Determinants of audit quality: evidence from China

This thesis consists of three separate research projects on auditing issues, including auditor switch, audit fees, and audit quality. 

The first study exploits the unique setting of China’s audit price deregulation in 2014 to examine the effect of audit firm characteristics on audit switches. I find a significant increase in audit firm-client realignments after the audit price deregulation policy was implemented. I also find that the increase in realignment is mainly driven by audit firms achieving economies of scale (EOS), suggesting that the efficient cost structure of audit firms provides an important advantage when competing for new clients. These main results are robust to alternative definitions of EOS. Additional analysis shows that, compared to non-EOS audit firms, EOS audit firms are more likely to offer audit fee discounts without compromising the audit quality. I also find that the EOS effect is more pronounced for auditors in highly homogenous industries. Overall, the results of this study provide important insights to policymakers and regulators not only in China but also in other countries when revisiting or developing new audit services policies. 

The second study examines whether the impact of a client firm’s environmental penalty on the cost of audit services differs between female and male auditors in China. I find that the audit fee increase is more pronounced for female auditors than male auditors when a firm incurs an environmental penalty. I also observe that the results are more pronounced for penalized firms that: (i) do not disclose any corporate social responsibility related deficiencies (ii) do not report any internal control weaknesses, (iii) are located in high legal indexed Chinese regions, and (iv) are in less polluting industries. I show that female auditors consider a client’s environmental penalty as an indicator of potential risks. Taken together, these findings confirm the importance of the “gender effect” on a client firm’s audit fees as a consequence of environmental misconduct. 

The third study exploits the unique setting of the 2018 US-China trade war to examine the impact of tariff absorption on audit fee cuts and audit quality for both US and Chinese firms. Following the US tariff increases, I find a significant decrease in profitability for both affected Chinese and US firms, indicating that the increased tariff costs are shared by firms at both ends of the US-China supply chain. Furthermore, I find that the decline in profitability results in a cut in audit fees which in turn has a significantly negative impact on audit quality for Chinese firms but not for US firms. Together, the findings suggest that “tariff absorption” could have a significant influence on firms’ audit fees and audit quality, conditional on the different legal regimes.