Opaque Information Environment Research Articles

Common auditor, knowledge transfer and audit quality: international evidence

PurposeUsing an international sample of firms affiliated with a business group, this paper aims to investigate the audit quality of common auditors, i.e. auditors shared by multiple firms affiliated with the same business group.Design/methodology/approachThis paper utilizes a large sample of group-affiliated firms from 35 regions. Following the frameworks of DeFond and Zhang (2014) and Fung et al. (2017), this paper measures audit quality using the absolute value of abnormal accruals and modified audit opinions. Ordinary least squares (OLS) regression is used to address the research question.FindingsThe findings demonstrate that audit quality improves for firms that share the same auditor with other group members. Importantly, cross-country analyses reveal that this relationship is stronger when auditors operate in countries with stricter local auditor inspection programs and an overall opaque information environment. Additionally, the impact of common auditors on audit quality is more pronounced for group affiliates that have a more opaque firm-level information environment and are monitored by heightened institutional ownership.Practical implicationsWhile affiliates are more likely to select the same audit firms as common auditors, the evidence regarding the effects of common auditors is mixed. The results of this study provide further insights into auditor choices for group-affiliated firms and offer a potential avenue for better protecting shareholders' interests.Originality/valueThe results of this study add to the ongoing debates regarding the costs and benefits of common auditor choice for group affiliates. To the best of the authors’ knowledge, this study is the first to demonstrate that the effects of common auditors may vary in different external environments.

Does Innovation Sustainability Attract Retail Investors? The Clientele Effect in China

Innovation sustainability is essential for businesses to maintain their competitive edge and ensure long-term growth. This not only benefits individual companies but also entire industries. Despite its importance, research on retail investors’ preferences for innovation sustainability remains limited. To address this gap, we analyzed unique data on shareholder numbers in listed Chinese companies from 2007 to 2020. We differentiate between institutional and retail investors to analyze the latter’s preferences. This finding indicates that retail investors prefer to invest in companies with higher innovation sustainability. This preference stems from their limitations in capabilities of information collection, analytical skills, and risk diversification. The clientele effect is more pronounced when companies face a poor innovation environment, an opaque information environment, and a weak political connection. This study contributes to the existing literature by providing empirical support for the clientele effect and shedding light on retail investors’ preferences and investment behavior. By focusing on company fundamentals, our study extends the examination of the clientele effect to the corporate governance level. These insights have significant implications for promoting sustainable development, impacting both companies and the capital market.

Audit firm informatization and audit quality during COVID-19

PurposeCOVID-19 has forced audit firms to change the way they operate. One change has been to rely more on information technology (IT) and IT human capital to overcome COVID-19-related challenges. We refer to audit firms’ use of these two resources as audit firm informatization (AFI). It is important to understand whether AFI helps audit firms address challenges created by the pandemic. Thus, this study examines the impact of AFI on audit quality during the COVID-19 pandemic in China with a focus on IT human capital.Design/methodology/approachWe use a mixed-methods approach. First, we perform multivariate regression analyses on archival data. Specifically, we investigate the relationship between IT human capital and audit quality and the two mechanisms (i.e. improved efficiency and reduced audit risk) underlying the relationship. We also investigate how this relationship is moderated by features of clients, audit firms and individual auditors. Then we use interviews to corroborate the results of our regression analyses.FindingsOur analyses of archival data show that IT human capital positively affects audit quality through improved efficiency and reduced audit risk and that this positive impact is more pronounced for clients in non-manufacturing industries, those with a more opaque information environment, audit firms with greater industry coverage and individual auditors with less experience. Our interview data indicate that audit firms with more advanced AFI and a higher level of IT human capital in particular are less disrupted by the pandemic and are better able to use IT to address challenges associated with COVID-19. Furthermore, the results confirm that improved efficiency and reduced audit risk are the mechanisms through which AFI enhances audit quality. Finally, we identify issues associated with the use of IT.Originality/valueThis study is the first to investigate how IT human capital (and by extension AFI) influences audit quality in the context of the COVID-19 pandemic. Our findings should be of interest to practitioners and setters of auditing standards.

The disclosure perspective of firm‐specific political risk measure from conference calls

AbstractHassan et al. (2019) quantified firm‐specific political risk during corporate conference calls. We argue that this metric captures voluntary risk disclosure by firms rather than just their level of political risk. Studying the impact of political risk disclosure (PRD) on stock price crash risk (SPCR) allows us to test how well their score captures firm‐specific risk or disclosure. Consistent with our disclosure perspective, we document that PRD significantly reduces SPCR. Our cross‐sectional analyses further indicate that the negative effect of PRD on SPCR is more pronounced for firms with poor monitoring and governance and those with more opaque information environments.

Do Short Sellers Target Firms with High Climate Risks? International Evidence

ABSTRACT Using an international sample of firms from 36 countries over the period 2002 to 2018, we investigate whether short sellers take firms’ climate risk into consideration when making investment decisions. Our empirical results show that short sellers increase their short-selling interest in firms with high carbon emission intensity but shun good carbon performers. Furthermore, the effect of climate risk on short-selling interest is more pronounced for firms operating in countries or regions that have adopted an emission trading scheme (ETS) as well as in countries characterized by higher regulatory quality and greater media pressure. We also document that short sellers in countries with stringent carbon regulations, higher environmental awareness, and superior environmental performance are more sensitive to climate risk. Our channel analyses highlight that stock overvaluation and an opaque information environment are two potential motives for short-selling interest in carbon-risky firms.

Local gambling attitudes and firms' financing strategies: New insights from the geographic structure in China

This study examines the effect of local gambling attitudes on firms' financing strategies, using the number of lottery sales stations as a proxy for the strength of these attitudes. We find evidence suggesting that firms headquartered in cities with a stronger gambling attitude tend to have more leverage than firms headquartered elsewhere. Furthermore, the effect of local gambling attitudes on firms' leverage is more pronounced among firms that have higher agency costs or exist in a more opaque information environment. Finally, a strong local gambling attitude triggers local firms to overinvest, resulting in reduced overall efficiency and increased risks of bond defaults and stock price crashes. Our findings suggest that a strong local gambling attitude may encourage firms to adopt aggressive financing strategies and lower their resource allocation efficiency.

Stock market liberalization and management earnings forecasts: Evidence from a quasi‐experiment in China

AbstractThis study examines the impact of Chinese stock market liberalization on the quality of firms' information disclosures. Although previous studies have explored the economic outcomes of stock market liberalization, little is known about its impact on the quality of management earnings forecasts. We treat China's Stock Connect program as a quasi‐experiment and draw data from Chinese A‐share‐listed companies from 2012 to 2017. Using a staggered difference‐in‐difference model, we find that eligible firms issue more accurate earnings forecasts after implementation of the Connect program compared with ineligible firms. Our mechanism analyses show that the positive effect is more pronounced for firms with initially opaque information environment and higher ex ante agency costs, suggesting that market liberalization facilitates higher‐opaque firms to issue more accurate earnings forecasts to meet the information demand from foreign investors, and facilitates monitoring in firms with weak internal governance, thereby improving earnings forecasts quality.

Regulatory investigations, media coverage, and audit opinions

After an investigation of an audit engagement is announced, does media coverage of the investigation affect the involved individual auditor’s behaviors in his or her other non-investigated engagements? We examine this question using a sample of Chinese firms. We find that an individual auditor is more likely to issue modified audit opinions in non-investigated engagements if the investigation attracts a high level of media coverage. This augmenting effect of media coverage exists only when the non-investigated firm has an opaque information environment or a relatively high level of earnings management, when the individual auditor is the review auditor or a non-busy auditor, and when the news comes from an opinion leader. Our results suggest that the media can play an effective role in broadening the sphere of influence of regulatory actions.

The ability of employee disclosures to reveal private information

AbstractManagers may provide incomplete disclosure for various reasons (e.g., high processing costs, operating uncertainty, proprietary concerns, agency conflicts, etc.). In contrast, rank‐and‐file employees face fewer of these limitations. Through “wisdom of the crowd” displayed on social media, employees can aggregate their individual private beliefs to provide an informative business outlook. Using employee data from Glassdoor.com, we find that employee business outlook disclosures reveal more information in loan spreads of private lending contracts when firms have more opaque information environments. Furthermore, we observe that employee disclosures help to reveal more private information when the business outlook is worsening and as employees’ collective knowledge increases. This relation is more prominent when employees are expecting worsening performance, consistent with employee disclosures revealing more private bad news. Our study demonstrates the conditions under which employee disclosures on social media are more likely to disseminate private information.

Earnings guidance stoppage and the value of financial analysts' research

AbstractWe examine the relation between voluntary disclosure and the value of analysts' research by studying the change in the informativeness of analysts' research after managers stop providing quarterly guidance to investors. We find that the market reaction to analysts' recommendation revisions increases significantly after guidance stoppage, controlling for confounding factors as well as for firm and time fixed effects. The increase in market reaction is greater for firms with more opaque information environments and for firms that previously provided disaggregated guidance. Further, the effect of guidance stoppage on the informativeness of analysts' research reverses after managers resume guidance. Finally, textual analyses of analysts' reports before and after guidance stoppage reveal that analysts issue longer, more frequent, and more detailed reports that convey more forward‐looking information after stoppages. These findings collectively shed light on the relation between the supply of voluntary disclosure and the value that sell‐side analysts add to price discovery in capital markets.

The Value of Eliciting Information: Evidence from Sell-Side Analysts

ABSTRACT The ability to elicit information is a critical skill that many analysts and other information agents strive to master. This paper develops and validates a novel approach to measure analysts’ skill in eliciting information and studies its relation with analysts’ performance. The results suggest that analysts who are skilled in eliciting information issue more accurate forecasts and more informative stock recommendations. Further, skilled analysts’ recommendations are incrementally more informative for companies with more opaque information environments and with managers who may be delaying bad news. Finally, analysts skilled in eliciting information are more likely to be cited by journalists, recognized by the profession (Institutional Investor all-star status), and less likely to be demoted. These findings demonstrate the importance of elicitation as a distinct skill that influences analysts’ output quality, thereby extending previous research that generally focuses on the performance effects of general analyst characteristics rather than specific skills. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; G11; G14.

Does the online interaction between retail investors and firm management affect capital structure?

This paper examines whether and how online interactions between retail investors and firm management affect financial leverage. Using a sample of Chinese A-share listed companies from 2010 to 2021, we find that retail investors’ interaction with management, measured by the number of posts and replies in online interactive investor platforms, significantly decreases firms’ financial leverage by mitigating information asymmetry. Further analyses show that this negative relationship is stronger for firms with more opaque information environments measured by higher research and development intensity, greater asset intangibility, lower analyst coverage, and higher retail ownership. Our findings suggest that retail investors significantly impact firms’ financial leverage decisions, and provide positive evidence for information disclosure reform in an emerging capital market.

Conditional Mandates on Management Earnings Forecasts: The Impact on the Cost of Debt

Exploiting a unique conditional disclosure mandate on management earnings forecasts (MEFs) in China, we examine the differential effects of voluntary and mandatory MEFs on the cost of debt. We find that firms providing voluntary MEFs have lower cost of debt than do mandatory forecasters and nonforecasters. The results of the channel analyses reveal that voluntary forecasters have greater commitment to voluntary MEFs in future periods than do mandatory forecasters and nonforecasters, and the precision, accuracy, and timeliness of MEFs are higher for voluntary forecasters than for mandatory forecasters. Additional analyses show that the differential effects of voluntary and mandatory MEFs on cost of debt are stronger for voluntary forecasters operating in opaque information environments, issuing high‐quality and confirming forecasts, controlled by private shareholders, and operating in highly competitive product markets. Overall, our results indicate that, compared with mandatory MEFs, voluntary MEFs are more informative for credit investors, particularly for firms facing greater information risk and operating uncertainty.

Does the threat of takeover affect default risk?

AbstractWe examine the impact of the threat of takeovers on default risk. Using a sample of 50,189 firm‐year observations for US firms over the period 1990–2015, we find that the threat of takeovers has a negative relation with default risk. We use difference‐in‐difference analysis to address potential endogeneity concerns and propensity score matching to control for self‐selection bias. The results are robust to alternative measures of default risk and exclusion of the dot com and financial crisis periods. Our results also hold after controlling for Governance Index and Entrenchment Index. We identify improvement in performance and earnings quality in response to the threat of takeovers as channels underlying our main result. The effect of the threat of takeovers on default risk is more pronounced for firms with opaque information environment and low institutional ownership. Our findings provide important insights for the market for corporate control as a disciplining mechanism in reducing default risk.

The effect of accounting fraud on future stock price crash risk

Accounting fraud constitutes serious misconduct that damages investor confidence in capital markets. While accounting fraud revelations trigger declines in stock prices, it remains unclear whether firms’ past accounting fraud revelations (ex-post) or predicted future likelihood of fraud (ex-ante) affect their future risk of stock price crashes. Hence, we examine the effect of accounting fraud on future stock price crash risk. We find that both ex-post and ex-ante accounting fraud are significantly and positively related to future stock price crashes. Channel analysis shows that the relationship is magnified for firms with opaque information environments. This supports our theoretical mechanism that accounting fraud affects stock price crash risk through information opacity. Cross-sectional analysis is also conducted to explore potential heterogeneity across firms. We find that the relationship is magnified in firms with managerial entrenchment, CEO power, and CEO-board cooption. • Accounting fraud has significant predictive power on future stock price crash risk. • Ex-post and ex-ante accounting fraud are linked to more risk of stock price crashes. • An opaque information environment is the mechanism that magnifies the relationship. • Managerial entrenchment, CEO power, and CEO-board cooption also amplify the link.

Trade secrets protection and stock price crash risk

AbstractThis paper provides evidence that the trade secrets protection increases stock price crash risk. Using a quasi‐experimental setting with the Uniform Trade Secrets Act (UTSA), we find that firms headquartered in states adopting the UTSA tend to have higher stock price crash risk. The results are robust to controlling for other trade secrets laws and the choice of crash risk measures, and they are more pronounced in small firms and firms with high market‐to‐book and low leverage ratios. A detailed mechanism analysis reveals that increased crash risk following the UTSA is attributed to an opaque information environment and investment inefficiency.

Information sharing between mutual funds and auditors

AbstractThis paper examines whether there is information sharing between mutual funds and their auditors about the auditors’ other listed firm clients. Using data from the Chinese market, we find that mutual funds earn higher profits from trading in firms that share the same auditors. The effects are more pronounced when firms have a more opaque information environment and when the audit partners for the fund and the partners for the listed firm share school ties. The evidence is consistent with information flowing from auditors to mutual funds, providing mutual funds with an information advantage in firms that share the same auditors. Our findings are robust to the use of audit‐firm mergers and acquisitions (M&As) as exogenous shocks and several other robustness checks. We further find that auditors benefit by charging higher audit fees for mutual fund clients and by improving their audit quality for listed firm clients. Our study provides evidence of bi‐directional information sharing between two important market intermediaries.

Being private, Big 4 auditors, and debt raising

AbstractThis study investigates the role of auditor choice (Big 4/Non‐Big 4) in debt financing for private and public firms. We find private firms have less access to debt than public firms, and Big 4 auditors support debt raising in both private and public firms. Consistent with private firms facing greater information asymmetry, Big 4 auditors are more important for debt raising in private firms than in public firms. The benefit of appointing Big 4 auditors for private firms' debt raising is greater in the opaque information environment of the global financial crisis. It is also greater when firms are smaller, younger, or have poorer financial reporting quality. We also find evidence consistent with Big 4 auditors mitigating agency conflicts and enhancing debt raising when ownership concentration is higher in private firms.

Research and Development Expenditure, Audit Fees, and Corporate Social Responsibility Disclosure: Evidence from Chinese Listed Firms*

AbstractThis study of Chinese listed firms from 2008 to 2018 shows that research and development (R&D) expenditure is associated with increased audit fees. However, corporate social responsibility (CSR) disclosure can attenuate this fee increase, especially in firms with an opaque information environment, high risks, and non‐high‐ and new‐technology enterprises. These findings are robust to the use of proxies and instrumental variables, propensity score matching, and controlling for firm fixed effects and CSR performance. This study contributes to the understanding of the economic consequences of R&D activities, determinants of audit fees, and CSR disclosure.

Serial acquirers and stock price crash risk: International evidence

This study investigates the relationship between serial M&A and stock price crash risk. Employing an international sample of 22,140 unique firms from 42 economies between 1989 and 2017, we show that serial acquirers experience higher subsequent crash risk after they initiate serial M&A. Consistent with the bad news hoarding channel, we find that serial M&A are associated with worse subsequent firm-level accounting information environment and poorer operating performance. Moreover, the observed heightened crash risk is more pronounced in countries with opaque information environments or weaker shareholder protection. Our results remain unchanged in several robustness checks addressing endogeneity issues.