The influence of foreign institutional investors on audit fees: evidence from Chinese listed firms

ABSTRACT

This study examines the influence of qualified foreign institutional investors (QFIIs) on investee companies’ audit fees. Using data from China, we find that ownership by QFII-licensed investors is positively associated with audit fees. Besides, audit fees are higher in companies with QFIIs than in those without, and the demand for more extensive audits increases with the number of QFIIs. Notably, the demand for more extensive auditing procedures is mainly attributable to QFIIs from jurisdictions with strong governance institutions or is driven by QFIIs from jurisdictions that are geographically distant from China. Our cross-sectional analysis reveals that this positive influence is more prominent when investee companies exhibit lower earnings quality or a weak sense of corporate social responsibility. Finally, our mediation analysis suggests that QFIIs can enhance firm value and that a portion of this effect is due to the increased audit effort driven by QFIIs.

KEYWORDS:

• Qualified foreign institutional investors
• audit fees
• institutional quality
• shareholder protection
• geographical distance
• firm value

Acknowledgments

We thank Professor Carol Tilt (the Editor) and two anonymous referees for constructive suggestions. We are grateful to Tianlong Wu because of a part of the data collection carried out between 2017 and 2019. The initial draft of this study was completed in early 2020. This study was invited to the presentation at the 2022 European Financial Management Association (EFMA) Annual Meeting. Send correspondence to the first author at [email protected] or [email protected]. All errors remain our responsibility.

Data availability statement

The data that support the findings of this study are publicly available from the sources noted in the text.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See https://www.imf.org/en/publications/gfsr?page=2.

2 See https://www2.deloitte.com/cn/en/pages/risk/articles/enterprise-risk-9.html.

3 Approximately 49.24% of QFIIs come from Western Europe, and 13.77% are from the US.

4 Similarly, Jia et al. (2020) report that 95.83% of QFIIs in Chinese listed firms come from economies deemed as advanced by the IMF.

5 See http://www.safe.gov.cn/en/2019/0118/1486.html and http://www.csrc.gov.cn/pub/newsite/gjb/sczr/qfiiylb/201906/t20190628_358352.html.

6 See https://www.wind.com.cn/ and https://www.safe.gov.cn/guangdong/2019/0107/1293.html.

7 The coefficient on QFIIOWN is 0.0149 in Model 1 of Table 3, and the standard deviation of QFIIOWN is 0.873, as shown in Table 2; this is calculated as 0.0149 × 0.873=0.01301 (1.301%). Notably, 8.7% of sample firms are with the presence of QFIIs (thus with QFII ownership greater than zero) while the rest of the sample firms are with QFII ownership of zero. Thus, it may appear to be a “modest” improvement. We then re-run Eq. (1) based only on firm-years with QFIIs, and find that the coefficient on QFIIOWN is 0.0143. Table 2 shows that the standard deviation of QFIIOWN (when QFIIDUMMY = 1) is 2.310. Economically, a one-standard-deviation (2.310) increase in QFIIOWN translates into about 3.303% (0.0143 × 2.310) increase in AUDITFEE, indicating a significant improvement.

8 We also test the parallel trends assumption by matching “each firm-year with QFIIs” to “an observation without QFIIs” within the same year, the same industry, and the nearest firm size. After matching, we find that AUDITFEE for firms with QFIIs in the year prior to QFII involvement is 13.7742 and that for firms without QFII involvement is 13.7235. The difference between these mean values is not statistically significant, which is evidenced by a p-value of 0.1250, indicating that the parallel trends condition is likely to be met.

9 We thank an anonymous referee for the following suggestion. We further re-run the baseline regression model by inserting SIZE, ANALYST, and BIG4 one by one and find that the key finding remains unchanged.

10 Following Del Bosco and Misani (2016), we averaged the six indicators (using equal weights) to build a WGI index as a comprehensive institutional quality measure. Higher WGI scores indicate stronger governance quality.

11 The Hexun platform, a leading rating agency, provides numeric scores of Chinese listed companies' CSR-engagement (Shahab et al., 2019). Firms are totally scored from 0 to 100, with higher values corresponding to better CSR. CSR engagements are categorised as shareholder protection, employee contributions, suppliers' and customers' rights, environments, and society. See http://stockdata.stock.hexun.com/zrbg/Plate.aspx?date=2017-12-31.

12 We also conducted the PSM method with the “no replacement” technique and our key finding is not affected.

13 First-differencing the dynamic model helps address the concern that unobserved heterogeneity and omitted factors may have an influence on audit fees.

14 For example, in column 2 of Table 8 where the dependent variable is Q, the coefficient on AUDITFEE is 0.1752 and significant at the 1% level, while that on QFIIOWN is 0.0209 and its significance reduces from the 1% level in column 1 to the 10% level in column 2 which additionally controls for AUDITFEE.