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This study, using data from the Chinese stock market, investigates the relationship between earnings management induced by profitability regulation and modified audit opinions (MAOs). We review recent developments in the accounting profession and in independent auditing to foster an understanding of the environment in which Chinese auditing operates. Based on annual reports published by listed companies from 1995 to 1997, we analyze the underlying reasons for MAOs. Our test results show a significant association between receiving MAOs and reporting profits marginally above the target levels specified in stock de-listing and rights offering regulations. Our findings are consistent with the notion that asymmetric profitability requirements exacerbate managers' propensity to engage in earnings management, which in turn is positively associated with receiving MAOs. Though based on Chinese data, our findings are of general interest because they address a fundamental issue of trade-offs between expected costs and expected benefits in deciding whether to avoid MAOs in a transitional economy.

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This paper examines the linkages between discretionary accruals (DAs), managerial share ownership, management compensation, and audit fees. It draws on the theory that managers of firms with high management ownership are likely to use DAs to communicate value‐relevant information, while managers of firms with high accounting‐based compensation are likely to use DAs opportunistically to manage earnings to improve their compensation. OLS regression results of 648 Australian firms show that (1) there is a positive association between DAs and audit fees; (2) managerial ownership negatively affects the positive relationship between DAs and audit fees; and (3) this negative impact is further found to be weaker for firms with high accounting‐based management compensation.