How do auditors respond to government debt? Evidence from the rise of LGFVs in China

Purpose This study aims to examine whether and how auditors respond to government debt. Design/methodology/approach This study investigates how auditors respond to increasing government debt using a data set covering 286 cities in China between 2007 and 2019. Instrumental variable approach, quasi-natural experiment and other robustness checks are used as well. The regression models are estimated with robust standard errors clustered at the firm level. Findings This study finds that auditors charge higher fees and issue more modified audit opinions to firms located in cities with higher government debt. Further analysis shows that the auditor’s responses are primarily caused by higher financial constraints, deterioration in financial reporting quality and higher business risk, which lead auditors to exert more effort. The impact of government debt on audit responses is weaker for state-owned enterprises and firms with more institutional ownership. Research limitations/implications This study offers valuable insights for policymakers in emerging markets aiming to understand the effects of government debt on auditors’ perspectives. Originality/value This study sheds light on an unexplored yet important consequence of government debt on firms through the lens of auditors.