Do Foreign Component Auditors Harm Financial Reporting Quality? A Subsidiary-Level Analysis of Foreign Component Auditor Use

Posted: 28 May 2021

See all articles by William Docimo

William Docimo

University of Connecticut - Department of Accounting

Joshua L. Gunn

University of Pittsburgh - Katz Graduate School of Business

Chan Li

University of Kansas

Paul N. Michas

University of Arizona - Eller College of Management

Multiple version iconThere are 2 versions of this paper

Date Written: May 20, 2021

Abstract

We hypothesize and find that financial reporting quality at the foreign subsidiaries of US multinational corporations (MNCs) is higher when the MNC’s principal auditor engages a component auditor to audit the foreign subsidiary on its behalf. An important innovation of this study is that we focus on comparing financial reporting quality of equivalent subsidiaries with and without component auditor work. Our approach contrasts with extant studies that examine the consequences of variation in the total amount of component auditor work at the MNC level. Our results are important for two reasons. First, we provide an alternative view on the consequences of component auditor use compared to the emerging literature in this area, which typically finds a negative association between the extent of component auditor use and financial reporting quality at the MNC level. Thus, we show that a different research design, conducted at the level at which component auditors actually perform their work, yields different inferences. Second, we demonstrate that using component auditors on US MNC group audits is an avenue through which US auditing institutions can affect financial reporting quality in foreign locations. We also reconcile our subsidiary-level results to the MNC level by introducing a new MNC-level component auditor “coverage” variable. Overall, we highlight that the best way to audit a foreign subsidiary is likely to be with a component auditor in the local country, which informs the debate surrounding recently proposed PCAOB guidance.

Keywords: audit quality, component auditor, financial reporting quality, group audit, multinational corporation, Public Company Accounting Oversight Board

JEL Classification: M41, M42

Suggested Citation

Docimo, William and Gunn, Joshua L. and Li, Chan and Michas, Paul N., Do Foreign Component Auditors Harm Financial Reporting Quality? A Subsidiary-Level Analysis of Foreign Component Auditor Use (May 20, 2021). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3854429

William Docimo

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States

Joshua L. Gunn (Contact Author)

University of Pittsburgh - Katz Graduate School of Business ( email )

Pittsburgh, PA 15260
United States

Chan Li

University of Kansas ( email )

Capitol Federal Hall
Lawrence, KS 66045
United States
7857661277 (Phone)
66045 (Fax)

Paul N. Michas

University of Arizona - Eller College of Management ( email )

Tucson, AZ 85721
United States

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