Board informal hierarchy and audit quality: evidence from China

Abstract

Purpose Improving audit quality is an important research area of managerial accounting. This study focuses on the informal institutions within organizations and their impact on audit quality. Specifically, this study aims to examine the impact of the informal hierarchy among directors on audit quality. Design/methodology/approach The authors examine Chinese companies with listed shares from 2008 to 2020. The authors proxy for audit quality using discretionary accruals and small profits, and use ordinary least squares regression to test their hypotheses. Findings The results demonstrate that the informal hierarchy of the board improves audit quality. The results are robust to a battery of sensitivity analyses. Additionally, there is weak evidence that the effect of the board’s informal hierarchy on audit quality is weaker in state-owned enterprises. Moreover, the mechanism tests indicate that the board’s informal hierarchy improves audit quality through the improvement of internal controls. In addition, the impact of the informal hierarchy among directors on audit quality further improves firm performance. However, audit fees are not reduced further because the board’s informal hierarchy demands higher audit quality by choosing industry audit experts. Originality/value This study not only enriches the research on the economic consequences of the board’s informal hierarchy but also expands on studies on antecedents of audit quality.