The impact of corporate governance on auditor choice: Evidence from China

As the largest and fastest growing emerging market, China is becoming more and more important to investors throughout the world. The purpose of this paper is to investigate the determinants of firms’ auditor choice in China in respect of their corporate governance mechanism. Normally firms have to take a trade-off in their auditor choice decisions, i.e., to hire high-quality auditors to signal effective audit monitoring and good corporate governance to lower their capital raising costs, or to select low-quality auditors with less effective audit monitoring in order to reap private benefits derived from weak corporate governance and less-transparent disclosure (the opaqueness gains). We develop a logit regression model to test the impact of firms’ internal corporate governance mechanism on auditor choice decisions made by IPO firms getting listed during a bear market period of 2001–2004 in China. Three variables are used to proxy for firms’ internal corporate governance mechanism, i.e., the ownership concentration, the size of the supervisory board (SB), and the duality of CEO and chairman of board of directors (BoDs). We classify all auditors in China into large auditors (Top 10) and others (non-Top 10), assuming the large auditors can provide higher quality audit services. The empirical results show that firms with larger controlling shareholders, with smaller size of SB, or in which CEO and BoDs chairman are the same person, are less likely to hire a Top 10 (high-quality) auditor. This suggests that when benefits from lowering capital raising costs are trivial, firms with weaker internal corporate governance mechanism are inclined to choose a low-quality auditor so as to capture and sustain their opaqueness gains. On the other hand, with improvement of corporate governance, firms should be more likely to appoint high-quality auditors.     

Audit committee financial expertise,corporate governance,and the voluntary switch from auditor-provided to non-auditor-provided tax services

A prime objective of the SOX is to safeguard auditor independence. We investigate the relation between audit committee quality, corporate governance, and audit committees' decision to switch from permissible auditor-provided tax services. We find that firms with more independent boards, audit committees with greater accounting financial expertise, higher stock ownership by directors and institutions, that separate the CEO and Chairman of the board positions, and with higher tax to audit fee ratios are more likely to switch to a non-auditor provider. Further, we document that firms are more likely to switch prior to issuing equity. We find no evidence that broad financial expertise on audit committees is related to the switch decision, suggesting that the SEC's initial narrow definition of expertise is more consistent with the objective of the SOX. Overall, our results suggest that accounting financial expertise and strong corporate governance contribute to enhanced audit committee monitoring of auditor independence.     

高管团队内部治理与企业资本结构调整——基于非CEO高管独立性的视角

本文以2001-2017年A股上市公司为研究样本,实证检验了高管团队内部治理对企业资本结构的影响。研究发现:当企业负债不足时,高管团队内部治理效应能够显著提高企业(尤其是非国有企业)的负债水平,降低企业实际资本结构与目标资本结构的偏离程度。这种高管团队内部治理效应在第一类委托代理问题比较严重以及非CEO高管监督动机较强的企业中更加显著。作用机制分析表明,高管团队内部治理效应能够通过降低第一类代理成本来降低企业资本结构与目标资本结构的偏离程度。本文的研究结论为改善我国上市公司治理提供了新的思路,对于优化企业融资结构、深化金融供给侧结构性改革具有一定的启示意义。     

Using machine learning to predict auditor switches: How the likelihood of switching affects audit quality among non-switching clients

In this paper, we utilize machine learning techniques to identify the likelihood that a company switches auditors and examine whether increased likelihood of switching is associated with audit quality. Building on research that finds a deterioration in audit quality associated with clients that engage in audit opinion shopping, we predict and find lower audit quality among companies that are more likely to switch auditors but remain with their incumbent auditor. Specifically, we find that companies more likely to switch auditors have a higher likelihood of misstatement and larger abnormal accruals. These results are consistent with auditors sacrificing audit quality to retain clients that might otherwise switch. Our findings are especially concerning because there is no public signal of this behavior, such as an auditor switch. Our methodology is designed such that it could be implemented by investors, audit firms and regulators to identify companies with a higher probability of switching auditors and preemptively address the deterioration in audit quality.     

The effect of auditor IT expertise on internal controls

Material weaknesses in internal controls related to information technology (IT) represent unique threats to organizations. Utilizing the external auditor as an example of an externally observable governance mechanism, we investigate if firms with revealed IT internal control deficiencies employ a strategy of disassociation with their current auditor. Our tests show that prior evidence of disassociation strategies hold in both IT and non-IT contexts. Of particular focus to our study, we document a positive association between firms that report IT material weaknesses and subsequent auditor dismissals or switching. We next investigate the potential internal control benefits of switching to auditors with greater expertise in environments that emphasize the importance of IT. We argue that greater audit firm IT expertise promotes improved internal controls for their clients, especially those controls that are dependent on IT. We find that clients that switch to auditors with greater IT expertise, relative to their former auditor, have a greater likelihood of material weakness remediation within one year of reporting control weaknesses. Complementing these findings, we find that audit IT expertise is negatively associated with both non-IT and IT material weaknesses in an ex ante reporting setting. Prior literature takes a longstanding interest in both the incentive for developing auditor expertise and the effects of that expertise. We contribute to this literature stream by providing additional evidence related to a specific type of expertise.     

Board governance and bank performance: A meta- analysis

Using a database of 56 studies on corporate governance in the banking industry that were published between 2007 and 2019, this study performs a meta-analytic review to examine the impact of board governance on bank performance. We investigate how board size, CEO duality, outside directors, and female directors on board play a role in determining bank performance. Variations in the relationship between board governance and bank performance that attribute to moderating effects of potential moderators, including the system of corporate governance, bank performance measures, the definitions of governance variables, publication quality, and endogeneity concerns, are also encapsulated. Our study shows that bank performance is positively associated with larger boards and a high proportion of outside and female directors, supporting the resource dependence theory. We find that the moderating variables considerably alter the link between board governance and bank performance. The study offers ways to enhance board effectiveness by enforcing governance practices in the banking systems based on each countries’ legal and institutional framework and suggests reconsidering mandates for smaller boards and duality on boards of banking firms.     

Performance and governance in microfinance institutions

We examine the relationship between firm performance and corporate governance in microfinance institutions (MFI) using a self-constructed global dataset on MFIs collected from third-party rating agencies. Using random effects panel data estimations, we study the effects of board and CEO characteristics, firm ownership type, customer-firm relationship, and competition and regulation on an MFI’s financial performance and outreach to poor clients. We find that financial performance improves with local rather than international directors, an internal board auditor, and a female CEO. The number of credit clients increase with CEO/chairman duality. Outreach is lower in the case of lending to individuals than in the case of group lending. We find no difference between non-profit organisations and shareholder firms in financial performance and outreach, and we find that bank regulation has no effect. The results underline the need for an industry specific approach to MFI governance.     

The association between employee stock option disclosures and corporate governance: Evidence from an enhanced disclosure regime

This study examines the role of corporate governance in employee stock option (ESO) disclosures following the revision of AASB 1028 Employee Benefits in 2001. We find that, while firms do not fully comply with AASB 1028 ESO disclosures, they voluntarily provide other ESO disclosures. In relation to corporate governance measures that have a role in the financial reporting process, we find two corporate governance measures dominate our results—the quality of auditor and duality of the role of CEO and Chair of the Board of Directors. We show that, in general, external auditor quality has positive incremental association with both mandatory and voluntary ESO disclosures while the dual role of CEO and chairperson of the board is associated with lower levels of mandatory disclosure.     

An Empirical Investigation of the Interface Between Internal and External Auditors

Professional standards place specific responsibilities on auditors for the discovery of material mis-statements in reports of corporate financial performance. Certain factors have been shown to increase the likelihood of fraudulent financial reporting. One warning sign is the potentially pervasive effect of a weak internal control environment consistent with a weak internal audit group. This study investigates the impact of internal audit department quality differences on auditors ‘willingness to place reliance on the work performed by internal auditors. The study also gives consideration to auditors’ recent experiences with material errors and irregularities and examines the influence of two previously untested individual auditor differences on audit judgment decisions: (1) conflict management style and (2) perception of internal/external auditor communication barriers. The results indicate that auditors attend to internal audit department quality differences and that individual auditor differences exhibit significant influence over auditor judgments. Implications for audit practice are considered and directions for future research are suggested.     

中国期货经纪公司治理有效性研究

中国期货经纪公司在内部治理方面存在着股权结构不合理、管理层独立性不强、监督机制不完善、独立董事制度尚未完全建立、相关利益主体对公司监控作用较小等问题;在外部治理方面存在信息披露制度落后和市场竞争不充分造成的经理人市场缺失等问题;期货经纪公司的经营业绩与其第一大股东持股比重、期货经纪公司的董事会和监事会规模、外部债权人质量、营业部数量等因素正相关,而期货经纪公司董事长兼任总经理现象则对公司业绩产生负面影响。     

Do External Auditors Perform a Corporate Governance Role in Emerging Markets? Evidence from East Asia

In emerging markets, the agency conflicts between controlling owners and the minority shareholders are difficult to mitigate through conventional corporate control mechanisms such as boards of directors and takeovers. We examine whether external independent auditors are employed as monitors or as bonding mechanisms, or both, to alleviate the agency problems. Using a broad sample from eight East Asian economies, we document that firms with agency problems embedded in the ownership structures are more likely to employ Big 5 auditors. This relation is evident among firms that raise equity capital frequently. Consistently, firms hiring Big 5 auditors receive smaller share price discounts associated with the agency conflicts. Also, we find that Big 5 auditors take into consideration their clients' agency problems when making audit fee and audit report decisions. Taken together, these results suggest that Big 5 auditors do have a corporate governance role in emerging markets.     

An international study of internal audit function quality

We investigate organisational and environmental factors that influence firms’ incentives to develop high-quality internal audit functions (IAFs) by using a unique international sample formed by matching proprietary data from a global internal auditor survey with public data obtained from Worldscope. Concerning organisational factors, we find that a positive relationship exists between IAF quality and firm complexity and confirm that complex firms have a higher demand for monitoring and advising and, therefore, a greater need for formal controls. In addition, IAF quality is positively related to board monitoring and audit committee diligence but negatively associated with CEO power, which suggests that IAF quality is influenced by other key players in corporate governance. Regarding environmental factors, we document that IAF quality is positively associated with industry competition, which implies that a firm’s incentive for a high-quality IAF is enhanced when confronted with greater environmental uncertainty. Furthermore, IAF quality has a significantly positive relationship with our self-constructed index of IAF requirements included in national corporate governance codes, which indicates that strong home-country corporate governance codes play a role in fostering IAF development.     

The Simultaneous Relation Between Auditor Switching and Audit Opinion: An Empirical Analysis

Previous studies examining the relation between the audit opinion and auditor switching assume a one-way causation, with the issuance of a qualified opinion triggering a switch. However, analytical studies dealing with auditor independence issues (e.g., Magee and Tseng, 1990; Dye, 1991; Teoh, 1992) suggest an opposite causation, in which the auditor is less likely to qualify the opinion for a client who may switch auditors. Some evidence of an opposite causation is provided by Krishnan (1994), who finds that auditors treat switchers more conservatively (relative to non-switchers) in issuing the audit opinion. The causation between switching and the audit opinion is clearly important for policy decisions regarding both opinion shopping and auditor independence. In this paper, we test the two-way causation hypothesis and find evidence in support of a two-way causation. Our simultaneity-adjusted estimates confirm previous findings of a positive effect of a qualified opinion on switching (Chow and Rice, 1982; Craswell, 1988; Citron and Taffler, 1992). However, we find in addition that auditors are more likely to issue qualified opinions to switchers. This finding does not support the analytical studies cited earlier.     

Corporate governance and capital allocations of diversified firms

We examine how various aspects of corporate governance structures affect the capital allocation inefficiency that drives the value discounts of diversified firms. Diversified firms with more effective internal or external governance mechanisms experience more efficient investment allocations at both the firm and segment levels and show less of a diversification discount. The efficiency of the investment allocation process is better for diversified firms with high board independence, low board busyness, high institutional ownership, high outside director ownership, high CEO equity-based pay, high audit quality, and strong shareholder rights. The results hold after controlling for other potential influences. Our evidence suggests that corporate governance considerations are important in assessing the relation between investment efficiency and firm value for diversified firms.     

The Influence of Country‐ and Firm‐level Governance on Financial Reporting Quality: Revisiting the Evidence

This paper examines how firm‐level governance and country‐level governance interplay in shaping financial reporting quality. Using IFRS adoption as a source of variation in firms’ reporting discretion, and a large sample of European firms that mandatorily switch to the new set of standards, we find that in countries with low enforcement and weak oversight over financial reporting, only firms with strong board‐level corporate governance mechanisms experience an increase in financial reporting quality, consistent with firm‐ and country‐level governance mechanisms being substitutes. However, in countries with high enforcement and strict oversight over financial reporting, firms with either strong or weak board‐level governance mechanisms experience an increase in financial reporting quality, even if the increase is larger for the former group. Overall, our findings indicate that in the debate about the effects of governance on the quality of financial reporting, it is important to consider both country‐ and firm‐level corporate governance mechanisms.     

Executive compensation and corporate governance in China

We investigate executive compensation and corporate governance in China's publicly traded firms. We also compare executive pay in China to the USA. Consistent with agency theory, we find that executive compensation is positively correlated to firm performance. The study shows that executive pay and CEO incentives are lower in State controlled firms and firms with concentrated ownership structures. Boardroom governance is important. We find that firms with more independent directors on the board have a higher pay-for-performance link. Non-State (private) controlled firms and firms with more independent directors on the board are more likely to replace the CEO for poor performance. Finally, we document that US executive pay (salary and bonus) is about seventeen times higher than in China. Significant differences in US-China pay persist even after controlling for economic and governance factors.     

Institutional Ownership and the Selection of Industry Specialist Auditors

This study provides evidence linking corporate governance mechanisms to the choice of auditor, namely industry specialists. Given that institutional investors are likely to prefer higher quality financial reports to lower quality reports, we theorize that institutional investors will influence managers of companies in which they invest to improve reporting quality by using higher quality, industry specialist auditors. Our findings indicate that firms having relatively greater levels of institutional ownership tend to employ industry specialist audit firms. The results of this study contribute to an understanding of an important facet of corporate governance, the selection of a high quality audit firm.     

Target CEO age,ownership decisions,and takeover outcomes

This paper examines the effect of target CEO age, in association with target corporate governance mechanisms, on the ownership decisions and takeover outcomes in eight East and Southeast Asian countries. The results show that acquirers are more likely to select partial-control acquisitions of target firms managed by older CEOs, and that the impact of target CEO age on the partial-control acquisition propensity is much stronger in emerging markets relative to developed economies. The study further finds that target CEO age leads to a lower probability of obtaining desired equity ownership levels compared to unmatched ownership achievements, controlling for target corporate governance structures. The findings also run robustness checks regarding variations in the compulsory acquisition cut-off in the sample countries. Overall, this paper adds to the growing of mainstream corporate governance literature regarding the relevance of CEO personal characteristics in agency problems for corporate decisions.     

Clawback provision adoption,corporate governance,and investment decisions

We examine the effect of corporate governance on the likelihood of clawback provision adoption, and its consequences in terms of corporate investment practices and risk‐taking behavior. We find that firms with strong governance (as proxied by board independence, diligence, and size) are positively associated with the firm's adoption of a clawback provision; whereas firms with weak governance (as proxied by management entrenchment, i.e., CEO duality status and tenure) are negatively associated with clawback provision adoption. Using the propensity‐score matching, difference‐in‐differences research design, and inverse Mills ratio to mitigate omitted variables and self‐selection biases, we find that after adopting a clawback provision, firms’ abnormal investment decreases and the firms’ investments are less risky.