Signing auditors’ experience and client investment efficiency

ABSTRACT

This study explores the relationship between signing auditors’ experience and client investment efficiency in the Chinese stock market. After controlling for firm-level, audit firm-level, and other individual characteristics, results show that it is signing auditors’ industry experience, rather than total experience, that significantly restrains client investment inefficiency, including over- and under-investment. This means that industry-specific experience may be the important experience affecting client investment behavior. The mechanism test results also show that experienced auditors can enhance client investment efficiency not only by playing an information role, through which they reduce over- and under-investment, but also partly through a financing channel to mitigate under-investment and a monitoring channel to restrict over-investment, respectively. Further analyses suggest that the effect of signing auditors’ industry experience on client investment efficiency is more pronounced for firms audited by large audit firms, those audited by expertise audit firms, and those located in the region with higher level of marketization. Overall, this study provides evidence related to the economic consequences of auditor experience at the individual level, thus extending the related literature.

KEYWORDS:

• Signing auditor
• auditor experience
• industry experience
• investment efficiency
• financial constraints

Acknowledgments

Xin Yang acknowledges the Fundamental Research Funds for the Central Universities at the Hohai University (B200201075). Minghui Li acknowledges financial support from Research Foundation of The Major Project of Philosophy and Social Science Research for Colleges and Universities in Jiangsu Province (2020SJZDA072).

Disclosure statement

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

Notes

1. According to the Code of Ethics for Certified Public Accountants of China (hereafter, the ‘Code’), which is issued by the Chinese Institute of Certified Public Accountants (CICPA), certified public accountants (CPAs) should abide by the principle of confidentiality for the confidential information obtained from their professional activities. The Code indicates that CPAs can make use of their experience accumulated from prior audit tasks, without utilizing and disclosing any confidential information from other clients. Moreover, as auditors’ experience is generally accumulated from their past practices with a great number of different clients, they can synthetically use their knowledge to communicate with the current client instead of violating confidentiality agreements.

2. According to a conversation with a senior partner working in one of the Chinese local five largest audit firms (Top 5), it is indeed true that they can share information that may be useful for management’s investment decisions, without breaching any confidentiality agreement during the engagement. The senior partner also told us that aside from the audit report, their team provided an analysis report related to their assessment and suggestions about clients’ internal control and some operation issues to the firm’s management and government. On the premise of not violating any legal and ethical restrictions, they are eager to maintain a great relationship with each client by providing supplementary services.

3. Although the requirement was first formally stipulated in 1995, the record of signing auditors’ information can be traced back to the opening of stock exchanges in Shanghai and Shenzhen in 1990 and 1991, which are the starting points of collecting signing auditor’ experience information.

4. See http://cmispub.cicpa.org.cn.

5. We also conduct a test of the reduced model without control variables. The untabulated results indicate that the inferences remain unchanged.

6. The Big 10 firms are identified using an annual ranking of audit firms’ total revenues disclosed on the CICPA website.

7. Consistent with our main results, the untabulated table shows that there is no difference between firms audited by the Big 10 and those audited by non-Big 10 firms, if we focus on the effect of signing auditors’ total experience (EXP) on client investment efficiency.

8. We also conduct an analysis based on firms’ merger and acquisition (M&A) activities. We manually collected the information and calculated the M&A premium. However, due to the incomplete information disclosure, we only obtained a reduced sample with 1768 observations. Untabulated results show a weak negative association between EXP and M&A Premium. However, we do not find a significant relationship between IND_EXP and M&A Premium, which is partially due to the reduced sample, leading to insufficient benchmark in an industry-year group. Nevertheless, to some extent, the results indicate that signing auditors’ experience can indeed influence clients’ M&A activities, in terms of premium.

Additional information

Funding

This work was supported by the the Fundamental Research Funds for the Central Universities at the Hohai University [B200201075]; Research Foundation of The Major Project of Philosophy and Social Science Research for Colleges and Universities in Jiangsu Province [2020SJZDA072].