Capital market liberalization and auditors' accounting adjustments: Evidence from a quasi‐experiment

Abstract

Using a shock to the Chinese capital market and unique and detailed audit-adjustment data, this paper investigates the effect of a capital market liberalization program on auditors' adjustments to their clients' financial reports. Employing difference-in-differences tests with propensity score matching and firm fixed effects (FE), we find that the capital market liberalization induced by the implementation of the Shanghai-Hong Kong Stock Connect affects auditors' professional judgment and leads to audit-adjustment changes stimulated by greater reputational and litigation risks for auditors. Specifically, while the liberalization significantly decreases the frequency and magnitude of upward audit adjustments, the probability of downward adjustments remains the same in most cases. Further evidence shows that the effect is more pronounced for companies with high trading volume from Hong Kong investors, audited by the largest audit firms and with low financial transparency.

Does stock market liberalization improve stock price efficiency? Evidence from China

“…Firms eligible in the Stock Connect scheme are subject to stricter regulation, including additional disclosure requirements than ineligible firms. Second, foreign investors and those from Hong Kong are accustomed to trading in higher‐quality information environments and are more able to collect and process firms’ fundamental information (K. Chen et al., 2020; Deng et al., 2021; Ke et al., 2015). The information they possess may also be different from that of domestic institutional shareholders and managers (Kacperczyk et al., 2021).…”

“…The stock market liberalization program initiated in 2014 by the Chinese government is of great interest to researchers. Yoon (2021) finds that the Chinese liberalization pilot program incentivizes the firms involved to increase the number of select private meetings they have with major foreign brokers, while Deng et al (2021) find that liberalization significantly decreases the frequency and magnitude of upward audit adjustments by eligible firms. However, the effect of liberalization on stock price efficiency, as a mechanism through which secondary stock markets affect real economic activity (Bond et al, 2012), is not fully explored.…”

Does stock market liberalisation restrain corporate financialisation?

“…Zou et al (2019) argue that stock market liberalisation through the CHSC program reduces corporate fraud by improving the corporate information environment and corporate governance structure. Deng et al (2021) use audit adjustment data to show that the frequency and magnitude of upward audit adjustments decrease as the stock liberalisation program significantly strengthens auditors' professional judgement. In this paper, we aim to complement this line of research from the perspective of corporate financialisation.…”

The impact of capital-market liberalization on audit reporting and pricing: evidence from a quasi-experiment

“…Second, the findings presented here have policy implications regarding the novel setting of the establishment of the SHK Connect program. Recent studies have explored the new governance mechanism brought in by capital market liberalization and documented the causal effect of the SHK Connect program on stock price efficiency (Chen et al , 2021), private disclosures (Yoon, 2021) and audit adjustment (Deng et al , 2022). In this regard, Deng et al (2022) have focused on the process of audit work, whereas we explore whether capital market liberalization brings a new and strong governance mechanism to the audit report, which is the outcome of audit work and is directly related to the legal liabilities of auditors.…”

“…Recent studies have explored the new governance mechanism brought in by capital market liberalization and documented the causal effect of the SHK Connect program on stock price efficiency (Chen et al , 2021), private disclosures (Yoon, 2021) and audit adjustment (Deng et al , 2022). In this regard, Deng et al (2022) have focused on the process of audit work, whereas we explore whether capital market liberalization brings a new and strong governance mechanism to the audit report, which is the outcome of audit work and is directly related to the legal liabilities of auditors. Further, we provide direct evidence that auditors of connected firms would increase the issuance of MAOs to avoid potential legal liabilities.…”