Xiaofei Pan

Legal Liability, Government Intervention, and Auditor Behavior: Evidence from Structural Reform of Audit Firms in China

Abstract This paper investigates how legal liability influences audit quality and audit fees, particularly in the presence of government intervention. Since 2010, all Chinese audit firms were required to transform from a structure of limited liability company (LLC) to limited liability partnership (LLP), which removes the cap on the liability exposure of negligent auditors. By adopting this natural experiment, we document the following findings: first, after audit firms reorganize as LLPs, auditors are more likely to (1) issue modified audit opinions and going-concern opinions, (2) constrain clients’ earnings management, and (3) charge a premium in audit fees, which suggest that exerting unlimited legal liability on negligent auditors improves both audit quality and audit fees. Second, the effect of the LLP adoption is more pronounced when auditors are from local audit firms, and clients are controlled by local governments. Further analyses suggest that the stock prices of clients positively react to the reform event, which indicates that LLP adoption improves the overall value of audits. In summary, our empirical findings are consistent with the argument that legal liability is able to effectively shape auditor behavior in emerging markets where the other institutional mechanisms are relatively weaker and government intervention is heavy.

Does Property Rights Protection Affect Firm Innovation? Evidence from the Chinese Property Rights Law Enactment

Using the 2007 property law enactment in China, we study the impact of property rights protection on firm innovation. We find that firms’ innovation activities increase after the law enactment, and this effect is more pronounced for firms located in provinces with more efficient contract enforcement, better progress toward marketization, and more confidence in the legal system. Consistent with the collateral channel, we also find that the above effect is stronger in firms with more tangible assets. The effect is also stronger in locations with high real estate prices, after using an instrumental variable method. Overall, the results suggest the importance of property rights protection in promoting innovations.

Does the Economic Stimulus Package Stimulate Firm Investment and Improve Investment Efficiency? Evidence from China

The Economic Stimulus Packages which was introduced in response to the recent global financial crisis has been debated vigorously for its implications for economic efficiency. Using Chinese firms in the period 2003-2013 from the supply side perspective, we show that with the implementation of an economic stimulus package in China, state-owned enterprises (SOEs) receive more bank loans and invest more than non-SOEs. We further find that the economic stimulus package distorts bank lending decisions and reduces firm investment efficiency of SOEs, non-SOEs from favoured industries and regions, and non-SOEs with political connections. Our findings are robust to event study analysis, controlling for bank-level unobserved heterogeneities, and other robustness tests. Overall, our findings support the view that the stimulus package and the associated increase of bank loan supply in China results in a resource misallocation to SOEs, so that resources are invested inefficiently, that is, the stimulus package stimulated investment by SOEs and crowded out investment by privately owned sectors.

Political Capital vs. Constraint: Evidence from CEO Turnovers in Chinese Private Firms

Previous theoretical and empirical studies suggest that CEOs’ political connections are valuable to firms. We examine whether such connections become constraints if the expected political capital fails to materialize and the firm lacks other type of political power in place. Using a sample of listed firms in China, we show that politically connected CEOs in privately controlled (i.e., not state-owned) firms have longer tenure, lower turnover, and weaker turnover-performance sensitivity than non-politically connected CEOs. Further identification tests show that these turnover patterns are not consistent with alternative explanations for turnover patterns such as superior managerial ability or reduction in managerial myopia. The turnover patterns are less pronounced in firms that have alternative political power, such as connected boards or state ownership. Following the turnover of politically connected CEOs, performance improves only for the state-owned firms. Our results call for new theories that comprehend both values and costs of political connection.