Ownership structure, financial reporting fraud and audit quality: Chinese evidence

This paper examines two types of financial reporting fraud (i.e., earnings manipulation fraud and tunnelling fraud) and their association with ownership structure and audit quality in detecting the fraud using a sample of Chinese listed firms. We find that more concentrated ownership tends to be associated with tunnelling fraud and more dispersed ownership tends to be associated with earnings manipulation fraud. Specifically, controlling shareholders tend to over-reach minority shareholders when they become more powerful, but at the same time they tend to curb earnings manipulation fraud. The second largest shareholder is able to curb earnings manipulation fraud through monitoring the management. However, we do not find evidence that they are able to curb tunnelling fraud. We also find that although auditors in China are generally effective in detecting earnings manipulation fraud, they are not so effective in detecting tunnelling fraud. Moreover, Big4 audit firms are not significantly different from non-Big4 firms in terms of detecting frauds. These findings further our understanding of the association between ownership structure and different types of fraud.