The article by Chen Wenchuan, Li Wenwen, and Li Jianfa published in Auditing Research, issue 5, 2021, was reprinted by "China Social Science Excellence". This article is hereby republished for readers.

Government Auditing and Financialization of State-owned Enterprises

Chen Wenchuan1 Li Wenwen2 Li Jianfa1

(1. Center for Accounting Studies of Xiamen University / Department of Accounting, School of Management, Xiamen University 2. School of Accounting, Nanjing Audit University)

The phenomenon that economy deviating from the real to the virtual is becoming more and more serious in China

China's economy has entered a stage of high-quality development, but the real economy continues to move away from the real to the virtual. According to research statistics, the proportion of profits in China's pan-financial industry has rapidly increased from about 15% in 2004 to 60% in 2018. Profit accumulation through financial channels has gradually become an important model for non-financial corporate profits. The study also found that about 77% of Chinese central state-owned enterprises are involved in financial investment activities, and nearly half of them take them as one of their business sectors.

If the Chinese economy can realize the transformation from the virtual to the real, it signifies a success, and means the avoidance of entering the middle-income trap (Li Xunlei and Yang Chang, 2018). Preventing and defusing financial risks, guiding enterprises to "break away from the virtual to the real", and promoting the high-quality development of the real economy are the important goals of China's current financial reform. So, how to effectively curb the excessive financialization of the real economy, and how to promote real enterprises to "get out of the virtual and into the real"?

How to govern effectively?

As an important external governance mechanism for state-owned enterprises, government auditing will also have external governance effects on enterprises in the capital market. Specifically, government audits can identify and expose corporate financialization problems through the revealing function, use the defense function to urge enterprises to transfer from the virtual to the real, and use the power of punishment and transfer processing power to exert a strong deterrent effect on state-owned enterprises and executives.

How effective was the governance?

Using the audit events of central state-owned enterprises implemented by the National Audit Office from 2010 to 2018, this paper applies a multi-time point difference-in-differences model to test the impact of government auditing on the financialization of listed companies controlled by central state-owned enterprises. The study found that government auditing will significantly reduce the financialization of state-owned enterprises. Compared with the sample which not affected by government audit, the financial investment level of sample enterprises subjected to government audit decreased by 0.8%. Further research shows that government auditing reduces the financialization of state-owned enterprises mainly by suppressing speculative financial assets of enterprises; the research also finds that when the regional supervision is stronger, the company's internal control level is lower, and the external auditors are from none of the four major accounting firms, the governance function of government auditing is more significant; in terms of economic consequences, the study found that along with government auditing reducing the financialization of state-owned enterprises, the enterprises' investment in real economy and that in R&D significantly increase.

Summary

This paper expands from the micro-level of government auditing on enterprises to the study of enterprise financialization. It empirically tests the mechanism and specific effects of government auditing on enterprise financialization, and provides micro-level evidence for effectively preventing the "deviation from reality to virtuality" for financial supervision. It also provides theoretical support for the coordination and unification of "promising government" and "effective market" to effectively manage the financialization of enterprises.

Contributor | Chen Wenchuan

This article is excerpted from Auditing Research