How does establishing a branch office affect audit quality? Evidence from China

Abstract

Establishing a branch office may improve audit quality for an audit firm’s existing clients in the same region as the newly established branch by relieving time and financial resource constraints (i.e., the input channel) and reducing information asymmetry between auditors and clients (i.e., the information channel). Conversely, it may reduce audit quality by undermining audit independence (i.e., the audit independence channel). We test these conjectures using data on Chinese listed firms from 2001 to 2019 and the propensity score matching–difference-in-differences method. Our results show that establishing a branch office improves audit quality, and they remain robust to a series of alternative measures for audit quality. Further analyses indicate that the positive effect of establishing a branch office on audit quality is primarily achieved through the information channel. In addition, we find a knowledge transfer effect from the newly established branch to non-local branches within an audit firm. Moreover, establishing a branch office can benefit both auditors and clients because it leads to the provision of higher quality audit services in less time without audit fee increases compared with the situation without the branch office. Our study contributes to the related literature and is of interest to regulators and practitioners.