Short Sales Mechanism, Litigation Risk and Audit Fees

Huang Chao, Huang Jun

Journal of Finance and Economics Vol. 42, Issue 05, pp. 77 - 87 (2016)  DOI:10.16538/j.cnki.jfe.2016.05.007

Abstract

This paper examines how the short sales mechanism affects firms' audit fees through the changes in litigation risk, based on the natural experiment of securities margin trading in China. It comes to the conclusions that the introduction of short sales mechanism reinforces the pressure of the fall in stock prices and strengthens the incentive of investors to search bad news of companies, leading to the increase in audit litigation risk of companies and higher audit fees required by accounting firms. Further analysis suggests that the short sales mechanism plays a more obvious role in the increase in audit fees of state-owned enterprises, owing to poor information disclosure environment in state-owned enterprises; due to stronger compensation capacities of "Big Four", the short sales mechanism significantly results in the rise in audit fees of "Big Four"; as for enterprises located in areas with poorer legal environment, because the management has the motivations to hide bad news, their audit fees significantly increase because of the existence of the short sales mechanism.

Keywords

short sales mechanism; litigation risk; SOEs; 'Big Four'