Does air pollution matter for audit process and audit outcomes? Evidence from China

Abstract

We investigate the impact of air pollution on audit process and audit outcomes using unique data from the Chinese capital market between 2013 and 2020. We find that auditors exert less effort in client firms located in cities with severe air pollution, leading to lower audit quality represented by a lower probability of and fewer audit adjustments. The cross-sectional analysis shows that auditors from Big 4 audit firms can mitigate the effect of air pollution on audit effort and audit quality. We also draw some interesting conclusions about the effect of auditors’ perceptions of air pollution variation in both spatial and time dimensions, and the impact of COVID-19. Our findings still hold in several robustness checks such as using alternative proxies, controlling for more fixed effects, considering mutual selection issues, employing regression discontinuity design, utilizing instrument variables method, and conducting placebo tests. Our study contributes to the emerging literature on behavioral finance by extending the research into ambient air pollution to the auditing context, provides new insights into the determinants of audit effort and audit quality, and has some implications for regulators.