U.S.-Listed Foreign Companies' Choice of a U.S.-Based versus Home Country-Based Big N Principal Auditor and the Effect on Audit Fees and Earnings Quality

Abstract

SYNOPSIS We examine why U.S.-listed foreign companies choose to have a U.S.-based (rather than home country-based) Big N firm as their principal auditor for SEC reporting purposes and the effects of that choice for audit fees and earnings quality. We find that the likelihood of the Big N principal auditor being U.S.-based is decreasing in client size and the level of investor protection in the home country, and increasing in the proportion of income earned outside the home country. We also find compelling evidence that U.S.-based Big N auditors are associated with higher-quality earnings (albeit for a higher fee), despite two factors—the greater distance between the U.S.-based (vis-à-vis home country-based) Big N auditor and the client, and the likelihood that much of the audit work is done outside the U.S.—which potentially could lower the earnings quality of the U.S.-listed foreign client when the Big N principal auditor is U.S.-based. Overall, our study suggests that the higher fees associated with a U.S.-based Big N principal auditor is not just price protection; rather, U.S.-based Big N principal auditors are also improving the financial reporting environment by reporting higher-quality audited earnings for their U.S.-listed foreign clients. JEL Classifications: L11; L15; M42.

Determinants of auditor choice: Review of the empirical literature

“…Hope et al () found that this negative association is also mitigated by the firms' international operations. This is consistent with the argument that (1) secrecy is related negatively to firm‐level disclosures (Gray & Vint, ) and (2) the level of internationalization increases the likelihood of hiring high‐quality auditors (Asthana et al, ; Tsao et al, ). Although the documented negative association supports a demand‐side view, it is not clear how the “supply of audit services” will be affected by the cultural value of secrecy.…”

“…The different legal environments related to investor protection could determine the governance functions of auditors. Asthana et al () found that cross‐listed firms, with smaller size and more international incomes, are more inclined to choose US‐based Big N auditors rather than Big N auditors based on their home countries. Moreover, the propensity for choosing US‐based Big N auditors decreases with an increase in the investor protection environment of the home country of cross‐listed firms.…”

“…On the other hand, a new stream of research studies has started to compare the various countries' legal environments and their implications for auditor choice (Asthana, Raman, & Xu, 2015;Broye & Weill, 2008;Choi & Wong, 2007; Ettredge, Kwon, & Lim, 2009;Francis, Khurana, & Pereira, 2003;Hossain, Lim, & Tan, 2010;Piot, 2005).…”

“…The different legal environments related to investor protection could determine the governance functions of auditors. Asthana et al (2015) found that cross-listed firms, with smaller size and more international incomes, are more inclined to choose US-based Big N auditors rather than Big N auditors based on their home countries.…”

“…Legal protection as an influential factor in auditor choice has become a growing area for research. Foreign firms from countries with weak legal protection aiming to raise funds in the US capital market tend to appoint US-based Big N auditors to demonstrate their commitment to audit quality (Asthana et al, 2015).…”