Capital market liberalization and auditors' accounting adjustments: Evidence from a quasi‐experiment.

Using a shock to the Chinese capital market and unique and detailed audit‐adjustment data, this paper investigates the effect of a capital market liberalization program on auditors' adjustments to their clients' financial reports. Employing difference‐in‐differences tests with propensity score matching and firm fixed effects (FE), we find that the capital market liberalization induced by the implementation of the Shanghai‐Hong Kong Stock Connect affects auditors' professional judgment and leads to audit‐adjustment changes stimulated by greater reputational and litigation risks for auditors. Specifically, while the liberalization significantly decreases the frequency and magnitude of upward audit adjustments, the probability of downward adjustments remains the same in most cases. Further evidence shows that the effect is more pronounced for companies with high trading volume from Hong Kong investors, audited by the largest audit firms and with low financial transparency. [ABSTRACT FROM AUTHOR]