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Does mandatory audit rotation affect insider trading? Evidence from China

He Xiao (Department of Business and Management, Beijing Normal University-Hong Kong Baptist University United International College, Zhuhai, China)
Jianqun Xi (Department of Business and Management, Beijing Normal University-Hong Kong Baptist University United International College, Zhuhai, China)
Hanjie Meng (University of Hong Kong, Hong Kong, Hong Kong)

Managerial Auditing Journal

ISSN: 0268-6902

Article publication date: 20 January 2023

Issue publication date: 16 March 2023

516

Abstract

Purpose

This study aims to investigate the impact of mandatory audit partner rotation (MAPR) on Chinese listed firms’ insider trading, as well as the moderating effects of firm characteristics on this impact. The economic mechanism behind this impact is also explored.

Design/methodology/approach

This study conducts a regression analysis on firms associated with mandatory and voluntary audit partner rotation based on 2009–2019 firm data and examines whether corporate insiders of these two types of firms increase their share sales within 12 months before their financial statements are submitted to a new rotated auditor.

Findings

Client firms’ corporate insiders increase their share sales within 12 months before their financial statements are submitted to a new mandatory rotated auditor. In addition, such an association is less pronounced for client firms that changed from Big 4 auditors to those with higher financial constraints. This is more pronounced for client firms with higher information asymmetry. The economic mechanism of the finding is that is the MAPR implementation reduces earnings management activities from client firms. Moreover, client firms’ buy-and-hold stock returns decline in the first year after MAPR.

Research limitations/implications

This study should assist investors, corporate shareholders and Chinese policymakers. Investors can be well protected through the adoption of MAPR because upcoming auditors enhance the audit quality of clients by restraining managers’ manipulation of reported earnings and declining firms’ insider trading afterwards. Investors, Chinese policymakers and corporate shareholders should pay more attention to firms’ financial report quality, auditor selection, financial situation, corporate governance and the information environment. Explicitly, firms with less transparent financial report quality, non-big 4 auditors and fewer financial constraints are more likely to be involved in insider trading.

Originality/value

To the best of the authors’ knowledge, none of the extant studies have examined the impact of MAPR on insider sales. This study extends the research on the effect of the audit process on firm market performance by investigating the impact of audit partner rotation policy on insider trading behaviors.

Keywords

Citation

Xiao, H., Xi, J. and Meng, H. (2023), "Does mandatory audit rotation affect insider trading? Evidence from China", Managerial Auditing Journal, Vol. 38 No. 4, pp. 514-552. https://doi.org/10.1108/MAJ-11-2021-3381

Publisher

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Emerald Publishing Limited

Copyright © 2022, Emerald Publishing Limited

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