Effects of Indebtedness, Taxes and Financial Distress on the Demand for Non-Mandatory External Audit: Evidence from the Chinese Firms

Abstract

This paper aims to examine the determinants of firms’ demand for non-mandatory external audit in China. Although the demand for non-mandatory external audit has often been investigated for the western economies, we are the first to present evidence for the China by using a unique dataset that the World Bank provided. Using enterprise surveys to estimate the likelihood of firms engaging non-mandatory external audit, the paper uncovers how the indebtedness, tax inspection probability, and the financial distress affect the demand for non-mandatory external audit. The results indicate a positive association between tax inspection probability and demand for external audit. Contrary to the previous literature, the likelihood of demanding external audit diminishes as financial distress level of the firm rises. This result indicates relatively high audit costs for the financially distressed firms that can not afford to cover their non-operational costs.