Green Finance Policy, Financial Risk, and Audit Quality: Evidence from China

ABSTRACT

Using the green finance policies (GFPs) in China as a shock to capital allocation, we find that the implementation of GFPs improves audit quality for green firms. Specifically, green firms are likely to receive favorable audit opinions, pay lower audit fees, and generate higher-quality financial reports after the implementation of GFPs. When examining the mechanisms through which GFPs affect audit risk for green firms, we find that green firms are likely to experience lower financial risks and have access to more bank loans at a lower cost after the implementation of GFPs. Further analysis shows that the main results are more pronounced when GFPs are better enforced, where auditors face more government intervention, and where firms are financially constrained. Overall, we document that GFPs decrease financial risk for green firms and have a positive spillover to auditors by mitigating audit risk.

Keywords:

• Green finance policy
• Audit opinion
• Audit fee
• China

JEL:

• G11
• G2
• G3

Disclosure statement

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

Notes

1 We sincerely thank Beatriz García Osma (Editor) and two anonymous reviewers for their insightful and helpful suggestions, which have significantly improved our paper. We also thank Emdad Islam, Qiliang Liu, Buhui Qiu, Yuxiang Zhong and other participants of the seminar at Huazhong University of Science and Technology (China) and the 33rd PhD Conference in Economics and Business (Monash University, Australia) for their valuable comments. All remaining errors are our own.

2 Green firms refer to high-technology-based and energy-saving-based firms. Section 2.1 gives more details of how green firms are defined.

3 Favorable audit opinions include unqualified opinions without explanatory notes. Other audit opinions are categorized as modified audit opinions including unqualified opinions with explanatory notes, qualified opinions, and disclaimed or adverse opinions. This definition is consistent with other studies examining China (Chan et al., 2006; Gul et al., 2013; Guan et al., 2016). The modified audit opinions capture either opinions on going-concern ability or opinions on financial statements, such as deviating from GAAP in preparing financial statements or having typical events that may significantly affect their financial strength (Gul et al., 2013).

4 The State Council has issued a comprehensive work plan for energy conservation and emission reduction, which includes specifying emission-reduction goals for each province, adjusting existing legislation and administrative frameworks, promoting green industries, and establishing a carbon-emission trading market (State Council, 2012).

5 This information is disclosed in the document ‘Impoving Information Disclosure to Promote Sustainable Development of Green Finance’, available at: http://www.cbirc.gov.cn/cn/view/pages/ItemDetail.html?docId=171282.

6 For example, the Huzhou branch of the China Construction Bank introduced a preferential interest rate for a green credit floating system and provided 1%-2% discount for newly granted green credit.

7 On October 10, 2010, the State Council issued ‘Decision on Promoting the Development of Strategic Emerging Industries’, which formally listed the key areas for green development.

8 The CBRC (2018) disclosed that apart from manufacturing in strategic emerging industries – specifically, energy-efficient and environmental technologies, new energy, and new-energy vehicles industries, and projects and services facilitating energy saving and environmental protection – green credit also supports overseas projects that are in accordance with international practices or standards, although that is outside the scope of this study.

9 ST stands for special treatment. ST firms refer to domestic listed firms with two consecutive years of losses, whose stock transactions are given special treatment, whereas ST* denotes domestic listed firms with three consecutive years of losses, whose stocks receive a delisting warning from the exchange.

10 We do not have any adverse audit opinions in our sample.

11 We also exclude observations of unqualified opinions with explanatory notes and repeat our main regressions. We get similar results. We do not report the results here, but they are available upon request.

12 We also repeat our main regressions using each industry respectively to rule out the possibility that our main results are driven by a single industry. We do not report the results, but they are available upon request. We also conduct a battery of robustness tests using alternative samples, including (1) excluding observations in 2013 or 2012, (2) using a propensity score matching (PSM) sample, and (3) excluding observations subject to 2013 internal control policy. These results are reported in the online supplemental materials.