The impact of internal governance mechanisms on audit quality: a study of large listed companies in China

Abstract

This paper examines whether the audit quality of Chinese listed companies is affected by internal governance mechanisms (IGMs). The dataset comprises 443 firm-year observations during 2002–2005. The results show that foreign ownership concentration and the number of professional supervisors are positively related to audit quality, but the size of the supervisory board shows a negative correlation. Other IGMs including state ownership concentration, the size of board of directors, the number of independent directors, the frequency of board meetings, and the frequency of supervisory board meetings are found to have no impact on audit quality. The contribution of this paper is threefold. First, according to Young et al. (2008), this paper develops hypotheses from the principal-principal agency problem perspective and examines the impact of IGMs of China’s highly concentrated state ownership and two-tier board system on audit quality. Second, this paper employs the directors on the board of directors and the supervisory board as pairwise functional units and examines whether there is a level of functional redundancy proposed by Ding et al. (2010). Third, this paper adds to the extant literature by showing the relevance of the legal environment as one of external governance mechanisms.