Institutional Change, Market Demand And Improvement Of Independent Audit Quality

According to the basic characters of China's transitional economies and emerging market, during the transition from planning economy to market economy, the absence of institution and hence the rapid evolution of institution are common phenomena. From this viewpoint, economy transition can be described as a process of institutional change. Since the security market's development in China rooted deeply in the gross background of economy transition and emerging market, which in its development process must be accompanied by more rapidly institutional change. Obviously, when analyzing the demand and supply issues of audit quality relating to security auditing market in China, we should take the former background as starting point.Based on the IPO market in 1998—2004, this dissertation extends Li Shu-hua (2000) 's research. In this article, taking the marketization evolution of China's IPO pricing system as entry point, we empirically examine the issues about the auditor choice and change of audit market structure, the audit quality differentiation among audit firms, and economic consequence of audit quality. The results show that, first of all, with the improvement of marketization level of China's IPO pricing system, after year 2000, the Li (2000) 's finding of ''improved auditor independence and the flight from audit quality" has come to an end and reversed, the large audit firms' (Big 10) shares in IPO market increase steadily. The main cause lies in that, during the rapid evolution of China's security market, the emerging spontaneous demand for high quality audit gradually appeared after year 2000 , and eventually promoted the market shares of large audit firms in IPO market. Second, the spontaneous market demand for high quality audit further promotes the audit firm's audit quality differentiation. The differentiation of audit quality distinguished by the size of audit firms emerged after year 2000, but still not clear. Nevertheless, the study results after year 2002 show that, the audit quality of large audit firms (Big 10) is systematically higher than that of other audit firms. Finally, this dissertation finds that, after year 2002, audit quality has distinct economic consequence, and the IPO companies which audited by high quality auditors (Big 10) have the lower underpricing level significantly. In addition, the finding about IPO audit pricing also shows that, the high quality auditor do command significant higher fees as "quality (or reputation) premium".The main academic contributions of this dissertation are presented as follows:(1) through theoretical analysis and empirical examination, we firstly find that the Li (2000) 's finding of " improved auditor independence and the flight from audit quality" has come to an end and reversed in China's IPO market ; (2) This dissertation extended Li (2000) 's research, investigates the issues relating to audit quality in China's IPO audit market in a long period (1998-2004) , thereby fills the research gaps on the above issues in 1997-2000 ; (3)This dissertation firstly detailedly analyses and examines the audit quality" demand and supply issues of security market in a long period. Thus we are able to answer the following questions: (a) In China, why and when merging high audit quality demand appeared, what does it include; (b) When the audit quality differentiation among accounting firms emerged, and how does the market perceive it. (4) Based on the background about China's IPO market, this dissertation systematically investigates the information hypothesis and monitoring hypothesis of audit quality. In particular, after year 2002, we find that, the lower ex ante risk of IPO company, the higher possibility to choose high quality auditor, which support information hypothesis. This result is firstly observed in China. (5) The research on audit pricing in IPO market enriches the current domestic literatures on audit pricing issues. (6) Comparing with similar studies at home and abroad, this dissertation improves the research method in three aspects: First, because the majority of researches used different variables to measure IPO ex ante risk, this dissertation applies Principle Component Analysis to reduce the number of the variables, and use the first principle component to measure IPO ex ante risk. Second, to ensure the reliability of results, we apply three methods to measure earnings management simultaneity. Third, we apply the two-stage method used by Kim et al. (2003) and Chaney et al. (2004) to control potential auditor self-selection bias .