Do regulations limiting management influence over auditors improve audit quality? Evidence from China

We use data from China to examine whether regulations that limit management influence over auditors improve audit quality. China’s State-owned Assets Supervision and Administration Commission of the State Council (SASAC) issued two rules in 2004 aimed at improving audit quality for state-owned enterprises ultimately controlled by the central government (CSOEs). These rules limit management influence over auditors by mandating that SASAC assign auditors for CSOEs and by requiring management to retain auditors for at least 2 years and at most 5 years. Since these rules apply only to CSOEs, we use a difference-in-difference design to study the impact of these regulations on audit quality. We find that audit quality for CSOEs relative to other companies improves after the enactment of these rules. Our results are robust to a battery of sensitivity analyses. Our findings suggest that limiting management influence over auditors helps improve audit quality.