Staying or switching: How companies react to audit firm penalties

We investigate the relationship between corporate governance characteristics and the change of penalized audit firms based on financing, reputation, and client relationship perspectives. Based on a sample of client companies of penalized audit firms in China between 2008 and 2023, we find that companies with financing incentives and good reputations tend to change penalized audit firms, while companies with close “audit firm-client” relationships tend to maintain cooperation. The above conclusion still stands after a series of endogeneity and robustness tests. Heterogeneity tests indicate that the intensity of the China Securities Regulatory Commission (CSRC)'s penalties, the company's level of real earnings management, and the nature of property rights all affect the company's decision to change the penalized audit firm. Further research finds that the company's continued cooperation with the penalized audit firm can harm its accounting information quality and accounting conservatism. The findings of our study enrich the existing research on the factors influencing the change of penalized audit firms in emerging markets.