Business Group Audit and Relative Performance Evaluation

• In Event: Breakfast and Research Forum
  In Roundtable Session: Table 7: Audit Markets

Abstract

Financial reporting quality of business groups is shaped by two opposing forces. On the one hand, complex group structure aids group controlling interests to hide rent-seeking activities through earnings management. On the other hand, relative performance evaluation theory implies the opportunity to compare auditor quality across engagements within a group increases group shareholders’ ability to monitor and motivate auditor effort, leading to enhanced audit quality. Such increase should be more pronounced for groups where shareholders have more audit engagements to benchmark. We study auditor selection, auditor switch and earnings quality of firms associated with business groups (i.e., group firms) relative to stand-alone firms (i.e., non-group firms). Compared to non-group firms, group firms are more likely to engage Top 10 audit firms in China, are more likely to dismiss delinquent auditors even before the arrival of public signals about the quality of those auditors, and exhibit higher earnings quality. Using a subsample comprising only group firms, we observe similar variations between business groups with more and less audit engagements. Further analyses reveal that the preceding results hold only when the controlling shareholders of group firms have incentives for high audit quality.

Authors

• Junxiong Fang, Fudan University

• Yinqi Zhang, American University

• Yuping Zhao, University of Houston–Downtown