The Effects of Group Audit Oversight on Subsidiary Entity Audits and Reporting

Abstract

International and U.S. accounting and auditing standard setters have focused considerable attention and rule making around group audits and in particular the reporting quality of subsidiary entities. We examine how membership in a consolidated group and the related group audit affects the quality of financial reporting of subsidiary entities. While regulators have expressed concern regarding the financial reporting quality of subsidiary entities based on inspection findings, we find that subsidiaries have, on average, higher financial reporting quality than non-consolidated entities. This effect is larger for subsidiaries with distinct management teams from the parent, lending support to the argument that higher auditor power increases financial reporting quality. Our results should inform standard setters, regulators, and practitioners as they consider how to improve the financial reporting and audit quality.

Keywords: Group Audits, Components, Subsidiary Entity Reporting Quality, Industry Specialization, Auditor Power

JEL Classification: M4, M41, E62, E60, G28, G30