Cross-Country Evidence on the Importance of Big Four Auditors to Equity Pricing: The Mediating Role of Legal Institutions

Abstract:     
We report large sample evidence on the importance of auditor choice to the ex ante cost of capital for public firms from 37 countries. In regressions that control for country, industry, and year fixed effects as well as other firm-level determinants, we find that corporate equity financing worldwide is cheaper when Big Four auditors monitor the financial reporting process, although this relation is weaker outside the U.S. where the implicit insurance coverage that auditors afford investors is much lower. Economically, our coefficient estimates translate into U.S. and non-U.S public firms’ cost of equity capital falling 49 and 20 basis points, respectively, in the presence of a Big Four auditor. We also generally provide empirical support for the predictions that the equity pricing role of Big Four auditors is stronger in countries with better institutions governing investor protection and disclosure standards. Collectively, our research implies that rather than governments having to resort to imposing the extreme auditor litigation exposure that prevails in the U.S., moderately protecting investors’ interests with these institutions is sufficient for them to benefit from differential audit quality.

Number of Pages in PDF File: 51

Keywords: Audit Quality, Corporate Governance, Cost of Equity

JEL Classification: G34, G32

working papers series