Zhang Limin: Reinforcement of Professional Ethics: A reputation-oriented approach

Reinforcement of Professional Ethics: A reputation-oriented approach

——Speech on the concurrent session of 19^th CAPA Conference Prof. Zhang Limin in Accounting, Beijing Jiaotong University, China

(Oct. 28 2015, Seoul, South Korea)

Good morning Ladies and gentlemen,

It is my great honor being here attending this concurrent session of the nineteenth CAPA Conference, and meeting with this beautiful city Seoul. Today we have the topic of “Asian Values and professional ethics: The effect of CPA on the promotion of professional ethics”. It has been an indisputable fact that Accounting Professional Ethics has been a well-concerned controversial topic along with the emerging accounting and auditing scandals. From the accounting practice we could infer that Asian values system could significantly impact the behavior of CPAs by maintaining professional ethics, establishing public image of justice and improving public service quality, and consequently promote the social status of accounting profession, which could profoundly realize the business ethics improvement. With this understanding, I would like to share my thoughts from the following 4 aspects:

A. A theoretical analysis: key factor

It’s well known that China has made significant achievements in the globalization process, which including the global convergence of Accounting standards. But it is still challenging to deal with the issue of professional ethics under diverse cultural circumstances. We hold the opinion that, the culture background will imperceptibly influence the individual behavior by forming specific value system. Afterwards, difference between cultures has no doubt impact the implement effect of international accounting professional ethics. So we asserts that, reforming the CPA reputation system based on both culture impact analysis and Chinese-specific features is the key factor to guarantee the implement of professional ethics standards as well as the CPAs’ function in business ethics enhancement.

Culture has the far-reaching power in establishing the relationship with value system. Based on Chinese long period of agriculture history which suffering various natural hazards, the growing collectivism spirit which elaborating human organizational force defensing nature has evolved the essence of Chinese traditional culture. During this process, the concepts of “GUANXI” and “FACE Culture” have been internalized into Chinese social value system, which inevitably impact CPAs’ behavior. So CPAs will struggle in the pressure between public and client interest when thinking about “GUANXI” or “MIANZI”, and result in the social attention to the concern of “GUANXI” reliance and worries about lack of audit independence. However, the existence of “GUANXI” will not necessarily result in the impairment of public interest during accounting practice. On one hand, our education principles of social core values have established the foundation of requirement for CPAs obeying professional ethics. On the other hand, it could be a practical measure of business value enhancement for CPAs by drawing their attention to the “Greater MIANZI”, that is to say, stimulating CPAs’ motivation to pursue higher ethics morals in Chinese traditional culture by excavating their outstanding character and establishing the behavioral incentive mechanism on reputation basis and client relationship maintenance.

Accounting ethics is the general term that describes not only the internal personality morality of accounting personnel but also the external incentive and supervision mechanism which control the accounting activities and behaviors constituted by accounting profession organization. The personality morality of accounting personnel is the elaboration of social morality, the basic professional requirement, and the emphasis of self-moral standards establishment. It is believed that it should be more important for accounting professionals complying with the professional virtue ethics related to the personality morality. But, when accounting personnel are more interested in profit-seeking, they will intentionally escape the regulatory request and use the loophole in the rules. Thus, it is critical to form an internal mechanism complying with professional ethics inside the accounting personnel’s awareness. I have to mention a Chinese idiom that states, “Man’s nature is good at birth”. Under the traditional Asian Confucian culture, we should stimulate the “good” side of internal morality of accounting personnel to make sure they could obey the professional ethics rules, form and remain their reputation, help them take care of self-quality of integrity, objectivity and preciseness rather than only care about “GUANXI” with single client. With these efforts, accounting personnel will gain more social respect and higher social reputation. Auditors with higher reputation and professional ethics will alleviate agency conflicts between principals and agents, lower agency costs, restrain opportunistic behaviors, improve the information quality of financial statement, and eventually transmit the positive signal of firms to the capital market as well as optimize resource allocation based on the better creditability mechanism.

B. Cause analysis of trust crisis: Negative culture impact

 Public trust crisis against auditors starts at the burst of “Enron” and “Yin Guang Xia” fraudulent event. Lots of literatures have discussed the reason of this crisis; however we should think about it from a deeper aspect of culture to better understand the causes and raise the most effective solution for this case. Based on the foreign research framework and corresponding viewpoint, we focus on the following 4 issues relating to the accounting culture:

a) Large power distance.

The large power distance and rigid hierarchy are widely reflected in Asian culture and make ordinary people difficult to protect themselves and participate in the administration of state affairs. This can lead to higher sensitivity of auditors when they are facing external pressure or threats, then compromise reluctantly and result in audit failure along with public trust crisis. In this phenomenon, all of auditor’s supervisors, audit clients or the government officials could be the root of pressure against auditors’ objectivity of audit opinion. In the case of Toshiba scandal reported in last few months could give us an opportunity to think about the power and pressure from the big clients.

b) Collective accountability.

As Asians have strong awareness of  -avoidance, A lots of accounting firms prefer limited liability company(LLC) for lower personal responsibility under the voluntary choice of legal form, which actually weaken the profession risk awareness and enhance the probability of moral hazard and audit failure. This situation will become worse especially under the institution of collective accountability. When audit failure happens, it will be more difficult to prosecute the responsible and penalize the auditors at fault. This will induce auditors taking chances and intensify the trust crisis.

c) Preference of Legal supervision

Asians prefer the legal-oriented supervision system rather than profession-oriented. In China, supervision authority on audit quality have been allocated to several government departments, including Ministry of Finance (MOF), State Auditing Administration (SAA), China Securities Regulatory Commission (CSRC), State-owned Assets Supervision and Administration Commission (SASAC) and Taxation department. Due to the size and complexity of administrative regions as well as the ambiguous authority and coordination, our supervision measures cannot practice effectively, along with the delay of correction of illegal activities. All of these will result in the trust crisis.

d) Ambiguous statement in audit report

The consideration for client’s need for confidentiality has been brought into accounting values based on Asians culture. With the increasing Chinese legal request of information transparency, some auditors tend to make ambiguous statements in audit reports and mislead repost users, and eventually impair users’ and public interest.

To sum up, from the above analysis on culture perspective we could infer that, under the impact of Asian culture and accounting values, the interest awareness of small-group, the excessive concern on “GUANXI” with clients and officials, the negative adoption to regulation environment, the neglect of accounting professionalism and education, the inactive sense of public interest and reputation are all the key causes of audit failure and public trust crisis.

C. Solutions and effects: CPA individual reputation establishment

In order to solve the above problems and guide CPAs’ self-restriction according to ethical values, Chinese Institute of Certified Public Accountants (CICPA) and relevant governmental departments have proceeded on creditability construction and CPA individual reputation enhancement in order to stimulate CPAs’ responsibility and inner motivation of compliance to professional ethics using the following  measures:

a) Build the national database recording creditability archives of both individual CPA and accounting firms.

This archive of professional members consist of basic information, prompt information and warning information sections. Prompt information records the illegal behaviors that have not been penalized yet or behaviors that are not severe enough to penalty level, as well as useful information relevant to creditability judgement. Warning information refers to the results of criminal punishment, administrative penalty, civil compensation and industrial disciplines. This institutional improvement of creditability archives establishment aims at resolving issues of underrated discredit cost and providing information support for professional creditability system construction and effective professional management.

b) Improve the audit report signature system of individual CPAs.

The audit report signature system of individual CPAs has preliminary set up at the beginning of Chinese capital market formation after the national reform and opening-up policy. But there have been many tricks for avoiding responsibility and make the personal responsibility nominal when it came into auditing practice. In 2001 MOF clearly required that audit report must be signed by both the CPA who is responsible for the engagement and the partner/senior accountant who is responsible for final review. In 2010 MOF mandatory required that big accounting firms must adopt the legal form of Limited Liability Partnership (LLP) in order to enhance the CPAs’ individual responsibility. Meanwhile, the individual signature system can help in cultivating CPAs’ sense of mission and responsibility by making outstanding auditors recognized by public.

c) Leading talent program of accounting profession

In 2005, MOF started to run a 10-year program for selecting and cultivating 1000 accounting leading talents on in a national scale. In this program, a selected CPA will spend 6 years in total which contains 3-year training on transition from staffs to leaders and anther 3-year overseas training for broaden their internationalization vision and responding to the “go global” policy of accounting talents. This program is meaningful not only to enhance the competent level of CPAs but also cultivate their responsibility, sense of mission and honor, and finally promote the professional ethics level of much more accounting personnel who learning these models.

d) Select and encourage outstanding CPAs participate in the public affairs

CICPA and accounting firms are active in recommending outstanding CPAs participating public affairs via NPC and CPPCC member election in order to raise their social status and influence. In terms of individuals, winning a seat in NPC or CPPCC means honor and social responsibility through problem seeking, analyzing and solving from the state and public interest aspect. With the appropriate suggestions and proposals, the professional ethics and morality of CPAs such as integrity, objectivity and preciseness could be highlighted.

The above 4 measures are only part of the whole auditor reputation system establishment process. Additionally, we adopt other coordination measures from both accounting firm and institutional aspects. For the accounting firms, we encourage and support CPAs by clarifying the responsibility of Principal Partner on audit quality, promoting the process of accounting firms “become bigger and stronger” strategy, disclosing “Top 100 accounting firms” on a yearly basis and guiding the internal governance construction of accounting firms. For the institutional aspect, both state leaders and government departments including MOF, CSRC, SASAC emphasize the importance of independent auditing in institutional evolution of state governance. Additionally, the national policies are substantially improving the high level of professional education and offering preferential benefit of market access for splendid accounting firms. These efforts have successfully obtained public approval of accounting profession and set up auditors’ sense of self-identification of professional ethics.

Consequently, the above measures have led to various effects according to previous research. Existing literatures have proved that development of CPA reputation can instruct CPA behaviors, clarify the responsibility and improve audit quality.

First, CPA signature mechanism have driven CPAs rather than accounting firms pay attention to individual reputation, so the individual CPA rotation performed better than that of accounting firms. Gong Qihui and Wang Shanping (2009) finds that auditors’ tolerance of earnings manipulation is higher after accounting firm rotation; but individual CPA rotation could restrain the positive earnings manipulation; Secondly, CPA signature mechanism help the market could get individual more CPA information and make more prompt and reasonable decisions of auditors switch. In terms of the penalized CPAs, our data shows that the number of clients of penalized CPAs has declined 50.9% from 4 years before penalty to the current penalty year; but this number just decrease 6.3% only after 2 years of penalty. This proves the efficiency of market compared to the government disciplinary system. Thirdly, CPA signature mechanism force engagement leader concern more about audit quality and significantly improve it. Yuan Hongqi and Han Weifang (2012) have found that, the professional experience and industrial expertise of engagement leader CPAs significantly promote audit quality; and this promotion could be much stronger on the legal form of LLP which enhancing the legal liability of partners (Wang Chunfei and Lu Zhengfei, 2014). Finally, compared to other CPAs, CPAs selected by leading talents program will select better clients along with assisting the development of excellent clients and maintain audit quality based on the concern of audit reputation.

In conclusion, both the cultivation of individual CPAs’ sense of responsibility, mission and honor and the promotion of professional values can motivate CPAs adhering to creditability culture and form a virtuous cycle with their clients. In accounting practice, role models of outstanding CPAs could also shape the image of justice and integrity for accounting professions; further affect other professionals and reverse the unhealthy professional tendencies; and eventually promote the ethics level of whole business and the society.

D. Challenges in the future

With the changing economic conditions of China, our accounting professional environment is also changing. In our opinion, there are 2 challenges in the globalization process for a developing country like China:

First, the coordination between globalization requirement of international standards and the conflict among the institutional settings.

China’s legislation system has been experiencing the continuous reformation and development in process of transforming plan economy into market economy. Business entities have to adapt to more laws and regulations, which have lots of inconsistency per se. Will it generate excessive pressure to auditors if we adopt a tougher international standard of the NOCLAR? Will the rule-orientated regulatory environment mislead the auditors overly concern with legal norms instead of economic substance? Thus, it is challenging to coordinate the globalization requirement of international standards and the conflict among the institutional settings during globalization process.

Second, the dilemma between development of non-audit service and requirement of audit independence.

From the change of earnings data of international Big 4 in recent years, we can figure out the non-audit service have experiencing the process of developing- delaminating-redeveloping status. It is still an opening question whether non-audit service has negative impact on public interest and audit independence. With the increasing market demand and the rising proportion in accounting firms revenue, non-audit services are stepping into the rapid development period in China. As a member of developing economies, should we encourage NAS or restrict it anyway? Thus, it is another challenge to solve the dilemma between non-audit service and audit independence requirement through professional ethics construction.

Thank you.