Audit Market Regulation and Audit Quality: Evidence from a Quasi-Natural Experiment

This paper examines how audit market regulation affects audit quality. To establish a causal relationship, we utilize the implementation of the filing system under the New Securities Law as a quasi-natural experiment. The results show that the implementation of the filing system has significantly improved audit quality, indicating that the reform has promoted healthy competition in China’s audit market. After controlling for endogeneity and testing robustness, we find that the results remain valid. The mechanism test finds that introducing the filing system under the New Securities Law reshapes auditors’ incentives, making them more cautious about audit risk and increasing their effort to avoid losses, thereby improving audit quality. Furthermore, the greater the policy shock perceived by an audit firm, the stronger its effect on improving audit quality. In addition, the increase in audit quality is concentrated in companies with less complex business, those with decentralized ownership structure and those with weak external governance. In terms of regional characteristics, we find the impact is greater for firms located in regions characterized by a more favorable business environment and stronger legal institutions. Collectively, we provide novel evidence of how this audit market regulatory reform impacts audit quality.