This study tries to investigate fraudulent financial reporting in China based firms listed on the Hong Kong Stock Exchange which has a high degree of officials’ involvement of China mainland and impact on audit quality and corporate governance. It intends to find out the motives behind fraudulent financial reporting and the opportunity which permits such kind of reporting; and whether the presence of politically-connected executives would likely provide an environment which would be more conducive for fraudulent financial reporting. This study hypothesizes the associations between fraudulent financial reporting and the corporate environment (from the perspectives of economic, ownership, political pressures and audit quality). These were measured by unsigned discretionary accruals, after controlling several characteristics of firm from the samples selected from a number of China based firms listed on the Main Board of the HKSE. The results show that the corporate environment that mostly leads to fraudulent financial reporting is characterized by accounting practices that are already pushing to earnings management. It is also found that firms involved in fraudulent financial reporting have significantly poor corporate governance structures, where the audit quality is lower and outside directors seem over-committed. However, no evidence was found that firm’s political connection factor or the level of board independence plays a significant role in fraudulent financial reporting. The findings of this study would lead to an understanding of corporate behaviors relating to fraudulent financial reporting, and the development of such an understanding is important for preventing frauds and improving better corporate compliance with financial reporting regulations.

Key words: Fraudulent reporting, corporate governance, political connections, earning management, audit quality.