5. Conclusion
The scrutiny of the audit profession following the dramatic increase in accounting restatements is not surprising, as external auditors' failure to detect a misstatement has been identified as one of the primary factors contributing to increased restatements (Eilifsen & Messier, 2000). Using accounting restatements data from China, we investigate whether high quality audit as proxied by audit firm revenue reduces the likelihood of accounting restatements. After controlling for self-selection bias, the results document that high quality audit indeed reduces the likelihood of restatements. However, this effect is more pronounced for firms with earnings management-induced restatements as opposed to cash flow management-induced restatements, possibly because of the intense scrutiny by regulatory authorities on earnings management concerns. Additionally, we also find that the market reacts negatively to non-cash flow restatement announcements in relation to earnings management but this effect is not discernible for cash flow restatements. High quality auditors lower the negative market reaction to non-cash flow restatements. Further analysis of 2005 auditing litigation reform suggests improved audit monitoring of non-cash flow restatements post-reform. Our study extends extant restatement literature by providing a new classification of restatements in light of intentional misreporting captured by earnings management and cash flow management. By differentiating restatements into types, our findings shed light into the variation in auditors' monitoring effectiveness. In addition, our study also enriches the audit literature by exploring auditors' concerns over cash flow misstatements, which is an under researched area. Lastly, our inquiry into audit quality and audit effectiveness in a competitive and segmental audit market, provides confidence in Chinese auditors' monitoring function and highlights the importance of legal reform in strengthening auditors' legal liabilities.
