Research on the Effect of Audit Quality on Inhibiting Firms' Tunneling Behavior of Loan Guarantees

Abstract

Abstract: In this paper, we study whether audit quality can inhibit companies' tunneling behaviors of providing loan guarantees. Firstly, this paper presents a theoretical mechanism model which shows the impact of external audit quality on tunneling behavior through loan guarantees. Secondly, based on guarantee events data of Chinese listed companies during 2007 to 2016, this paper calculates the cumulative abnormal return (CAR) before and after guarantee announcement days to measure the extent of tunneling. The measurement method of tunneling in our paper can alleviate type II statistical error, which appears when normal transactions are tunneling transactions are confused in the previous cross-sectional researches. The empirical tests find that (1) higher input-based audit quality (i.e. hiring high-quality accounting firms) cannot improve the CAR of guarantee events, and (2) modified audit opinions with guarantee statements significantly increase the CAR of guarantee events in the next accounting year. The results imply that just by playing its governing role, high-quality auditing cannot restrain large shareholders from tunneling, while releasing guarantee information in the audit opinion has an ex-post deterrent effect on listed firms that are intent on tunneling by guarantees.

Key words: audit quality, loan guarantees, tunneling behavior, cumulative abnormal return (CAR), audit opinion

Wang Mengdi, Leng Aolin, Guo Ju'e. Research on the Effect of Audit Quality on Inhibiting Firms' Tunneling Behavior of Loan Guarantees[J]. Management Review, 2022, 34(5): 235-251.

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