Abstract: With China stepping into the stage of new economy, there arises an urgent need to regulate the activities of listed companies and audit organizations. Auditors in the accounting firms may issue inappropriate audit opinions when carrying out their audit tasks for listed companies due to the listed company's fraudulent practices, which leads to audit failures and loss of social resources. In order to analyze the reasons for audit failure, we must define the responsibilities of the listed companies, the auditors and the market surroundings. By exploring the theory foundation of audit failures, we found the key factor that leads to audit failure is the incomplete contracts, which result in conflict between private and public interests and imbalanced responsibility allocation. An analysis of the decision making process of the listed companies and the audit personnel, reveals that the failure in the auditing is closely related to cognitive abilities of the personnel concerned and the social surroundings. We suggest preventing audit failure by improving listed company's internal governance structure and internal control system and enhancing auditor's abilities and moral of professional performance, and by enhancing supervision over listed companies and the accounting firms.

Key words: incomplete contract, listed company, audit failure, definition of responsibility, dynamics evolution