Do Operations in Corrupt Foreign Countries Affect Auditor Behavior?

57 Pages Posted: 2 Mar 2020

See all articles by Yangyang Fan

Yangyang Fan

Hong Kong Polytechnic University - School of Accounting and Finance

Mark (Shuai) Ma

University of Pittsburgh - Accounting Group

Jeffrey Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Yuping Zhao

University of Houston

Date Written: January 30, 2020

Abstract

Auditors are required by the Foreign Corrupt Practices Act and other rules to evaluate the probability that a firm’s management bribes foreign government officials. If the auditors comply with these rules by assessing higher audit risk for firms with operations in corrupt foreign countries, we would expect to observe a positive association between operations in corrupt foreign countries and auditor effort evident in higher audit fees. However, in the other direction, a firm may generate considerable economic benefits by committing foreign bribery. Such economic benefits reduce an auditor’s perceived business risk of the firm, potentially leading to lower audit fees. In analyzing a sample of U.S. multinational firms, we document that having operations in more corrupt foreign countries is negatively associated with audit fees. In cross-sectional evidence consistent with expectations, we find that the negative link between operations in corrupt countries and audit pricing is concentrated in firms with strong political connections known to lighten enforcement, poor internal controls conducive to hiding foreign bribery, and subsidiaries in host countries that refrain from joining a major international anti-corruption cooperation agreement. Our research has implications for the PCAOB which is considering issuing additional guidance concerning auditors’ responsibilities surrounding clients’ possible illegal acts.

Keywords: Audit Fees; Foreign Corruption; Foreign Corrupt Practices Act

Suggested Citation

Fan, Yangyang and Ma, Mark (Shuai) and Pittman, Jeffrey A. and Zhao, Yuping, Do Operations in Corrupt Foreign Countries Affect Auditor Behavior? (January 30, 2020). Available at SSRN: https://ssrn.com/abstract=3528745 or http://dx.doi.org/10.2139/ssrn.3528745

Yangyang Fan

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Mark (Shuai) Ma

University of Pittsburgh - Accounting Group ( email )

United States

Jeffrey A. Pittman

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

Yuping Zhao (Contact Author)

University of Houston ( email )

334 Melcher Hall
Houston, TX 77204
United States
713-743-2166 (Phone)
713-743-4828 (Fax)

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