Abstract: Based on historical research, the external audit function plays a critical role in corporate external governance. When the quality of external audit of an enterprise is improved, high-quality accounting information will be delivered to enterprises both internally and externally. Therefore, high-quality accounting information will alleviate internal agency problems of enterprises, reduce short-sighted behaviors of managers, and improve the attention of managers to innovation activities. Furthermore, such information will reduce the cost of investors obtaining enterprises′ information, provide more credible and accurate information regarding enterprise operations to parties that finance enterprises, and ease the financing constraints faced by enterprises, thereby enabling enterprises to have sufficient funds to support innovation activities. Therefore, we hypothesize that better-quality external audit potentially promotes innovation investment and the long-term stable growth of enterprise value.
Based on data of Chinese listed companies in 2007—2017, we construct an empirical analysis model to verify the aforementioned hypothesis. In our model, the dependent variable (enterprise innovation) is measured using the ratio of an enterprise′s research and development (R&D) investment to its total assets. Subsequently, the main explanatory variable (audit quality) is measured using audit fees. Simultaneously, we control for other variables, such as enterprise scale, asset liability ratio, net cash flow, asset return ratio, the proportion of major shareholders, whether the chairman and general manager are the same person, scale of enterprise plant asset, and listed period. The empirical results reveal that high-quality external audit can effectively promotes enterprise innovation activities, thus supporting the aforementioned hypothesis and verifying the effect of audit quality on enterprise innovation activities.
We seek to confirm that the effect of external audit quality on enterprise innovation occurs through two channels: the reduction of agency costs and the easing of financing constraints. We construct two intermediary variables—agency cost and financing constraints—to test the transmission mechanisms. We find that high-quality external audit has a significantly positive effect on enterprise innovation activities through the two intermediary variables of agency cost and financing constraints. Therefore, high-quality external audit can promote the innovation activities of enterprises by reducing agency costs and alleviating the financing constraints of enterprises.
Our research theoretically enriches our understanding of the mechanism through which external corporate governance influences enterprise innovation;it also prescribes practical measures such as the optimization of corporate governance and the financing environment, creating a general climate conducive to enterprise innovation, and improving the innovation ability of enterprises.

Key words: external audit quality, enterprise innovation, agency cost, financial constraint