Audit Quality in China: Evidence from Audit Market Development and Split-share Structure Reform

Abstract

This study examines audit quality in China over the period 2003 to 2014. In particular, we study the period where two main structural reforms took place in China and investigate how they affect audit quality. The first of these is the privatization of Local State-owned Enterprises (LSOEs) through the Split-share Structure Reform (SSSR) and the second is the development of the domestic accounting industry through "Document 56". We also study how government influence over firms affects audit quality and the moderating effect of auditor choice on this relationship. We finally study how audit quality differs across China's regions based on the level of market development. In this study, we use an input-based measure “total audit fees” as a surrogate for audit quality, in response to the findings of DeFond and Zhang’s (2014) survey of empirical audit quality research. Using a sample of 1,826 Chinese listed firms during the period from 2003 to 2014, we run quantitative regression models (i.e., OLS, first difference and GMM estimation models) to explain how audit quality was developed in China throughout its structural reforms period. The main results show that LSOEs are charged lower audit fees compared with NSOEs. The results also show that big audit firms, both domestic Big 6 and international Big 4, charge higher audit fees than non-Big-10 audit firms. We observe a drop in audit quality after the SSSR, followed by a slight improvement after the announcement of Document 56. The results provide no evidence that market development improves audit quality in China.