Actions speak louder than words: environmental law enforcement and audit fees

Abstract

Using the staggered establishment of environmental courts in China, we study the effect of environmental law enforcement on audit fees. We find that companies’ abnormal audit fees increase significantly after the establishment of a specialized environmental court strengthens environmental law enforcement. Our cross-sectional analyses show that the increase in abnormal audit fees is greater for companies with worse environmental performance and for those in heavily polluting industries. We then assess the channels through which environmental courts affect companies’ audit fees and find that the effect of the courts on fees is driven by both audit effort and audit risk and the establishment of a particular type of environmental court (an independent environmental adjudication division). Finally, our results reveal that public concern about environmental protection plays a substitutive role for environmental courts in affecting the increase in audit fees. Our findings suggest that environmental courts aimed at strengthening environmental laws and regulations alter firms’ and auditors’ behaviors and decisions, having unintended spillover effects on audit pricing.