The impact of capital-market liberalization on audit reporting and pricing: evidence from a quasi-experiment

Purpose The purpose of this study is to investigate the effects of capital market liberalization on audit reporting and pricing. The authors use the announcement of the Shanghai-Hong Kong Stock Connect program in China as a shock to capital market liberalization. Design/methodology/approach The authors use the difference-in-differences method to study the difference in changes in the frequency of modified audit opinions and audit fees between the treatment group and the control group. Findings This study finds that capital market liberalization increases reputational and litigation risks for auditors and leads to more conservative audit reports. In addition, capital market liberalization stimulates the management of eligible firms to improve the information environment, helps to reduce information asymmetry and decreases audit fees. Specifically, the authors identify the channels of active foreign institutional investors as a new governance mechanism through which capital market liberalization impacts eligible firm and auditor decisions. Research limitations/implications This study complements the literature by showing that capital market liberalization may bring a new and strong governance mechanism for eligible firms and auditors. Practical implications This study may provide new references for active foreign institutional shareholders as a new and strong governance mechanism in weak institutional regimes such as China, auditors’ optimization decisions when litigation risks increase and management’s improvements in the information environment under the monitoring of foreign institutional shareholders. Originality/value Overall, this study contributes to the literature by showing that capital market liberalization can bring a new governance mechanism for the management of eligible firms and auditors in a weak institutional environment. Foreign institutional shareholders may be superior to the domestic market forces and other corporate governance in the role of monitoring the management of eligible firms and auditors.