Institutional environment, political connection and IPO audit quality: Evidence from Hong Kong

Abstract

This study examines the unexplained information content of abnormal audit fees in the initial public offering (IPO) market. Using a sample of IPO audits in Hong Kong where the investor protection environment is strong, we find that abnormal IPO audit fees are negatively associated with pre-IPO real activities manipulation (RAM), suggesting higher audit quality for the IPO financial statements. However, the association is less pronounced for politically connected Chinese IPO firms. Taken together, our findings reveal that abnormally high IPO audit fees indicate additional audit efforts, and the increased audit efforts effectively constrain IPO clients’ earnings manipulation.