Foreign Ownership and the Auditor's Opinion: An Analysis in Private Subsidiaries

Abstract

In a large sample of private Spanish subsidiaries, we observe a significantly greater incidence of modified audit reports in foreign than in local group subsidiaries. Results are consistent with foreign group subsidiaries having lower incentives to avoid receiving modified audit opinions (MAOs) because of their lower dependence on external financing. Additionally, our tests reveal that, of the two types of MAOs that are potentially avoidable, only opacity related MAOs are significantly more frequent in foreign than in local group subsidiaries. Curiously, despite that the literature documents a higher incidence of earnings management in foreign-owned private subsidiaries, the evidence of higher frequency of GAAP violation related MAOs in foreign group subsidiaries is weak. Our findings indicate that foreign shareholders do not improve financial reporting quality in the private setting, but are associated with more opaque companies where the auditors are prevented from doing their work. Additionally, results suggest that the cost-benefit relation of avoiding MAOs hinges on the underlying reason for modification.

Keywords: audit opinion, financial reporting quality, foreign ownership, private companies, subsidiaries

JEL Classification: F23, M41, M48