M., Filatotchev, I., Hoskisson, R. E., & Peng, M. W. (2005). Strategy research in emerging economies: Challenging the conventional wisdom. Journal of Management Studies, 42(1), 1 33. Wu, S., Xu, N., & Yuan, Q. (2009). State control, legal investor protection, and ownership concentration: Evidence from China. Corporate Governance: An International Review, 17(2), 176 192. Xiang, B. (1998). Institutional factors influencing China’s accounting reforms and standards. Accounting Horizons, 12(2), 105 119. Xiao, J. Z., Weetman, P., & Sun, M. (2004a). Political influence and coexistence of a uniform accounting system and accounting standards: Recent developments in China. Abacus, 40(2), 193 218. Xiao, J. Z., Yang, H., & Chow, C. W. (2004b). The determinants and characteristics of voluntary internet-based disclosures by listed Chinese companies. Journal of Accounting and Public Policy, 23(3), 191 225. Xiao, J. Z., Zhang, Y., & Xie, Z. (2000). The making of independent auditing standards in China. Accounting Horizons, 14(1), 69 89. Xie, B., Davidson, W. N., & DaDalt, P. J. (2003). Earnings management and corporate governance: The role of the board and the audit committee. Journal of Corporate Finance, 9(3), 295 316. Xin, Z., & Huang, S. (1951). How to construct new China’s theoretical accounting basis (in Chinese). New Accounting, 1, 12 16. Xinhua. (2007). China’s GDP grows annual average of 9.67% from 1978 to 2006. Xinhuanet, May 7. Retrieved from http://www.xinhuanet.com/ Xu, L. C., Zhu, T., & Lin, Y. m. (2005). Politician control, agency problems and ownership reform. Economics of Transition, 13(1), 1 24. Xu, X., & Wang, Y. (1999). Ownership structure and corporate governance in Chinese stock companies. China Economic Review, 10(1), 75 98. Xu, Y., & Xu, X. (2003). Become professional: Chinese accountants in early 20th century Shanghai. The Accounting Historians Journal, 30(1), 129 153.

254

REFERENCES

Xu, Y. Z. (1933). An outline of Chinese accounting reform (in Chinese). Shanghai: Xu Yong Zhao Accounting Firm. Yan, D., & Wang, H. (2000). Research on the reform of accounting curriculum and the teaching programs facing the 21st century (in Chinese). Beijing: Economic Science Press. Yan, J. (1951). A critique of Tao De’s ‘My reading of how to construct China’s theoretical basis of accounting (in Chinese). New Accounting, 7, 19 20. Yan, J., & Sorenson, R. (2006). The effect of Confucian values on succession in family business. Family Business Review, 19(3), 235 250. Yang, J. S., & Krishnan, J. (2005). Audit committees and quarterly earnings management. International Journal of Auditing, 9(3), 201 219. Yang, K. (2007). State-owned enterprise reform in post-Mao China. International Journal of Public Administration, 31(1), 24 53. Yang, L., Tang, Q., Kilgore, A., & Jiang, Y. H. (2001). Auditor-government associations and auditor independence in China. The British Accounting Review, 33(2), 175 189. Yao, S., & Luo, D. (2009). The economic psychology of stock market bubbles in China. The World Economy, 32(5), 667 691. Yee, H. (2009). The re-emergence of the public accounting profession in China: A hegemonic analysis. Critical Perspectives on Accounting, 20(1), 71 92. Yeo, G. H., Tan, P., Ho, K. W., & Chen, S. S. (2002). Corporate ownership structure and the informativeness of earnings. Journal of Business Finance & Accounting, 29(7 8), 1023 1046. Yeung, I. Y., & Tung, R. L. (1996). Achieving business success in Confucian societies: The importance of guanxi (connections). Organizational Dynamics, 25(2), 54 65. Yin, R. K. (2009). Case study research: Design and methods (Vol. 5). London: Sage. Yoshikawa, T., & Rasheed, A. A. (2009). Convergence of corporate governance: Critical review and future directions. Corporate Governance: An International Review, 17(3), 388 404. Yoshikawa, T., Tsui-Auch, L. S., & McGuire, J. (2007). Corporate governance reform as institutional innovation: The case of Japan. Organization Science, 18(6), 973 988. Yu, G. Y. (1998). The primary stages of China’s socialist economy (in Chinese). Guangzhou: Guangdong Economy Publishing House. Yu, Q., Du, B., & Sun, Q. (2006). Earnings management at rights issues thresholds Evidence from China. Journal of Banking & Finance, 30(12), 3453 3468. Yuan, J. (2007). Formal convergence or substantial divergence Evidence from adoption of the independent director system in China. Asian-Pacific Law & Policy Journal, 9, 71. Zhang, B. (2008). Duration dependence test for rational bubbles in Chinese stock market. Applied Economics Letters, 15(8), 635 639. Zhang, M. (2009). Crossing the river by touching stones: A comparative study of administrative reforms in China and the United States. Public Administration Review, 69(s1), S82 S87. Zhang, Y., & Ma, G. (2005). Law, economic, corporate governance, and corporate scandal in a transition economy: Insight from China. Beijing University Working Paper. Zhang, Y., Zhou, J., & Zhou, N. (2007). Audit committee quality, auditor independence, and internal control weaknesses. Journal of Accounting and Public Policy, 26(3), 300 327. Zhao, H. (2006). Private firms powering China economy. China Daily, September 22. Zhao, R., & Millet-Reyes, B. (2007). Ownership structure and accounting information content: Evidence from France. Journal of International Financial Management & Accounting, 18(3), 223 246.

References

255

Zheng, Y. (2004). Globalization and state transformation in China. Cambridge: Cambridge University Press. Zhou, Z. H. (1988). Chinese accounting systems and practices. Accounting, Organizations and Society, 13(2), 207 224. Zhu, L. B. (2002). Accounting principles (in Chinese). Beijing: Tsinghua University Press. Zou, H., Wong, S., Shum, C., Xiong, J., & Yan, J. (2008). Controlling-minority shareholder incentive conflicts and directors’ and officers’ liability insurance: Evidence from China. Journal of Banking & Finance, 32(12), 2636 2645. Zysman, J. (1983). Governments, markets, and growth: Financial systems and the politics of industrial change (Vol. 15). New York, NY: Cornell University Press.