To Centralize or Not: Control Right Allocation and Auditor Incentives

70 Pages Posted: 4 Jan 2023 Last revised: 17 Mar 2023

See all articles by Qihui Gong

Qihui Gong

Zhejiang University; Zhejiang University

Yupeng Lin

National University of Singapore (NUS) - Sustainable & Green Finance Institute (SGFIN); Business School, National University of Singapore

David M. Reeb

National University of Singapore - Dept of Accounting

Date Written: December 27, 2022

Abstract

We use the audit industry in China as a laboratory to examine the role of control right allocation on individual auditors’ incentives when balancing coordination and local information acquisition. Relying on proprietary information of internal control right allocations, our tests reveal that local engagement auditors of more centralized audit firms provide more effort than their decentralized peers. Auditors in centralized firms are also more likely to adjust reported earnings downward and produce better-quality audited financial statements than in decentralized firms. These effects attenuate in headquarters where the tension between coordination and local information acquisition is absent. We use Confucian culture and rice farming regions as instrumental variables of preference for centralization and find consistent results. Tests based on changes in centralization due to audit firm mergers also yield similar inferences. Further analyses show that the beneficial effects of centralization are more pronounced when central authority has lower information acquisition costs but are weaker when local clients are complex. Our findings directly inform the classic debate on coordinated versus spontaneous adaptation (Williamson, 1996; Hayek, 1945).

Keywords: Centralization, Decentralization, Control Rights, Coordination, Local information, Auditor

JEL Classification: D23, L23, G3

Suggested Citation

Gong, Qihui and Gong, Qihui and Lin, Yupeng and Reeb, David M., To Centralize or Not: Control Right Allocation and Auditor Incentives (December 27, 2022). Available at SSRN: https://ssrn.com/abstract=4312463 or http://dx.doi.org/10.2139/ssrn.4312463

Qihui Gong

Zhejiang University ( email )

38 Zheda Road
Hangzhou, Zhejiang 310058
China

Zhejiang University ( email )

38 Zheda Road
Hangzhou, Zhejiang 310058
China

Yupeng Lin (Contact Author)

National University of Singapore (NUS) - Sustainable & Green Finance Institute (SGFIN) ( email )

Singapore

Business School, National University of Singapore ( email )

David M. Reeb

National University of Singapore - Dept of Accounting ( email )

Mochtar Riady Building
15 Kent Ridge Drive
Singapore, 119245
Singapore

HOME PAGE: http://www.davidreeb.net

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