Do Auditors Tolerate Management’s Attempt to Meet Earnings Targets? Evidence from Executive Stock Option Plans in China

SYNOPSIS In this study, we investigate whether auditors tolerate management’s attempt to meet earnings targets in China. We examine audits conducted in the year before the client announces its first executive stock option (ESO) plan. We conduct our analysis in the Chinese audit market, which gives us access to data on both preaudit earnings and audit adjustments. We find that auditors are less likely to propose that the client adjust earnings upward before the client announces its first ESO plan. This relationship is particularly strong for economically important clients. Our results are robust to controlling for self-selection of ESO plans and to alternative measures of audit adjustment. We also find that auditors charge higher audit fees for clients who announce their first ESO plan. Finally, among the clients announcing their first ESO plan, those with upward adjustments to their earnings are charged lower audit fees. JEL Classifications: M42; J33.