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[email protected] (Z.J. Lin).
1061-9518/$ – see front matter © 2009 Published by Elsevier Inc.
doi:10.1016/j.intaccaudtax.2008.12.00546 Z.J. Lin, M. Liu / Journal of International Accounting, Auditing and Taxation 18 (2009) 44–59
We examined the relationship between firms’ internal corporate governance mechanisms and their auditor choices for
the Chinese initial public offering (IPO) firms during this testing period. The empirical results show that firms with larger
controlling owners (holding a high proportion of equity), with smaller the supervisory boards (SBs), or in which the CEO
and the chairman of the board of directors (BoDs) are the same person, are less likely to hire a high-quality (large) auditor
in China. This result suggests that when benefits from lowering capital raising costs are trivial, firms with weak corporate
governance mechanisms would decline to choose a high-quality auditor so as to capture and sustain their opaqueness
gains.
The evidence, in general, suggests that large auditors have been able to product-differentiate themselves in the Chinese
equity market. The quality of independent audits and corporate disclosure is identified as an important factor for the Chinese
stock market, in which investor confidence has to be bolstered in order to mobilize social resources to facilitate China’s
transition towards a market-oriented economy. Our findings on the determinants of auditor choice in the Chinese context
will shed light on how to improve firms’ corporate governance and audit monitoring to enhance the credibility of corporate
reporting and to promote smooth development of capital market in China.
Our study also has implications for international investors. As CSRC has recently granted licenses to Qualified Foreign
Institutional Investors (QFII), such asMorgan Stanley, Goldman Sachs, and Citibank, to participate directly in China’s domestic
stock market, the findings suggest that international investors need to be aware of the structural arrangement of corporate
governance of the listed firms and the effectiveness of audit monitoring in China.
The paper is organized as follows: Section 2 reviews relevant prior studies in the literature. Hypotheses are developed
to examine the association between internal corporate governance mechanisms and auditor choice decisions in Section 3.
Section 4 develops a model to test the hypotheses. Empirical results are presented and discussed in Section 5, followed by
the sensitivity tests in Section 6. Section 7 concludes the paper.
2. Literature review
2.1. Audit quality
Prior auditing research uses agency theory to explain the utility of external audit services (Chaney et al., 2004; DeAngelo,
1981; Dye, 1993; Watts & Zimmerman, 1986). The separation of ownership and management can result in opportunistic
management behaviors and severe agency problems in firms (Fama & Jensen, 1983). Thus contractual arrangementsmust be
set between owner (principal) and management (agent) to ensure that management will act in the best interest of the owner,
which includes the external monitoring carried out by independent auditors. An audit provides an independent check on the
work of agents and the information provided by the agents, and therefore serves a fundamental role in reinforcing confidence
in financial reporting as w
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