How Have Auditors Managed Their Chinese ADR Engagements?

The controversy over Chinese reverse mergers, which are directly listed on U.S. stock exchanges, has led to concerns about the audit quality of all U.S. listed Chinese companies. Because a sizeable number of foreign firms cross list their shares as American Depositary Receipts (ADRs) issued by U.S. depositary banks (as opposed to directly listed), we study how auditors have managed Chinese ADRs. Our motivation for examining Chinese ADRs is based on the findings that cross-listing via the ADR process is beneficial for U.S. shareholders, generally results in higher valuations, and is less likely to be associated with misreporting. We find that relative to other ADRs, Chinese ADRs are: (1) more likely to be associated with a Big 4 auditor, (2) expected to pay more for their external audits, (3) are likely to have longer audit report lag (proxy for audit investments), and (4) less likely to restate prior period financial statements. When we include Chinese reverse mergers, which are non-ADR companies, we find that the audit quality problems are only confined to Chinese reverse mergers. Our results do not suggest that Chinese ADRs have lower audit quality than other ADRs or Chinese reverse mergers. A key conclusion is that the audit quality concerns of Chinese reverse mergers, or other directly U.S. listed Chinese companies, may not extend to Chinese ADRs.