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Geographic location of audit committee chairs and accruals quality: evidence from China

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Abstract

Using a large sample of Chinese firms, we examine if the geographic proximity of audit committee chairs (ACCs) to firms is associated with accruals-based financial reporting quality. We define an ACC who is in the same province/municipality as the firm headquarters as “local” and an ACC who is not as “nonlocal”. We find that a local ACC is associated with higher accruals quality, evidenced by a decrease in the absolute value of discretionary accruals. The improvement in financial reporting quality may lie in the fact that the firms with local ACCs more likely appoint Top10 auditors and/or hold more audit committee meetings. Furthermore, we find that local ACCs are associated with better accruals quality in firms with more opaque information environments and higher uncertainties in future prospects, and that the relation between local ACCs and better accruals quality is weakened in firms with powerful CEOs. Our findings suggest that the informational benefit derived from the geographic proximity of local ACCs outweighs the resultant agency effect on financial reporting.

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Notes

  1. The SOX in the U.S. requires all listed firms to set up an audit committee and give the committee a significant set of responsibilities to monitor and advise on corporate financial reporting practices. The audit committees should consist of independent directors only. In China, however, the Code of Corporate Governance for Listed Companies requires the audit committee chairs and the majority of audit committee members to be independent directors.

  2. To promote internal control of listed firms, the Shanghai Stock Exchange issued policy guidance in 2013 to encourage A-share firms listed on the exchange to disclose audit committee activities in “audit committee reports.” The filing is separate from annual reports. The audit committee reports include information such as the frequency of audit committee meetings, the meeting agenda, and the appointment of auditors.

  3. In our analysis, we classify local versus nonlocal ACCs depending on whether the director and firm headquarters are located in the same province. To validate this definition, we examine the physical distance (measured as a continuous number) between the director and firm headquarters. In our sample, we find that among the local ACCs, 84% work within a 100 km radius of the firm’s headquarters, while among the nonlocal ACCs, only 4% do. This suggests that our measure of local ACCs, based on jurisdictions, is consistent with the continuous measurement of geographic distance.

  4. From April 22, 1998, under regulations of Shenzhen Stock Exchange and Shanghai Stock Exchange, in the event of financial issues or other abnormal conditions of listed companies that make investors unable to judge the future of the companies and may endanger the interests of investors, the Stock Exchanges shall take special treatment on these stocks. These shares will be marked “ST” ahead. When the abnormal conditions return to normal conditions, the “ST” will be removed. Earlier studies have found that ST firms have stronger incentives in engaging earnings management to improve reported performance.

  5. Though, on average, local ACCs have lower salaries, they may not be of low quality. While salary is one incentive for ACCs to fulfill their governance role, there are other incentives at play, such as litigation risk concerns, reputation concerns, career development concerns, etc. (Srinivasan 2005; Fich and Shivdasani 2007; Jiang et al. 2016; Gao et al. 2017). Similarly, Chen and Keefe (2020) find that rookie independent directors, who are inexperienced, attend more board meetings and help improve firms’ operating performance more, in order to develop reputation.

  6. The predicted signs on control variables are presented in the table.

  7. According to statistics, the operation of HSR significantly changes the passengers’ travel time (Chen and Haynes 2017). For example, the travel time from Beijing to Shanghai (Guangzhou) is 15 (21) hours by regular train but just 4 (8) hours by HSR. The introduction of HSR also reduces air traffic volume (Chen 2017). The number of passengers who will travel by air between Beijing and Shanghai (Guangzhou) declined approximately 34% (24%) after the opening of the Beijing-Shanghai (Beijing-Guangzhou) HSR.

  8. To put in another way, the treatment firms and their ACCs are in different provinces/municipalities, between which an HSR is introduced during the ACCs’ appointment period.

  9. In our sample, the change is always the introduction of HSR, as there is no closure of HSR.

  10. We also evaluate if it is possible to examine the accruals quality changes around the change of ACCs’ location (e.g. when a nonlocal ACCs becomes local or vice versa). However, such cases are very rare in our sample.

  11. Cateris paribus, the odds for firms with nonlocal ACCs to appoint a Top10 auditor is around 2.8% (= exp(-3.548)), and the odds for firms with local ACCs to appoint a Top10 auditor is around 3.8% (= exp(-3.548 + 0.283)).

  12. We download audit committee reports from the Shanghai Stock Exchange for the period between 2013 and 2016. We extract the words/phrases surrounding “audit committees”, “audit committee chairs”, “meetings”, “numbers”, and “host” with web-crawling tools and read the texts manually to identify the number of audit committee meetings in a year. For 4,153 firm-years in our sample from 2013 to 2016, we obtain 2,643 audit committee reports with information on audit committee meeting frequency. We find that most firms organize four audit committee meetings in a year, possibly to finalize the four quarterly financial statements.

  13. We caution a caveat in this part of analysis. The data used in the test are only available from A-share firms that have provided audit committee meeting frequency in their audit committee reports filed to Shanghai Stock Exchange between 2013 and 2016.

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Acknowledgements

We are grateful to Jonghag Choi, Fang Hu, Linda Myers, Feng Tian, Hao Zhang, workshop participants at the Hong Kong Polytechnic University and conference participants at the 8th Conference of the World Accounting Frontiers Series for helpful comments, Ziye Zhao at the Shanghai University of Economics and Finance for providing auditor location data in China, and Alice Cheung for excellent editorial assistance. Yumiao Yu acknowledges financial support from the National Science Foundation of China (#71672131, #72072133). Any errors are our own.

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Authors and Affiliations

  1. School of Accounting and Finance, Faculty of Business, Hong Kong Polytechnic University, Hunghom, Hong Kong

    C. S. Agnes Cheng & Yuan Huang

  2. Department of Accounting, Zhengzhou University, Henan, China

    Di Sun

  3. Department of Accounting, Wuhan University, Hubei, China

    Yumiao Yu

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  1. C. S. Agnes Cheng
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  2. Yuan Huang
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Correspondence to Yuan Huang.

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Appendix

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Table 9 Variable definitions
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Cheng, C.S.A., Huang, Y., Di Sun et al. Geographic location of audit committee chairs and accruals quality: evidence from China. Rev Quant Finan Acc 57, 1215–1246 (2021). https://doi.org/10.1007/s11156-021-00976-3

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