Auditor Choice in Politically Connected Firms

Abstract:     
Firms with political connections represent a relatively high share of the world’s stock market capitalization. For a large sample of firms from 28 countries, we extend recent research on the links between political connections and financial reporting by examining the role of auditor choice. Our strong, robust evidence that public firms with political connections are more likely to appoint a Big Four auditor supports the intuition that insiders in these firms are eager to improve accounting transparency to convince outside investors that they refrain from exploiting their connections to divert corporate resources. In evidence consistent with another prediction, we find that this link is stronger for connected firms with ownership structures conducive to insiders seizing private benefits at the expense of minority investors. We also find that the relation between political connections and auditor choice is stronger for firms operating in countries with relatively poor institutional infrastructure, implying that tough external monitoring by Big Four auditors becomes more valuable for preventing diversion in these situations. Finally, we report that connected firms with Big Four auditors exhibit less earnings management and enjoy greater transparency, higher valuations, and cheaper equity financing.

Number of Pages in PDF File: 64

Keywords: Auditor Choice, Political Connection, Corporate Governance

JEL Classification: G32, G34, M41, M42

working papers series