We investigate whether and how audit partners differ in the auditing of key audit matters (KAMs) in expanded audit reports in the United Kingdom. Using hand-collected audit report data and manual categorization, we first present descriptive evidence of audit partners' heterogeneity in their KAM topic choices and the corresponding audit procedures. We then document that when an audit partner rotates within the same audit firm, the incoming partner tends to change KAMs and the corresponding audit work, and the characteristics of the incoming partners affect audit judgment. In addition, we show that heterogeneous KAM selection and audit work choices are associated with variations in audit outcomes. Finally, we provide evidence that audit partners exhibit different, yet consistent, audit traits.

SUMMARY Firms undertaking an initial public offering (IPO) appoint investment bankers and auditors to certify information disclosed to investors. We find that social connections significantly increase the likelihood that the bankers and auditors become involved in the same IPO deal. Although some theory and evidence suggests that information transferred via social networks may enhance economic agents’ performance, other research implies that such links may admit bias into auditor judgment or impair their independence. Empirically, we find that IPO firms report higher discretionary accruals when bankers and auditors are socially connected. We also document that banker-auditor social ties are associated with lower earnings credibility and worse post-IPO performance. However, auditors benefit from social connections with bankers by attracting higher fee premiums and securing more future IPO audit businesses.

Viewing audit teams as social groups of auditors, we utilize network analysis algorithm "n-clans" to identify clustering of individual auditors, that is, audit teams, based on individual collaboration history. Drawing upon social learning theory, we argue that team network connectedness, specifically network density and closeness, shapes the similarity in the audit styles among team members. We first validate the team construct by showing the existence of team styles in audit outcomes and audit pricing. Using the dispersion of audit outcomes and abnormal audit fees as inverse measures of au-dit-style similarity, we find that more closely connected teams exhibit lower within-team variation in these measures. Further, the role of network connectedness for the within-team convergence of audit styles is more pronounced when firm-level quality control is less robust, the teams include junior auditors, and the clients served by the teams are more divergent. Network density and closeness also strengthen the relation between audit-team style and that of team members. We extend prior literature by identifying the audit team as a relevant unit of the analysis for audit production and documenting the importance of network connectedness to more consistent audit outcomes.

This paper examines the determinants of internal audit outsourcing from the macro perspective of financial ecological environment. We find that in regions with a poor financial ecological environment, firms are more likely to outsource internal audit and more inclined to outsource to other service providers than to accounting firms that provide financial report audit services for them. Furthermore, those firms with high financing constraints and non-state-owned firms are more likely to outsource internal audit in poor financial ecological environments. Firms outsourcing internal audit in poor financial ecological environments will have low debt financing costs. These results suggest firms in weak financial ecological environments tend to use internal audit outsourcing to enhance investor confidence and reduce financing costs. This paper helps expand the literature related to the determinants of internal audit outsourcing from a macro perspective, and provide a reference for improving the resource-allocation efficiency of the governance-oriented internal audit.

We investigate the impact of remote auditing on audit quality and the good practices undertaken by auditors to improve audit quality in remote auditing. The outbreak of the COVID-19 pandemic in China provides an opportune testing ground for analyzing the impact of remote auditing on audit quality. Using both survey and archival data, we document that audit quality is lower when auditors switch to remote auditing following the outbreak of the pandemic. The negative effect of remote auditing is more pronounced for non-local or short-tenured auditors. However, several good practices, including adjusting audit procedures in a timely manner, relying more on risk evaluation and data analysis, emphasizing the sufficiency and reliability of digital evidence, and exploiting information and communication technology, can improve the effectiveness of remote auditing. Our findings can help financial-statement users better understand the quality of audits when conducted virtually and have implications for practitioners to improve audit quality in remote auditing.

Focusing on mandatory partner rotations, we examine the importance of within-firm network connections to the selection of successor partners and the impact of those connections on post-rotation audit performance. Using data from China, we track partners' history and identify incumbent-successor connections stemming from jointly conducted prior engagements. Although these connections can enhance incumbent-successor information transfers and thus post-rotation audit performance, they may also pose a threat to quality by compromising the successor's independence. Among the pool of replacement candidates, we find that individuals with stronger connections with the incumbent are more likely to be appointed as successors. This finding is more pronounced when the audit engagement is more complex, client-specific knowledge is not readily available to the succeeding partner, and the engagement is more valuable to the audit firm. We also document that successor-incumbent connections are associated with equal or better post-rotation audit quality and fewer client defections. These results suggest that the benefits of network-based successor selection may outweigh its costs. By enriching our understanding of the partner transition process, this study contributes to the public policy discourse on partner rotation.

Backed by China's economic growth, the initial public offering (IPO) market in China has been one of the most vigorous in the world. In this market, practicing auditors routinely sit on the regulatory committee responsible for screening prospective IPO firms. Against this backdrop, we examine whether IPO-audit expertise can influence IPO-audit quality and capital allocation. We find that auditors with richer IPO-audit experience improve the quality of earnings in IPO prospectus, earn an audit fee premium, and are significantly more likely to be assigned to IPO engagements by audit firms or appointed to the regulatory committee by regulators. We also show that, by enhancing the credibility of information disclosure in IPO prospectus, IPO exper-tise of the regulatory committee members and the IPO engagement auditors improves capital allocation efficiency. Collectively, our evidence implies that a more sophisticated audit profes-sion can contribute to the development of capital market in a country.

Although mandatory audit partner rotation has become prevalent worldwide, prior empirical research seldom considers how the successor partners are identified and the economic consequences of different rotation strategies. We examine the importance of internal networks to the selection of successor partners and the underlying incentives in the selection process in China, which affords an opportune testing ground for analyzing our research questions. We find that candidate partners who are familiar with the incumbents—evident in prior teamwork experience—are more likely to be selected as successors. Consistent with expectations, this phenomenon is more pronounced when the engagement information is more complex, alternative channels to transfer client information to the successor are not available, and the engagement is more attractive. These results are consistent with auditors’ incentive to facilitate information transfer and maintain client satisfaction after the transition. Reinforcing this interpretation, we find that post-rotation audit quality improves and clients are less likely to switch audit firms after the rotation when the successor partner is familiar with the incumbent. Enriching our understanding of the production of audit services in audit firms, our analysis contributes to the public policy discourse on partner rotation.

Using a comprehensive sample of public-company audits in China, we demonstrate the contagion of audit misbehavior among individual auditors (i.e., CPAs) through their teamwork experience. Regulators sanction CPAs whose audits are deemed to have failed. We first present evidence that sanctioned CPAs systematically provide low-quality audits during, but not before or after, the audit-failure period. We then document that CPAs who have teamed up with the sanctioned CPAs are also more likely to issue lenient audit opinions and have accounting irregularities in their audited financial reports during the sanctioned CPAs’ audit-failure period. We find no systematic evidence of such contagion effect among CPAs who work in the same audit firm as sanctioned CPAs but are only indirectly connected to them. Our findings highlight the importance of analyzing contagion via teamwork experience in understanding individual-auditor behavior.

Reputation has long been recognized as an important mechanism to mitigate opportunistic behavior in the audit market. However, whether and how reputation motivates auditors to provide high-quality audits is empirically not clear. We exploit the Chinese audit market, where a group of auditors is titled “senior CPAs.” Representing the highest professional recognition, the designation of senior CPA enhances auditors’ reputation in an observable manner. We find that, following the senior-CPA designation, auditors improve audit quality in terms of audit reporting and audited financial statements. The senior-CPA designation is also followed by several market consequences, including higher audit-fee premiums commanded and larger au-dit-market shares gained by the senior CPAs, and higher market valuation of earnings audited by the senior CPAs. Overall, our study provides novel evidence on how the reputation mecha-nism shapes auditor behavior and matters to capital market participants.

ABSTRACT In China's political selection system, officials capable of growing local economies are rewarded with promotions. Eager to demonstrate economic achievements, newly appointed local leaders may raise tax revenues to expand fiscal expenditures on infrastructure projects. Against this backdrop, we study how political appointments influence local firms' tax planning. Based on a sample of locally administered state-owned enterprises (SOEs), we find that firms decrease their tax avoidance after new leaders take office. The political-turnover effect on these firms' tax positions is more evident when the incoming leaders have more political clout over SOE managers, the incentives to divert resources are stronger, or politician-manager networks are present, and subsides following the launch of the anticorruption campaign. Furthermore, firms with higher post-turnover tax payments subsequently receive more government contracts or subsidies. Overall, our findings suggest political incentives shape the tax-planning activities of SOE managers in a “two-way favor exchange” manner. JEL Classifications: H26; E32; P26; G30.

We investigate whether and how auditor heterogeneity affects key audit matters (KAMs) of auditing and reporting in the expanded audit reports in the United Kingdom. By using hand-collected audit-report data and manual categorization, we first present descriptive evidence of auditors’ heterogeneity on KAM-topic choices and corresponding audit procedures. We then document that, when there is an auditor switch, the incoming auditor tends to change the KAMs and the corresponding audit procedures. In addition, the incoming auditor is more likely to identify new KAMs that are worth audit attention, supporting the notion that auditor change can bring a fresh perspective to the audit. Overall, we find that audit firms are heterogeneous in KAM-topic selection and audit-procedure choices.

In China’s transitional economy, one of the major objectives of the government is to maintain social stability. We hypothesize that, through state ownership and appointment of executives, Chinese government officials can influence firms’ labor employment decisions by limiting layoffs when firms’ sales decline. Consistent with this hypothesis, we find that state-owned enterprises (SOEs) have stickier labor costs than non-SOEs, and the presence of politically connected managers makes labor costs even stickier in SOEs while having little effect in non-SOEs. Such effects are stronger in regions with weak market institutions and during time periods when government officials are to be promoted. We also show that the government reciprocates SOEs’ sticky labor policies with subsequent subsidies. This paper was accepted by Suraj Srinivasan, accounting .

ABSTRACT Adverse client publicity can entail regulatory scrutiny over audited financial statements and impose political costs on auditors. We use the changes in client publicity caused by their controlling owners’ presence on the Hurun Rich List (the rich listing) in China to test the hypothesis that auditor conservatism increases with client publicity. Our evidence indicates auditors issue more adverse audit opinions to clients and charge higher fees following the rich listing events. Moreover, we observe that auditors strategically respond to clients with different attributes—for clients whose owners accumulated wealth in a more questionable manner, auditors choose more stringent audit reporting to better defend themselves from regulatory scrutiny; for clients without such attributes, auditors primarily rely on increasing audit fees to cope with any post‐listing increase in audit risks. Our analyses also suggest the impacts of rich listings tend to be concentrated among large audit firms with stronger reputation concerns or among engagement auditors with more conservative reporting styles. By showing how auditors manage political risks associated with heightened public scrutiny, we contribute to both the auditing and political cost literature.

In relationship-based economies, operating transactions are carried out not in markets but within networks of related stakeholders. The paper presents a contracting framework to show that the primary objective of corporate governance and accounting in these economies is to facilitate firms’ relational contracts with their related stakeholders and protect the interests of these stakeholders. Resolving the firms’ agency conflicts with arm’s length capital providers is not necessarily the primary goal of corporate governance and accounting. Thus, to reduce the agency costs of raising arm’s length capital, firms will have to consider the interests of all its stakeholders when developing governance mechanisms that protect arm’s length capital providers. I discuss two recent China papers that show how information intermediaries’ embeddedness in firms’ social network bridges the information gap between the firms and their arm’s length shareholders. We also propose research opportunities for studying how accounting and corporate governance can bridge this information gap between relational networks and markets. I benefited from conservation with Zengquan Li while researching on relational contracts together, and my discussion with Kaiwen Wu and the rest of the China research discussion group at USC. I appreciate the comments by Donghua Chen, Pingyang Gao, Donghui Wu, Lijun Xia, Qingquan Xin and Tianyu Zhang and other workshop participants at the Chinese University of Hong Kong (Shenzhen), Fudan University, the Shenzhen Financial Institute and the 2019 Annual Conference of China Accounting Review.

China’s split-share reform of 2005 (the Reform) converts the previously restricted shares held by founding shareholders to shares tradable on the open market. Against this backdrop, we study how underwriter-affiliated analysts and firms’ large shareholders interact in the event of the latter’s sales of restricted shares. We document that recommendations made by affiliated analysts are significantly more optimistic when firms’ large shareholders plan to sell their restricted shares. This optimism, however, is associated with negative post-sale stock returns, suggesting that large shareholders profit from share sales but at the cost of public investors. Furthermore, large shareholders sell more restricted shares through the affiliated brokerages with analysts issuing more optimistic recommendations and firms under their control are more likely to appoint such brokerages as lead underwriters when they refinance in the future. For the affiliated analysts, they conduct more site visits to the firms after the share sales, thereby improving their earnings forecast accuracy. Our analysis shows how conflicts of interest by financial intermediaries arise following the Reform and leads to large shareholders’ extraction of rents from public investors. These findings have regulatory implications.

Previous research on whether the market responds to auditors' opinions has provided mixed results. We revisit this issue in China, where individual investors who are more likely to neglect value-relevant information dominate the stock market. In addition to going concern opinions (GCOs), China permits modified audit opinions (MAOs) on violations of accounting standards or disclosure rules (GAAP/DISC MAOs), providing an opportunity not available in the literature to enrich the study of audit-opinion pricing. We find that, ceteris paribus, MAO recipients underperform in the future and have a higher incidence of adverse outcomes such as misreporting and stock delisting, and the market reacts negatively to MAOs during the short window around MAO disclosure. Importantly, MAO disclosure is not followed by negative long-term stock returns, suggesting stock price adjustments to MAOs are speedy and unbiased. These findings hold for both GCOs and GAAP/DISC MAOs. Together, our findings support the informativeness of audit opinions and cast doubt on the argument that investors inefficiently price audit opinions due to information-processing bias.

Exploiting time-series data on labor laws from 39 countries, we investigate how labor power influences firms’ payouts. We find that legislative changes that strengthen labor power reduce firms’ dividend payments and total payouts. The payout restriction effect of labor power is more pronounced in firms with greater labor intensity and in firms operating in countries with broader collective bargaining coverage and more effective law enforcement. Tightened operating flexibility and excess wage extraction are two plausible channels through which labor power affects payouts. These findings indicate that labor power is another important country-wide institution that shapes corporate payout policy.

We present a synthesis of academic research on corporate payout policy grounded in the pioneering contributions of Lintner (1956) and Miller and Modigliani (1961). We conclude that a simple asymmetric information framework that emphasizes the need to distribute FCF and that embeds agency costs (as in Jensen (1986)) and security valuation problems (as in Myers and Majluf (1984)) does a good job of explaining the main features of observed payout policies — i.e., the massive size of corporate payouts, their timing and, to a lesser degree, their (dividend versus stock repurchase) form. We also conclude that managerial signaling motives, clientele demands, tax deferral benefits, investors' behavioral heuristics, and investor sentiment have at best minor influences on payout policy, but that behavioral biases at the managerial level (e.g., over-confidence) and the idiosyncratic preferences of controlling stockholders plausibly have a first-order impact.

ABSTRACT We examine whether social ties between engagement auditors and audit committee members shape audit outcomes. Although these social ties can facilitate information transfer and help auditors alleviate management pressure to waive correction of detected misstatements, close interpersonal relations can undermine auditors' monitoring of the financial reporting process. We measure social ties by alma mater connections, professor-student bonding, and employment affiliation, and audit quality by the propensity to render modified audit opinions, financial reporting irregularities, and firm valuation. Our evidence implies that social ties between engagement auditors and audit committee members impair audit quality. In additional results consistent with expectations, we generally find that this relation is concentrated where social ties are more salient, or firm governance is relatively poor and agency conflicts are more severe. Implying reciprocity stemming from social networks, we also report some suggestive evidence that audit fees are higher in the presence of social ties between an engagement auditor and the audit committee. Collectively, our analysis lends support to the narrative that the negative implications—namely, worse audit quality and higher audit fees—of these social ties may outweigh the benefits.