Auditor Engagement Proposal,Minority Shareholders’ Disapproval And Auditor’s Response

The agency problem between large shareholders and minority shareholders is the major issue of corporate governance in our country. In order to solve or mitigate the interest expropriation of large shareholders, and protect minority shareholders’ interests, many corporate governance mechanisms, such as board arrangements, ownership structure, management incentives, debt financing, manager market, takeover market and investor legal protection and so on, have been studied. However, minority shareholders governance mechanism(such as shareholder voting) has long been neglected. In recent years, with many corporate governance mechanisms being proved ineffective in capital market, there are increasingly more initiative and practice for minority shareholders to participate in corporate governance. The research on minority shareholders governance mechanism begins to raise attention of the parties.As the self-governance mechanism to protect minority shareholders’ interests, shareholder voting system gives minority shareholders a significant governance right, minority shareholders have “voting by hand” and “voting by foot” two selections. Although minority shareholders and large shareholders have equal voting right according to our law, because of the highly concentrated ownership structure, minority shareholders are at disadvantage. Generally, managers’ or large shareholders’ corporate governance proposals are passed without being affected by minority shareholders’ voting result. Therefore, traditional view generally argues that it’s hard for minority shareholders “voting by hand” to play an effective role in corporate governance. For the interest expropriation of large shareholders, minority shareholders usually only “voting by foot” or act as “free riders”.This paper argues that traditional view on the effect of minority shareholders’ “voting by hand” only considers the effect of minority shareholders’ voting to proposal’s final passage, that is the direct binding effect on the opportunism behavior of managers and large shareholders. But, it does not consider the information value that contained minority shareholders’ voting results and the indirect governance effect that the information may arise. When minority shareholders vote against or abstain from important company governance proposals(hereafter “minority shareholders’ disapproval”), this can be seen as an important way to express dissatisfaction with managers and large shareholders through company important governance proposals, to a considerable extent, this reflects the agency risk information between large shareholders and minority shareholders. Because the agency problem between large shareholders and minority shareholders is the major issue of corporate governance in our country, the research on minority shareholders’ disapproval is especially important. However, so far, combined with China’s special economic institution background, there are few studies researching under what circumstances minority shareholders’ disapproval is more likely to appear in governance proposals, and whether minority shareholders’ disapproval affect other market participants(such as auditors) who pay attention to corporate governance risk and generate indirect governance effect. This is the major motivation of the research.This paper mainly contains two major concerns, the economic factors of minority shareholders’ disapproval, and the effect of minority shareholders’ disapproval to auditors. The main study subjects are auditor engagement proposals. The main research contents and conclusions are as follows:First, selecting audit committee, board and auditor that may affect shareholders’ perceptions on corporate governance risk, and selecting shareholders’ meeting that may affect shareholders’ voting activity, this paper studies the economic factors of minority shareholders’ disapproval.Using data from 726 firm-year observations with votes on auditor switching proposals during 2002-2013, the results show that:(1) The audit committee size, the proportion of financial expert in audit committee are significantly negatively related to the probability of minority shareholders’ disapproval appearing in voting on auditor switching proposals(hereafter “PMSDSP”), but the proportion of independent directors in audit committee is not significantly related. These results indicate that minority shareholders are more likely to agree with the larger and more professional audit committee, and thus less likely to cast a negative vote or abstain from voting. Minority shareholders don’t value the proportion of independent directors in audit committee.(2) Board chairman dulity is not significantly related to PMSDSP. The results also show that minority shareholders perceive board chairman dulity as board vigilance, instead of bad earnings quality.(3) The decline of auditor quality can significantly improve PMSDSP. This implies that minority shareholders can perceive governance risk imformation hidden in corporate governance proposals and respond accordingly.(4) The number of shareholders particioating in the shareholders’ meeting, and providing online voting can significantly improve PMSDSP. This implies that the cost reduction and the activity improving of minority shareholders’ participating in shareholder’ meeting are helpful for the governance effect of minority shareholders’ voting mechanism.Second, this paper examines whether the agency risk information between large shareholders and minority shareholders reflected by minority shareholder’ disapproval can be perceived by auditors and affect their audit fees behavior and audit reporting behavior. The content is divided into three parts:1. Minority shareholders’ disapproval’ effect on audit fees in the context of voting on auditor switching. Using data from 1180 firm-year observations with votes on auditor switching proposals during 2000-2013, the results show that the incidence of minority shareholders’ disapproval significantly increases the audit fees of the successor auditor in the first year following auditor switching, which indicates that the successor auditors pay attention to minority shareholders’ disapproval on auditor selection. There are two possible interpretations for this effect. It could be that the successor auditors regard minority shareholders’ disapproval as reflection of higher risk levels, thus calling for higher audit fees, which is “audit risk hypothesis”; the other explanation, however, could be that minority shareholders’ disapproval on auditor switching give rise to successor auditors’ concern on the conflicts between majority shareholders and minority shareholders. Managers and/or majority shareholders may pay more audit fees to relieve successor auditors’ worries, which is “auditor bribe hypothesis”.2. Minority shareholders’ disapproval’ effect on auditors’ reporting in the context of voting on auditor switching. In order to disentangle the two hypotheses mentioned above, I proceed to study how the incidence of minority shareholders’ disapprovals influences auditor’ reporting behavior. The results show that caters paribus, incidence of minority shareholders’ disapproval has no notable effect on the successor auditors’ reporting in the first year following auditor switching. But when the client receives a modified audit opinion before the auditor switching, the incidence of minority shareholders’ disapproval significantly increases the probability of modified opinion by the successor auditors’ in the first year following auditor switching. These results show that the successor auditors’ reaction to minority shareholders’ disapproval on auditor switching is by no means unconditional. Meanwhile, it shows that successor auditors are actually aware of the agency risk underlying minority shareholders’ disapprovals and accordingly adjusts their audit fees and reporting behaviors, which supports the “audit risk hypothesis”.3. Minority shareholders’ disapproval’ effect on auditors’ reporting in the context of voting on auditor renewal. Based on a sample of 1028 firm-year observations from 2003 to 2013 obtained by using propensity scoring matches(PSM), I find that the incidence of minority shareholders’ disapproval on incumbent auditor renewal significantly decreases the probability of modified audit opinions in the first year following the renewal. Because auditor renewal is less conspicuous as a regular corporate activity, managers and/or majority shareholders may have incentives to shop for favorable audit opinions if they perceive that the firm might receive a modified opinion after strict auditing. When minority shareholders notice these motivations and accordingly disapprove on the renewal voting, managers and/or majority shareholders may continue their bribing activities and even promise more to the auditors. As a result, the probability of receiving a modified opinion decreases. The further test of minority shareholders’ disapproval’ effect on audit fees in the context of voting on auditor renewal also confirms the above results.In conclusion, on one hand, this paper implies that minority shareholders’ perception on corporate governance matters, and the cost and activity of participating in shareholder’s meeting can affect minority shareholders’ voting performance. On the other hand, this paper implies that minority shareholders’ “voting by hand” has the capacity to raise a third party’s concerns, thus playing an indirect role in corporate governance. My thesis contribution to the literature in the following ways:Theoretical contributions:First, it extends and enriches the literature on the determinants and the consequences of shareholders’ voting on auditor selection. Second, it provides evidence of the indirect governance effect of minority shareholder voting. Third, this paper shows minority shareholders’ disapproval can to some extent reflect the agency conflicts between majority shareholders and minority shareholders. It provides a possible measure of agency risks.Practice and policy implications:Firstly, this paper can help managers understand the corporate governance elements that can cause minority shareholders’ dissatisfaction, and provide reference for their management practices and corporate governance.Secondly, the study can help auditors to identify the agency risk information between large shareholders and minority shareholders of the client company, adjust service strategy, and improve service quality.Thirdly, this article can help investors understand the impact of their voting behavior, remind them valuing the voting right on the company’s major governance proposals, and provide investors another empirical reference to measure its investment decisions.Fourthly, this article can help regulators to understand the effect of the minority shareholders voting mechanism, and thus targeted to strengthen supervision, and create favorable conditions for the formation of activity shareholder, and thus improve the governance effect of minority shareholders.