Aggregate Quasi Rents and Auditor Independence: Evidence from Audit Firm Mergers in China

45 Pages Posted: 16 Feb 2011

See all articles by K. Hung Chan

K. Hung Chan

Lingnan University - Department of Accountancy

Donghui Wu

The Chinese University of Hong Kong; Center for Institutions and Governance

Date Written: February 1, 2011

Abstract

Using a sample of audit firm mergers in China’s audit market, this paper provides evidence on the way auditor independence can be improved following audit firm mergers as a result of a change in the aggregate quasi rents that are exposed to risk (i.e., the quasi rents at stake). This setting allows us to examine the relationship between auditor independence and the aggregate quasi rents at stake directly after controlling for the confounding effects of auditor competence, audit firm brand name, and the self-selection problem that may exist in previous studies. We hypothesize that auditors become more independent in the post-merger period only if the mergers increase the aggregate quasi rents at stake. Proxying audit quality by the frequency of modified audit opinions (MAOs) and using a “difference-in-differences” research design, we conduct separate tests for two types of mergers under the institutional arrangements in China: one with an increase in the aggregate quasi rents at stake and the other with little change in these rents. Consistent with our hypothesis, we observe an improvement in auditor independence, but only for mergers that increase auditors’ aggregate quasi rents at stake. Moreover, the post-merger increase in the propensity for MAOs in this type of merger is positively associated with the magnitude of the change in the aggregate quasi rents at stake. Our empirical findings support the theory that auditor independence is a positive function of the aggregate quasi rents at stake.

Keywords: Audit quality, Auditor independence, Quasi rents, Audit firm mergers

JEL Classification: G34, L10, M42

Suggested Citation

Chan, K. Hung and Wu, Donghui, Aggregate Quasi Rents and Auditor Independence: Evidence from Audit Firm Mergers in China (February 1, 2011). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1761923

K. Hung Chan

Lingnan University - Department of Accountancy ( email )

Donghui Wu (Contact Author)

The Chinese University of Hong Kong ( email )

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