Institutional Investors, ESG Performance, and Audit Quality
Shuyue Wang
1,* a
, Yajuan Shangguan
2b
and Rong Men
1c
1
Beijing Jiaotong University, China
2
China Railway Xi'an Group Co., Ltd., China
Keywords: Institutional Investors, ESG Performance, Audit Quality, Internal Governance.
Abstract: In the process of promoting the high-quality development of China's economy, investors are paying
increasing attention to the ESG performance and audit quality of listed companies. This paper empirically
examines the impact and the mechanisms of institutional investors on audit quality, using Chinese A-share
listed companies from 2015 to 2020 as the research object. The study finds that the higher overall
shareholding of institutional investors, the higher audit quality of listed companies; and that the ESG
performance of firms plays an intermediary role in mediating the influence of institutional investors on audit
quality protocols. The heterogeneity test finds a more significant role of stable institutional investors in
improving audit quality. The research conclusions enrich the relevant literature in the area of institutional
investors and audit quality, and provide empirical evidence for strengthening ESG disclosure regimes.
a
https://orcid.org/0000-0002-8718-8389
b
https://orcid.org/0000-0002-7528-9510
c
https://orcid.org/0000-0002-3580-1938
1 INTRODUCTION
In the process of promoting the high-quality
development of China's economy, enterprises are
improving the quantity and quality of information
disclosure in pursuit of high-quality and sustainable
development. A quality audit by a CPA must have
the ability to distinguish the earnings management
phenomenon of enterprises and alert investors and
stakeholders to the extent of it. Institutional
investors have an incentive to monitor a company's
management's use of manipulable accrued profits for
surplus management and therefore institutional
investors can improve audit quality to some extent.
Enterprises will take the initiative to report to the
community on their own social responsibility and
improve the quality and transparency of disclosure
of information on the three aspects of
environmental, social and governance (referred to as
ESG). More and more investment entities promote
continuous efforts by portfolio companies to
improve their ESG performance, and higher ESG
performance provides auditors with more basis for
audits.
In the above context, this paper empirically
examines the impact of institutional investors on
audit quality and the intermediary role of ESG
performance on the relationship between the two,
using A-share listed companies in China from 2015-
2020. From the perspective of institutional investors,
this paper explores its impact on audit quality. And
this paper provides a basis for how how the capital
market can improve internal corporate governance
and audit quality. Besides, it also provides a
reference for promoting the improvement of ESG
information disclosure by enterprises.
2 LITERATURE REVIEW
2.1 Literature Review
Audit quality, as an important basis for corporate
financial credibility, plays an increasingly important
role in the capital market and has become a hot topic
of research for experts and scholars in the field of
auditing. Li and Li (2008) proposed that institutional
investors should participate in corporate governance,
timely supervise the management behavior, and
Wang, S., Shangguan, Y. and Men, R.
Institutional Investors, ESG Performance, and Audit Quality.
DOI: 10.5220/0012026400003620
In Proceedings of the 4th International Conference on Economic Management and Model Engineering (ICEMME 2022), pages 95-101
ISBN: 978-989-758-636-1
Copyright
c
2023 by SCITEPRESS – Science and Technology Publications, Lda. Under CC license (CC BY-NC-ND 4.0)
95
promote the normal and good operation of the
enterprise to bring more benefits. Institutional
investors are able to accurately identify the presence
of opportunistic behaviour due to their own
advantages in terms of information, which improves
the transparency of accounting information and the
quality of financial reporting, which in turn
contributes to the improvement of audit quality
(Zhou et al., 2015). There are many academic views
on the results of the impact of institutional investors
on audit quality, but most scholars quite agree that
institutional investors can overall improve the audit
quality of listed companies (Feng, 2014).
In 2021, KPMG published a report on valuing
companies from an ESG perspective, which explains
how to incorporate the internal and external
influence of ESG factors. They suggest that ESG is
also one of the drivers of value that investors and
company management should not ignore, and that
relying solely on traditional financial metrics is an
outdated and one-sided approach to valuation.
According to Huang (2021), ESG is gradually
becoming a core concept and framework system for
evaluating the sustainability of companies. The
existing literature on ESG has focused on examining
ESG performance on financial performance (Wang
et al., 2022), financing constraints (Li et al., 2022),
and firm value (Liu and Tang, 2021), and has not
considered the role of institutional investors in
contributing to ESG performance
This paper introduces the phenomenon of
enterprise ESG performance, link the internal
governance characteristics of institutional investors
and the auditor the external supervision mechanism,
deduce the ESG performance in the bridge in the
process of audit quality.
2.2 Research Hypotheses
An increasing number of institutional investors are
now actively involved in the governance aspects of
their investees, by virtue of exercising their rights to
scrutinise management decisions and participate in
corporate governance, thus greatly enhancing the
quality of audits. This behavior can further
effectively reduce the principal-agent cost and ease
the conflict between the owner and the agent.
Institutional investors are able to collect company
information on their own and use their professional
analytical skills to screen the information in the
market to determine whether there are opportunistic
acts such as false disclosures in the financial reports
of listed companies, and share the results with other
shareholders and investors, alleviating the
information asymmetry. Institutional investors
participate in corporate governance, through field
research, shareholders' proposal activities play its
supervision effect, inhibit the opportunistic behavior,
prompt the information disclosure, reduce the
auditor work intensity and audit risk, which is
conducive to the auditor issued a more fair audit
opinions, and improve the quality of audit.
Institutional investors, who hold a larger stake
than small and medium-sized investors and have
specific criteria for selling their shares, can suffer
significant losses in the event of more serious 'low
audit quality'. For this reason, institutional investors
who recognise that there is a clear 'insider control
problem' in a listed company will put pressure on
management to ensure the auditors' own
independence characteristics.
Therefore, this paper proposes hypothesis 1:
Hypothesis 1(H1): The higher the overall
shareholding ratio of institutional investors, the
higher the audit quality of listed companies
Institutional investors promote truthful
information disclosure by participating in corporate
governance, optimising company operations and
discouraging the occurrence of opportunistic
behaviour. For companies with a higher
shareholding ratio of institutional investors, the
better their ESG performance is, which in turn
makes it easier for problems to be identified and
addressed. Information on corporate governance is
included in ESG disclosures and can reflect the
scientific nature of corporate governance. As
financial information of listed companies is an
important basis for the audit work of CPAs, ESG
performance determines audit quality to a certain
extent.
Therefore, this paper proposes hypothesis 2:
Hypothesis 2(H2): The higher shareholding ratio
of institutional investors, the better ESG
performance of the company, providing auditors
with a more realistic, reliable and relevant audit
basis, thus improving audit quality.
3 RESEARCH DESIGN
3.1 Sample and Data
This paper takes Chinese A-share listed companies
as the research object and selects A-share listed
companies in Shanghai and Shenzhen as the sample
from 2015-2020. After data collection and collation,
the final sample obtained contains 6 years of data
from 2602 listed companies with a total of 11,854
ICEMME 2022 - The International Conference on Economic Management and Model Engineering
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observations. The data in this paper mainly comes
from CSMAR database and WIND database.
3.2 Variable Definition
The Explained Variable: Audit Quality (AQ).
Drawing on relevant research on surplus
management, this paper adopts the negative of the
absolute value of manipulated accrued profits
estimated by the modified Jones model by industry
by year as a proxy variable for audit quality, as
follows.
it
01 2 it
i, 1 i, 1 i, 1 i, 1
1
+
it
tt t t
TA PPE
REVit RECit
AA A A
(1)
where the subscript i represents the company, t
represents the time.
The Explanatory Variable: Share-holding ratio of
institutional investors (INVH).
The Intermediate Variable: ESG Performance
(ESG). This paper uses the ESG rating data of China
Securities, which is classified into AAA~C from
high to low, and assigns 9~1 respectively. Enterprise
ESG performance depends on the ESG score of the
enterprise in the Wind database. The higher ESG
score is, the better ESG performance of the
enterprise is.
Control Variables. This paper draws on the
studies, adding the following variables to the model:
firm size (SIZE), financial leverage (LEV), firm
growth opportunity (TQ), auditor firm (BIG),
proportion of independent directors (INDEP). In
order to control the impact of year and industry on
audit quality, year, industry virtual variables were
added to the regression model. Variables and their
definitions are detailed in Table 1.
Table 1: Definitions of main study variables.
Type Variable Symbol Calculation Method
Explained variable Audit quality AQ
Negative absolute value of
manipulated accrued profits using
the modified Jones model
Explanatory variable
Share-holding ratio of
institutional investors
INVH
Number of institutional holdings as
a percentage of the total number of
such shares or shares outstanding
Control variables
Firm size SIZE
Natural logarithm of total assets at
the end of the year
Financial leverage LEV
Total liabilities at the end of the
y
ear / Total assets at the end of t
Firm growth opportunity TQ
(Market value of shares
outstanding + number of non-
marketable shares x net assets per
share + book value of
liabilities
)
/total assets
Auditor firm BIG
Virtual variable, value 1 if the
company is audited by a Big 4
firm; 0 otherwise
Proportion of independent
directors
INDEP
Number of independent directors /
total number of board members
3.3 Model Specification
To test H1, this paper constructs a regression model
(2) for the relationship between institutional investor
shareholding and audit quality:
it 0 1 n
ear+ +
it it
AQ INVH Controls Y Industry
(2)
where the subscript i represents the company, t
represents the time.
If the
1
is positive, which proves that the higher
institutional investor shareholding ratio, the higher
audit quality, then H1 is true.
In order to investigate the intermediary role of
ESG in institutional investors and audit quality,
draw on the research results of Wen et al. (2004),
use the intermediary effect test procedure, and
construct the three-step regression model using the
gradual regression method based on model (2):
it 0 1 nit it
ESG INVH Controls Year Insustry
(3)
it 0 1 2 nit it it
AQ INVH ESG Controls Year Industry
(4)
Institutional Investors, ESG Performance, and Audit Quality
97
where the subscript i represents the company, t
represents the time.
If the
1
is positive, the higher institutional
investor shareholding ratio, the better corporate ESG
performs; if both
1
and
2
are positive,
assumption 2 holds.
4 EMPIRICAL ANALYSIS
4.1 Descriptive Statistics
Table 2 presents the full sample descriptive statistics
for the main variables. The minimum value of audit
quality (AQ) is -0.28 and the maximum value is -
0.0007, indicating a large degree of variation in
audit quality between different listed companies.
The average shareholding ratio of institutional
investors (INVH) is 0.45, indicating that the average
shareholding of institutional investors in listed
companies in the sample amounted to 45%.
The average ESG performance of the sample
companies is 6.54, indicating that the ESG
performance ratings of listed companies in the
sample are relatively good, which is mainly because
since 2018, the SSE and SZSE have taken
corresponding initiatives for listed companies to
monitor the disclosure of CSR information and set
mandatory information disclosure requirements for
some industries; the standard deviation is 1.22,
indicating the large gap in the ESG information
disclosure rating of the sample company.
Table 2: Descriptive Statistical Analysis.
Variable N Mean Min P50 Max SD
AQ 11854 -0.05 -0.0 -0.04 -0.28 0.05
INVH 11854 0.44 0 0.45 1.01 0.24
ESG 11854 6.54 1 6 9 1.22
SIZE 11854 22.6 20.2 22.41 26.4 1.26
LEV 11854 0.44 0.07 0.43 0.87 0.20
TQ 11854 2.04 0.83 1.61 8.48 1.34
BIG 11854 0.06 0 0 1 0.25
INDEP 11854 0.38 0.33 0.36 0.57 0.05
4.2 Baseline Regression Results
Table 3 presents the results of the baseline
regression. As can be seen from the regression
results of model (2), the more institutional investors
hold shares, the higher audit quality. Hypothesis 1 is
verified. According to the regression results of the
model (3), the more institutional investors hold their
shares, the better corporate ESG performance is.
According to the regression results of model (4),
institutional investors play a partially mediating role
through corporate ESG performance, thereby
improving audit quality.
Institutional investors have a positive role in
ESG performance, and the audit quality of listed
companies will improve as institutional investors
exert corporate governance effects and improve
information transparency, namely institutional
investors exert monitoring and governance effects
through participation in corporate governance,
curbing the occurrence of opportunistic behaviours,
while alleviating the degree of information
asymmetry and improving corporate ESG
performance, which in turn facilitates the audit work
of CPAs and contributes to the improvement of audit
quality.
Table 3: Baseline Regression Results.
Model(2) Model(3) Model(4)
AQESGAQ
INVH 0.0078
***
0.3887
***
0.0064
***
(
3.18
)
(
7.62
)
(
2.60
)
ESG 0.0036
***
(7.62)
SIZE 0.0053
***
0.4282
***
0.0037
***
(9.05) (38.37) (6.13)
LEV -0.0426
***
-1.0224
***
-0.0389
***
(
-11.70
)
(
-15.89
)
(
-10.69
)
TQ -0.0025
***
0.0420
***
-0.0027
***
(-5.15) (4.90) (-5.49)
ICEMME 2022 - The International Conference on Economic Management and Model Engineering
98
BIG 0.0042
**
0.1323
***
0.0038
**
(2.38) (3.55) (2.12)
INDEP -0.0213
**
0.0623 -0.0216
**
(
-2.35
)
(
0.36
)
(
-2.37
)
_
cons -0.1419
***
-3.2965
***
-0.1300
***
(
-10.44
)
(
-12.35
)
(
-9.58
)
Industry Effect yes yes yes
Year Effect yes yes yes
Observations 11854 11854 11854
Adj R
2
0.0550 0.2490 0.0600
Note: * p < 0.1, ** p < 0.05, *** p < 0.01
4.3 Heterogeneity Analysis
According to the characteristics of institutional
investors, they can be divided into transactional
institutional investors and stable institutional
investors.
The Institutional Investor Heterogeneity
Identifier Variable (INVW) indicator is obtained by
drawing on Niu et al. (2013) and Li et al. (2014),
which use two dimensions of time and industry to
study the heterogeneity of institutional investors.
The formula is as follows:
,3 ,2 ,1
j
(, ,)
1, ( )
0,
it
it
it it it
it t j
INVH
SD
STD INVH INVH INVH
SD MEDIAN SDt
INVW
其他
(5)
where the subscript i represents the company, t
represents the time, and j represents the industry.
The results of the institutional investor
heterogeneity regressions are presented in Table 4.
As can be seen from column (1), there is a positive
correlation between stable institutional investors and
audit quality. According to column (2), stable
institutional investors are conducive to improving
corporate ESG performance. As can be seen from
the column (3), the stable institutional investors play
some intermediary role through the enterprise ESG
performance, so as to improve the audit quality. The
regression results show that stable institutional
investors are more likely to exert corporate
governance effects through monitoring than
transactional institutional investors, resulting in
sound corporate ESG disclosure and providing more
information for auditors to refer to, thereby
improving audit quality.
Table 4: Institutional Investor Heterogeneity Regression Results.
(1) (2) (3)
AQ ESG AQ
INVW 0.0027
***
0.2019
***
0.0020
**
(2.76) (9.93) (2.01)
ESG 0.0036
***
(7.60)
Controls yes yes yes
_cons -0.1510
***
-3.6421
***
-0.1379
***
(-11.54) (-14.30) (-10.54)
Industry Effect yes yes yes
Year Effect yes yes yes
N 11854 11854 11854
r2_a 0.0548 0.2516 0.0598
Note: * p < 0.1, ** p < 0.05, *** p < 0.01
4.4 Robustness Tests
Substitution of explanatory variables. In this paper,
audit opinion (OPIN: if the company's financial
report is issued a standard opinion, the value is 1,
otherwise 0) is used as a replacement variable for
audit quality and is used in the regression as an
alternative to model (2).
Replacement of the ESG performance metric.
Drawing on the replacement method of Gao et al.
(2021), a more straightforward and simple
assignment method is used to construct the
mediating variable ESG_R, which is constructed
Institutional Investors, ESG Performance, and Audit Quality
99
directly based on the broad categories (A, B and C)
of the ESG rating, with an assignment of 3 to 1.
Table 5 shows the results. The regression results
are significant and prove that the baseline regression
of this paper is robust.
Table 5: Robustness Tests Regression Results.
(1) (2) (3)
OPIN ESG_R AQ
INVH 0.0175
**
0.1434
***
0.0069
***
(2.35) (6.36) (2.81)
ESG_R 0.0062
***
(5.90)
Controls yes yes yes
_cons 0.6663
***
-1.3449
***
-0.1336
***
(14.55) (-12.24) (-9.82)
Industry Effect yes yes yes
Year Effect yes yes yes
N 11854 11854 11854
r2_a 0.0276 0.2230 0.0577
Note: * p < 0.1, ** p < 0.05, *** p < 0.01
5 CONCLUSIONS
This paper examines the relationship between
institutional investors and audit quality, as well as
the mediating role of ESG performance on the
relationship between the two, using a sample of A-
share listed municipal companies in Shanghai and
Shenzhen in China for the period 2015-2020, and
draws the following key conclusions: the higher
shareholding of institutional investors, the higher
audit quality; and ESG performance plays a partial
intermediary effect in the role of institutional
investors on audit quality; stable institutional
investors are more helpful in improving ESG
performance and audit quality of listed companies.
The entire impact path is that institutional
investors actively participate in the governance
aspects of their investees, by virtue of exercising
their rights, to strictly monitor management
decisions, participate in corporate governance and
play a controlling role in their falsification, surplus
manipulation, profit falsification and statement
embellishment, thus greatly enhancing audit quality.
By improving the ESG performance of companies,
institutional investors provide auditors with a more
truthful, reliable and relevant basis for audits, thus
improving audit quality.
In order to promote the improvement of audit
quality of listed companies in China, this paper puts
forward relevant policy recommendations. Firstly,
the governance effect of institutional investors
should be strengthened. Secondly, the development
of institutional investors with stable shareholdings is
a big step forward. Thirdly, strengthen the ESG
information disclosure system and improve the ESG
performance of listed companies.
The study in this paper only selected that ESG
acted as the mediating variable, which found that
ESG acted as a partial mediator, and proved that
other variables will also mediate the role in this path
of influence. In future research, other intermediary
variables in the impact of institutional investors on
audit quality can be studied to further broaden the
research on audit quality.
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