The Effect of External Auditors on Managerial Slack

SYNOPSIS We investigate the role of external auditors in constraining managerial slack. Using panel data on Chinese public firms, we find that firms hiring Big 8 auditors are associated with reduced managerial slack after controlling for the endogenous auditor choice. We also document that Big 8 auditors are more effective in mitigating slack in privately controlled firms and firms located in more developed regions. Moreover, we show that international Big 4 auditors are more effective than the domestic Big 4, and the Big 8 effect is more salient in more competitive and less regulated industries, and in industries with higher litigation risks. Finally, we document a positive relationship between managerial slack and audit fees, particularly in the presence of Big 8 auditors. Overall, our results suggest that high-quality external auditors play an important corporate governance role by serving as both bonding and controlling mechanisms to mitigate managerial exploitation of firm resources. Data Availability: Data are publicly available from sources identified in the article.