“Investor Sentiment and Audit Quality” by Dr. Jieying Zhang
Dr. Jieying Zhang
Associate Professor of Accounting
Naveen Jindal School of Management
University of Texas at Dallas
Existing auditing literature focuses exclusively on rational incentives of investors and auditors to demand and supply audit quality, while the potential effect of behavior bias such as sentiment on audit quality is underexamined. Investors with high sentiment might pay less attention and impose less monitoring to audited financial statements, which potentially lowers the supply of audit quality. We take advantage of the Chinese data on audit adjustments and audit hours because these input-based measures are directly under auditors’ control and less confounded by managerial actions. We find that higher sentiment is associated with lower likelihood of audit adjustments and fewer audit hours. We also find that high sentiment is associated with lower likelihood of modified audit opinions and higher absolute discretionary accruals. Cross-sectional analyses show that the effect of sentiment on audit quality is more pronounced for smaller audit firms, lower regulation risk periods, and less experienced engagement auditors. Finally, we show that the effect of sentiment on the output-based audit quality measures is generalizable to the U.S.. Our paper is the first to identify the role of behavior biases in determining audit quality.