We found that fund managers are more likely to obtain more support from analysts with whom they have guanxi ties, more likely to hold stocks covered by those analysts, and make higher abnormal returns from the connected holdings. To reciprocate the benefits received from their connected analysts, fund managers are more likely to vote in favour of the analysts in star analyst elections.
Does Guanxi Affect the IPO Process?
We then ask whether guanxi connections between investment bankers and auditors affect the IPO process and firms' post-IPO performance. When firms conduct IPOs, they appoint investment banks and audit firms to certify information disclosed to investors. During the process, bankers and auditors interact with each other. The need for close collaboration between the two could provide a fertile ground for social ties to deepen.
Our study found that guanxi connections increase the likelihood that bankers and auditors participate in the same IPO deals.
In 2004, China started to require IPO firms to hire investment banks as sponsors to assist with their IPO applications. We found that guanxi connections increase the likelihood that bankers and auditors participate in the same IPO deals. Such engagement can undermine IPO-audit quality and the interest of IPO investors. Nevertheless, guanxi ties work in the favour of auditors. Our study shows that through their social ties with bankers, auditors can command higher fee premiums and may later land more IPO-audit businesses from connected investment banks.
The Impact on Audit and Bad News Dissemination
The third type of guanxi ties we discuss are those between auditors and audit committees. Auditors play an important role as gatekeepers who ensure the quality of financial reports, which represent a key information source on which many economic decisions are based.
Overall, our studies show that the negative implications of guanxi between auditors and executives or audit committee members outweigh their benefits. Specifically, auditors' social ties with the client management or audit committee significantly reduce the likelihood that the auditors issue modified audit opinions (MAOs), a practice that implies an auditor is able to discover and report accounting irregularities. Even if connected auditors do issue MAOs, the modifications tend to be less severe.