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We develop a theoretical framework to investigate (1) both the determinants and the consequences of auditor conservatism in a capital market setting and (2) the implications of Section 201 of the Sarbanes-Oxley Act for auditor conservatism and investment efficiency. We derive three primary results. First, by adjusting the mix of audit and nonaudit fees, companies with high business risk induce auditor conservatism, while companies with low business risk induce auditor aggressiveness. Second, if auditor conservatism is in force, a greater client pressure on auditors improves audit quality; but if auditor aggressiveness is in force, a greater client pressure on auditors impairs audit quality. Third, the nature of a firm's investment inefficiency (overinvestment or underinvestment) depends on its auditor's attestation (conservative or aggressive). Our analysis also implies that a mandatory restriction of nonaudit services imposed by Section 201 may decrease audit quality and damage investment efficiency.

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Recently, the presumed benefits of corporate governance have become one of the most contentious issues especially for emerging markets in Asia where institutional settings are quite different from other parts of the world. Using an internationally accepted benchmark (OECD's Principles of Corporate Governance, OECD, 2004), this study evaluates the progress of corporate governance practice of Chinese listed companies. A corporate governance index (CGI) is constructed to measure the quality of corporate governance practices of the 100 largest listed firms in China during 2004China during -2006. The results show that Chinese companies have been making progress in the corporate governance reform. The findings also show a positive relation between market valuation and overall corporate governance practices, as measured by the CGI, among these Chinese listed companies. Additional investigation reveals that the rights of shareholders are the main driver in the relationship.

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