Outsourced External Audit Work and Audit Quality

Abstract

We examine whether audit quality is reduced when part of the audit is conducted by auditors other than the audit firm signing the audit report (“other” or “participating” auditors) which typically occurs in a multinational group audit. Prior literature suggests group audits could face difficulties in coordinating work across multiple countries and legal jurisdictions. PCAOB concerns over audit quality when participating auditors are involved led to a requirement that audit firms disclose their use of participating auditors on Form AP. Consistent with concerns of the PCAOB, we find audit quality is lower when participating auditors are involved in the engagement compared to those without participating auditors. In analyses on a sample limited to engagements with participating auditors, we find having more than one participating auditor leads to lower audit quality relative to having only one participating auditor. We find no evidence to suggest that the percentage of the audit conducted by participating auditors influences audit quality. Other than the legal origin of the participating auditor, we find no evidence to suggest participating auditor characteristics (i.e. affiliated with the lead Big 4 auditor; not registered with the PCAOB; inexperienced with SEC clients of their own; or domiciled in a country that does not allow PCAOB inspections) influence audit quality. Lastly, we find higher audit fees for engagements that use more than one participating auditor, suggesting group audits entail a higher risk premium and increased costs to coordination.

Keywords: PCAOB; other auditors; participating auditors; audit quality; abnormal accruals; Form AP; AuditorSearch; outsourced audit work