Negative press coverage, litigation risk, and audit opinions in China

Purpose This study aims to investigate whether and why auditors are more likely to issue modified audit opinions (MAOs) to clients receiving negative news reports. Design/methodology/approach Exploiting a legal regime change in China in 2005 that significantly increased auditor litigation risk, the authors divide the sample period into two subperiods: the low litigation risk period (2001–2004) and the high litigation risk period (2006–2009). The authors manually read and code all newspapers to identify firm-years in which clients received negative press coverage. To address endogeneity and self-selection concerns, the authors use propensity score matching, instrumental variable estimation and Heckman’s two-stage model. Findings This study finds that auditors are more likely to issue MAOs to clients receiving negative news reports in the high litigation risk period. In particular, auditors’ MAOs are positively related to the first negative news reports, accounting-related negative press coverage and negative news reports from state-owned media in the high litigation risk period. Further analysis shows that negative news reports increase the probability of covered firms receiving regulatory sanctions or getting sued. As a strategic defense, auditors can reduce the probability of being sued and making litigation payments by issuing MAOs in the high litigation risk period. Originality/value To the best of the authors’ knowledge, this study is the first to provide comprehensive evidence in support of the strategic view and its implications (negative news reports increase the probability of covered firms getting sued and auditors can mitigate litigation risk by issuing MAOs).