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Demand for Information Enhancement: The Case of Chinese Firms

Abstract: This study examines publicly traded Chinese firms to identify their incentives to make investments to enhance the credibility of their financial disclosures. The results indicate that firms traded exclusively on the Mainland exchanges are more likely to employ auditors perceived as high-quality (Big 5 affiliated) when they report high returns on equity. This finding is consistent with the perception that, on the margin, positive results will be more readily accepted by financial statement users when those results have been audited by Big 5 affiliated firms. Additional analysis indicates that firms traded exclusively on the Mainland exchanges that employ Big 5 auditors are also relatively more leveraged than their counterparts traded on the Hong Kong Stock Exchange (SEHK). This finding is consistent with capital providers to Mainland traded firms placing an incrementally high value (relative to firms trading on the SEHK) on reports that have been audited by Big 5 affiliated auditors. Additional findings indicate that larger firms are more likely to list shares on the SEHK and use Big 5 affiliated auditors, consistent with larger firms trading on the SEHK than on Mainland only exchanges acting to attract a more sophisticated (and potentially wary) international investment clientele. There is some evidence that firms trading on the SEHK are relatively less highly leveraged than other firms in the sample studied. While it is not possible to infer causality, the relations we find suggest that firms make investments to enhance information credibility when circumstances are such that doing so will reduce their cost of capital. The evidence also suggests that Chinese firms that want to attract capital from international sources are more likely to list of the SEHK. The study's findings contribute to a relatively sparse empirical literature on the relation between the acquisition of information enhancement and various factors hypothesized to influence demand.