The Impact of Major Shareholders' Equity Pledges on Audit Pricing: Empirical Evidence from China's Private Listed Companies

Abstract

Compared to financing options like bank loans, equity pledge financing is widely recognized among shareholders of listed companies due to its convenience, ability to raise funds at a low cost while retaining control. However, when a company's stock price declines to the liquidation threshold, pledged shareholders face the risk of losing control over their shares, which heightens their motivation to appropriate corporate assets or engage in earnings management to stabilize stock prices. State-owned enterprises benefit from natural political connections with the government, granting them advantages in financing and tax policies, as well as superior margin-call capabilities. Moreover, due to stricter and more complex conditions for equity transfers in state-owned enterprises, pledgees are more inclined to use private negotiation to cover loans. In contrast, private enterprises lack these policy and negotiation advantages, making their controlling shareholders more likely to resort to equity pledges to meet financial needs. However, in the event of a stock price drop, they often lack the capital to adequately cover margin calls, leading them to focus on controlling stock price fluctuations through earnings management. Thus, after pledging equity, private enterprises face intensified risks of asset appropriation and earnings management, prompting auditors to establish higher audit pricing to compensate for additional audit resources and hedge against increased audit risks.This study analyzes the relationship between controlling shareholders' equity pledges and audit pricing using data from China's A-share private listed companies between 2015 and 2020. The findings indicate a significant positive relationship between equity pledges by controlling shareholders and audit pricing, with higher pledging levels leading to increased audit fees. Further analysis reveals that this significant positive relationship only exists in regions with higher marketization and among firms audited by the "Big Ten" accounting firms. The conclusions enrich the literature regarding the economic consequences of equity pledges and factors influencing audit pricing, providing valuable insights for corporate governance and market regulation.