Controlling Shareholder’s Share Pledging and Firm’s Auditor Choice

ABSTRACT

This study investigates auditor choice in firms whose shares are pledged by their controlling shareholders as collateral for margin loans to financial institutions. To cope with risks arising from share pledging, controlling shareholders can be divided in choosing an auditor in terms of auditor quality—with some who might engage in financial reporting manipulation prefer a low-quality report while the others favor a higher quality to alleviate minority shareholder’s potential concerns. Using detailed data of Chinese listed-firms from 2007 to 2016, we find that it is less likely for firms with share pledging controlling shareholders to employ Top 10 audit firms. Further tests show that the reporting quality of pledge firms choosing non-Top 10 audit is poorer, but the audit opinion is not worse. Besides, higher audit fee for pledge firms suggests that controlling shareholders’ share pledging is considered to be with higher audit risk by auditor.

KEY WORDS:

• auditor choice
• controlling shareholder
• share pledging

Supplementary material

Supplemental data for this article can be accessed here.

Notes

1. The mean value 0.501 is larger than the number in Fang et al. (2017) who report the mean value of Top 10 is 0.324. The main reason for the difference is the choice of different sample periods. Our sample period covers from 2007 to 2017 while Fang et al. (2017) are 2003 to 2011. For alleviating the concern of the Big Ten as the proxy for high-quality auditor, we alternatively use Big Four as the dependent variable in the robustness checks. Besides, we provide the lists of Top 10 audit firms in our study, and the lists from CICPA. The information can be found in Table S7/S8 in Supplementary Material.

2. To alleviate the concern about the possible multi-collinearity problem, we check the VIF values for our main test. The relevant results can be found in Table S5/S6 in Supplementary Material.

3. T-test results for the variables after applying PSM methodology are showed in Table S3 in Supplementary Material.

4. The results by using Pledge_Ratio are consistent.

5. The results are consistent by using “A_opin”, which equals zero to three for disclaimers, qualified opinions, unqualified opinions with explanatory notes, and clean opinions, respectively.

6. The insignificant result is not contrary to the theory that “low-quality auditors are less likely to issue MAOs”. The theory that low-quality auditors are less likely to issue MAOs is focusing on the possibility of different audit firms to issue MAOs when auditing same companies, and our argument is focusing on the possibility of pledging companies to get MAOs compared with non-pledge companies. However, pledge firms and non-pledge firms have different auditor choice strategy, that is pledge firms, especially those with low-quality financial reports, are more willing to choose low-quality audit. Thus, the insignificant result is plausible since the clients are worse, and to some extent, it is the insignificant result that manifests the low quality of non-bigten auditors since they do not issue more MAOs to their “worse” clients.

7. Big Four auditing firms are the four biggest international audit firms: PricewaterhouseCoopers (PWC), Deloitte and Touche (DTT), Ernst and Young (EY), and KPMG. They are considered to provide high-quality audit services. The software (stata 12.0) drops 309 observations when we use BigFour as the proxy for high quality audit, so the number of observations is 19878.

Additional information

Funding

Jingjing Xu appreciates the financial support from National Natural Science Foundation of China [NSFC-71602057] and the Fundamental Research Funds for the Central Universities [2018ECNU-HWFW021].