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The Impact of Guanxi on

the Ethical Decision-Making

Process of Auditors –
An Exploratory Study on Alan K. M. Au
Chinese CPAs in Hong Kong1 Danny S. N. Wong

ABSTRACT. Using professional accountants as development. In addition, the influence of

respondents in Hong Kong, this study strives to guanxi is included as the individual differences
develop a model to depict the effect of ethical rea- variable and is hypothesised to have an interac-
soning on the relationships between guanxi and tion with the ethical reasoning process; hence,
auditors; behaviour in an audit conflict situation. The influencing individual behaviour in an ethical
results of the study found that (1) there is a signifi-
cant relationship between an auditor’s ethical judge-
ment and one’s moral cognitive development; (2)
there is a relationship between an auditor’s ethical
judgement and the existence of guanxi; and (3) the Ethical reasoning research in the
impact of guanxi on an auditor’s judgement is accounting profession
depending on the level of ethical reasoning.
A wide range of ethical decision making models
can be found in the literature (Dubinsky and
Introduction Loken, 1989; Ferrell and Gresham, 1985; Ferrell
et al., 1989; Hunt and Vitell, 1986; Jones, 1991;
Professional ethics is more than just instrumental and Trevino, 1986.) One common feature of
to the maintenance of a moral, ethical and honest these models is the incorporation of the cogni-
image among the public. This is basically the tive moral development process into their theo-
only way which professional bodies can ensure retical frameworks. As represented by the works
the empowered trust from the society can be of Jones (1991) and Ferrel et al. (1989), these
upheld. The maintenance of high professional models suggest that the ethical decision-making
ethical standards relies on an understanding of the is a four-stage process: awareness, cognition, eval-
moral reasoning process. This reasoning process uation and intention. Based on these models, it
forms part of the entire moral consciousness of is argued that differences in ethical behaviours
an individual’s belief system and from which are affected by the kind of moral thinkings
decision is made when an individual is facing advanced through the first three stages of the
difficult dilemmas. In this research, this moral moral development process.
reasoning process of professional accountants is In addition, a volume of prior research has
investigated by utilising the theory of ethical also covered the underlying ethical reasoning
processes of professional accountants in practice.
Alan Au is the Strand Leader in Marketing at the Open In general, findings of these studies suggested that
University of Hong Kong. (1) professional accountants have not reached
Danny Wong is the Vice President (Academic) of the Open their potential for higher levels of ethical rea-
University of Hong Kong. soning (Armstrong, 1987, 1993; Lampe and Finn,

Journal of Business Ethics 28: 87–93, 2000.

© 2000 Kluwer Academic Publishers. Printed in the Netherlands.
88 Alan K. M. Au and Danny S. N. Wong

1992; Ponemon, 1990, 1992a; Shaub, 1989, influence of guanxi on the ethical reasoning
1994); and (2) ethical reasoning could be a major process will be a very interesting topic to study.
determinant of professional judgement (Arnold Since no serious research has looked into the
and Ponemon, 1991; Peonmon, 1990, 1992a, influence of guanxi in the ethical decision-
1992b; Ponemon and Gabhart, 1990; and Tsui, making process, this study is designed to fill in
1996) as well as unethical behaviour (Ponemon, this research gap. As an exploratory study, the
1992b). scope of this study is limited to only investigate
However, some authors (Pratt, 1980; Gul, the impact of guanxi on the moral decision
1984; Tsui, 1996) have argued that simply by making process of Chinese professional accoun-
considering the cognitive development impact on tants in Hong Kong when they are confronted
the ethical reasoning process may be inadequate with an ethical dilemma.
since ethical decision-making behaviour cannot
be just predicted by an understanding of the
cognitive process and other “. . . individual and Statement of hypothesis
situational variables [can] interact with the
cognitive components to determine how an The most important question this study strives
individual is likely to behave in response to an to answer is the effect of ethical reasoning on
ethical dilemma” (Trevino, 1986, p. 602). Hence, the relationships between guanxi and auditors’
the focus of this research is to investigate the behaviour in an audit conflict situation. This
impact of guanxi, as an individual variable, on study hypotheses that auditor’s behaviour in an
auditors’ professional judgement. audit conflict situation will be influenced by the
existence of guanxi in the Chinese culture. In
addition, this relationship between guanxi and
What is guanxi? auditors’ behaviour is also hypothesised to be
depending on the level of cognitive moral devel-
Guanxi is closely related to the Confucian doc- opment of the auditors. Besides, since the rela-
trines which stress the ties of kinship and close tionship between cognitive moral development
personal relationships. In business terms, guanxi and the behaviour of an auditor has been sup-
or personal connection can be seen as the man- ported by previous research, as manifested in the
ifestation of group orientation through which earlier section, this study also provides further
interpersonal associations can replace formal evidence to the validity of this relationship. The
organisational structure (Boisot, 1986; Coleman, model is depicted in Figure 1 below.
1993; Putnam, 1993; Walder, 1986). The impor- Hence, based on this model, the following
tance of guanxi over formal business relationships three hypotheses are tested:
can be illustrated through the conclusion of
business contracts in Chinese communities. In
Chinese business communities, business contracts
may be specified in legal terms but the imple-
mentation of them can be based on trust. This
is supported by a study conducted by Kao (1996)
which indicated that guanxi is the pre-requisite
for the conclusion of a contract in Taiwan. In
addition, many studies (Alston 1989; Hall and
Xu, 1990; Leung and Yeung, 1995; Nee, 1992,
1989; Putnam, 1993; Redding, 1990; Xin and
Pearce, 1996; Yang, 1994) also stressed the
importance of guanxi in the Chinese business
environment. If the Chinese uses guanxi as a Figure 1. The effect of ethical reasoning and guanxi
substitute for formal structural support, the on ethical judgement.
Ethical Decision-Making Process of Auditors 89

H1: There is no significant relationship The third part of the questionnaire is designed
between an auditor’s ethical judgement to capture the respondent’s response on an ethical
and one’s moral cognitive development. dilemma involving guanxi and the professional
H2: There is no significant relationship integrity of an auditor. This part of the ques-
between an auditor’s ethical judgement tionnaire is developed to identify and examine
and the existence of guanxi. the role of guanxi in the decision-making process
H3: The impact of guanxi on an auditor’s of auditors. The auditor’s response to the audit
judgement is depending on the level of conflict situation is assessed through a scenario.
ethical reasoning. The purpose of the scenario is to investigate the
ability of the respondents to resist the temptation
to help a good friend when it requires a viola-
Research methods tion of the profession’s code of conducts. In
particular, the respondents are presented with a
Subjects in this research are professional accoun- moral dilemma relating to their professional
tants in public practice in Hong Kong. The integrity in maintaining client confidentiality and
sample size is 70. Since the subjects are required their personal responsibility to a close friend. In
to make decisions on an auditor-client conflict this case, the auditor’s close and long-time friend
situation, only experienced auditors are invited who has help the auditor and the auditor’s family
to participate in this research. After consultation tremendously for many years asks the auditor for
with 3 partners of one of the Big Six professional a professional advice on a major investment on
accountancy firms in Hong Kong, it is established a company which the auditor has just completed
that auditors with 3 years of audit experience a statutory audit. This close friend has the
may be required to face auditor-client conflict majority of his personal wealth invested in this
situations. Hence, the selection criterion in term company and does not have a healthy financial
of audit experience is set at 3 years or more. position. In addition, the auditor also knows
Convenience sampling method is adopted to that the company is, in fact, in deep financial
select the sample for this survey. The use of non- troubles.
probabilistic method in this research is because The fourth part of the questionnaire is devised
of the difficulties involve in selecting the subjects to capture the respondent’s response on an
by random sampling. The main difficulty is arisen auditor-client conflict situation. The author’s
from the time required to complete the ques- response to the audit conflict situation is, again,
tionnaire. It is estimated that the entire research assessed through a scenario. The purpose of the
instrument required subjects to spend approxi- scenario is to investigate the ability of the respon-
mately 40 minutes to finish the exercise. dents to resist pressure from the client in these
conflicts situations. In this case, the respondents
are presented with a moral dilemma relating to
Research instruments their professional integrity in maintaining client
confidentiality and their social responsibility as a
A questionnaire is developed to collect the citizen. In this case, the auditor overheard a con-
required information for this study. The ques- versation between the senior management of
tionnaire is divided into four parts. The first part a construction equipment company that their
is the introduction in which instructions to fill equipment, though complied with the govern-
out the questionnaires together with illustrations ment’s safety standards, has a defect in it.
are provided to the respondents. However, no hard evidence is detected during
The second part is related to the measurement the normal course of audit. This auditor is also
of the level of the cognitive moral development auditing another company which has concluded
of the subjects. The Defining Issues Test (DIT) a substantial contract with this construction
developed by Rest (1979, 1986) is adopted to equipment company. The auditor is faced with
provide such a measurement. a dilemma in whether such information obtained
90 Alan K. M. Au and Danny S. N. Wong

from the first client should be disclosed to the measured by the P score in the DIT, does a
second client. change occurs between the guanxi variable and
In both scenarios, the respondents are required the ethical judgement of auditors. The point of
to role play as the auditor of the company reflection is obtained by solving Equation 2.
described in the case and are asked to explicate
their perceptions on a range of issues which
they could have faced in discharging their daily Findings and discussions
responsibilities as auditors. Their perception is
measured along a eight point semantic scale. The results of the multiple regression analysis are
shown in Table I below.
The results, as depicted in Table I, suggest that
Research procedures the equation is significant and all the coefficients
are significant at the 1% level. Hence, the results
After conducting the procedure for checking the indicate that the three hypotheses tested in this
internal consistency of the DIT instrument, 12 study can be rejected at the 1% level.
questionnaires are discarded; thereby leaving only In this respect, the results seem to have sug-
58 usable questionnaires. Multiple regression is gested that there is a significant relationship
used to analyse the data. Because of the need between an auditor’s ethical judgement and one’s
to investigate the two-way interaction effects moral cognitive development. The sign of the
between the ethical reasoning and guanxi vari- regression is negative. A further investigation into
ables, a multiplicative model is adopted. The fol- the design of the questionnaire reveals that this
lowing multiple regression equation is employed direction is correct since a higher score in the
to analyse the data: scenario investigating the auditor’s ethical judge-
ment implies that the auditor is making a less
Y = α + β 1X 1 + β 2X 2 + β 3X 1X 2 (1) ethical decision. On the other hand, a higher P
Where Y = auditors’ judgement in ethical score suggests in higher level of cognitive moral
dilemma development. Hence, a negative relationship
X1 = ethical reasoning insinuates that the higher the level of cognitive
X2 = effects of guanxi moral development of the respondent, the more
X1X2 = interaction term (ethical rea- ethical decision one will made when confronting
soning X effect of guanxi) with an ethical dilemma.
Regarding the second hypothesis, the results
The interaction variable in the regression of the regression analysis also find that the
equation is created to determine the cross- hypothesis can be rejected (p = 0.000). Hence,
product effect occurring between the indepen- the results suggest that there is a relationship
dent variables on the dependent variable.
However, in order to ascertain the nature and
direction of the interaction, the partial derivative
Results of the regression analysis
of the multiple regression equation is obtained,
with the following equation depicting the rela- Variable Beta Sig. t-value
∂Y/∂X2 = β2 + β3X1 (2) X1 (ethical reasoning) –0.7870 0.000
X2 (effects of guanxi) –3.7050 0.000
In solving this partial derivative equation, the X1X2 (ethical reasoning
ethical reasoning variable is treated as the mod- × effects of guanxi) –0.0577 0.001
erator in the relationships between guanxi and
the auditors’ ethical judgement. In addition, the R2 0.400
Multiple R 0.630
point of inflection is calculated to determine at
Sig. F-value 0.000
which point in the scale of ethical reasoning, as
Ethical Decision-Making Process of Auditors 91

between an auditor’s ethical judgement and the begins to change when the level of ethical rea-
existence of guanxi. Again, the sign of the coef- soning, as measured by the P score of the DIT,
ficient is negative. A further detailed analysis into surpasses 64.21. At a higher level of ethical rea-
the responses indicated that the negative direc- soning, the relationship between guanxi and the
tion only implies the existence of a one-way auditors’ professional behaviour is positive, which
relationship between guanxi and auditors’ judge- implies that the impact of guanxi on auditors’
ment. As mentioned earlier, a higher score on professional behaviour may be minimal.
the auditors’ judgement means a less profession-
ally accepted (that is, ethical) judgement. In the
guanxi scenario, a higher score implies the exis- Conclusion
tence of a guanxi effect on the respondents in
making a less ethical decision. A negative rela- The findings of this research support the three
tionship in this case suggests that even respon- hypotheses of this study. The results confirm that
dents who have behaved in a professionally (1) there is a relationship between ethical judge-
ethical manner (that is, those with a lower score) ments and level of moral reasoning for auditors;
will act in a professionally less acceptable behav- (2) there is a relationship between an auditor’s
iour under the influence of guanxi. After inves- ethical judgement and the existence of guanxi;
tigating the responses provided by the auditors, and (3) the impact of guanxi on an auditor’s
it reveals that this negative relationship only exists judgement is depending on the level of ethical
in this direction and not the other way round as reasoning.
there is not a single case which shows a low score These findings have important implications for
on the guanxi scenario and a high score on the the accounting profession as a whole. Since both
other scenario. Hence, it can be concluded that the existence of guanxi and the level of ethical
auditors’ professional judgement could be affect reasoning can influence an auditor’s professional
by the existence of guanxi. judgement, it is important that the profession
In order to test the third hypothesis, the inter- needs to investigate effective ethical interventions
action effects between guanxi and the level of for accountants with relatively low level of cog-
cognitive moral development on an auditor’s nitive moral development.
judgement is investigated. Again, the regression One possible area for future research is to
results confirmed that the hypothesis can be study the effects of an effective self-regulatory
rejected (p = 0.001). Hence, it can be concluded system in the accounting profession through the
that the impact of guanxi on an auditor’s judge- incorporation of the Code of Conduct to restrain
ment is depending on the level of ethical rea- the behaviour of professional accountants with a
soning. Since a significant interaction between lower level of ethical reasoning.
guanxi and ethical reasoning on auditors’ pro- Finally, just a note of caution that since
fessional judgement is found, the partial deriva- random sampling is not employed in the data col-
tive equation, as exhibited in Equation 2, is lection process, generalising of the results to
studied. The point of reflection calculated from other subjects as well as other environments may
Equation 2 is 64.21. After conducting the regres- not be appropriate.
sion analysis, Equation 2 can be written as:
∂Y/∂X2 = –0.37 + 0.0577X1 (3)
Therefore, the point of reflection calculated is
64.21 which means that at lower levels of ethical The research is funded by the President’s Advisory
reasoning, the relationship between guanxi and Committee on Research and Development.
the auditors’ professional behaviour is negative.
In other words, guanxi can affect the professional
judgement of an auditor under lower level of
ethical reasoning. However, this relationship
92 Alan K. M. Au and Danny S. N. Wong

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