Board informal hierarchy and audit quality: evidence from China

Abstract

Purpose Improving audit quality is an important research area of managerial accounting. This study focuses on the informal institutions within organizations and their impact on audit quality. Specifically, this study aims to examine the impact of the informal hierarchy among directors on audit quality. Design/methodology/approach The authors examine Chinese companies with listed shares from 2008 to 2020. The authors proxy for audit quality using discretionary accruals and small profits, and use ordinary least squares regression to test their hypotheses. Findings The results demonstrate that the informal hierarchy of the board improves audit quality. The results are robust to a battery of sensitivity analyses. Additionally, there is weak evidence that the effect of the board’s informal hierarchy on audit quality is weaker in state-owned enterprises. Moreover, the mechanism tests indicate that the board’s informal hierarchy improves audit quality through the improvement of internal controls. In addition, the impact of the informal hierarchy among directors on audit quality further improves firm performance. However, audit fees are not reduced further because the board’s informal hierarchy demands higher audit quality by choosing industry audit experts. Originality/value This study not only enriches the research on the economic consequences of the board’s informal hierarchy but also expands on studies on antecedents of audit quality.

Board's informal hierarchy: influences on enterprise innovation quality

“…The need for attention and trust further amplifies the risk decision-making inclination of higher-level members. The identification of the members on the top hierarchy will help guide each member to maintain the consistency of behavior and opinions and maintain a stable order in the division of labor and cooperation (Hogg, 2001; Peng and Luo, 2000; Zhang et al. , 2023c).…”

“…In this study, we define the informal hierarchy of the board of directors based on expectation states theory and existing literature references (He and Huang, 2011; Zhang et al. , 2023c).…”

“…, 2023), often overlooking interaction effects induced by informal hierarchies within the board, arising from disparities in power and status. Viewed through the lens of social psychology research, the exchange and harmonization of viewpoints – a resultant of inherent dialogue, coordination, and contestation among board members – is deemed a pivotal determiner in subsequent decision-making (Finkelstein and Mooney, 2003; Zhang et al. , 2023c).…”

“…Current research has explored the economic consequences of the board's informal hierarchy from multiple perspectives. For instance, Zhang et al. (2023c) discovered that the board's informal hierarchy could result in higher audit quality in the company.…”

“…By explaining the logical mechanisms in the paper, we expand upon the existing literature's understanding of the influence of the board's informal hierarchy (Jebran et al. , 2019; Zhang et al. , 2023c).…”