How Audit Quality Influences Investment Efficiency: The Roles of Information Asymmetry and Behavioral Biases

Abstract

High-quality auditing and financial reporting are anticipated to mitigate information asymmetry and agency conflicts, which in turn enhances investment efficiency. Existing research provides limited insight into how distorted audit signals arising from the perceived and implicit audit gap interact with behavioral biases to shape capital allocation. This study addresses that gap by analyzing how managerial discretion increased information asymmetry and inflated perceptions of audit quality. Distorted audit signals led to overconfidence and herding, which sustained overvaluation and contributed to capital misallocation, reduced investment efficiency and diminished market trust. The findings indicate that these behavioral biases amplified mispricing by weakening independent judgement and reinforcing consensus optimism. Understanding these psychological dynamics offers a more complete view of audit-related market risks.