Risk-preparedness mechanism and audit quality: Evidence from mandatory increase of professional indemnity insurance and professional risk fund

Abstract

We examine the risk-preparing benefits of Chinese audit firms’ professional indemnity insurance (PII) and professional risk fund (PRF) by using the Notice on Adjusting the Application Requirement of Audit Firms for Securities Qualifications as an exogenous shock. This policy requires audit firms to raise the sum of the cumulative compensation limit of their PII and PRF from 6 million to 80 million yuan. It is found, first, that the capital market regards this policy revision as a signal to strengthen investor protection and responds positively; client firms with high audit risks have a stronger response. Second, auditors’ governance of financial information has strengthened, resulting in the..