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  • Jennifer M Mueller-Phillips
    U.S.-Listed Foreign Companies' Choice of a U.S.-Based...
    research summary posted September 21, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 15.0 International Matters in Auditing Section Research Summaries Space public
    Title:
    U.S.-Listed Foreign Companies' Choice of a U.S.-Based versus Home Country-Based Big N Principal Auditor and the Effect on Audit Fees and Earnings Quality.
    Practical Implications:

    This study offers insights into the value of a U.S.-based Big N audit in a U.S.-crosslisting context and suggests that the higher fees associated with a U.S.-based (vis-a` -vis home country-based) Big N principal auditor are not just price protection; i.e., U.S.-based Big N principal auditors are not simply shifting the expected cost of the additional litigation exposure to the foreign client. Rather, they are also improving the financial reporting environment by providing the U.S.-listed foreign client higher-quality audited earnings. U.S.-listed foreign companies and U.S. investors may be interested in the finding that U.S.-based (relative to home country-based) Big N principal auditors are associated with higher fees as well as higher earnings quality for these companies.

    Citation:

    Asthana, S. C., K. K. Raman, and H. Xu. 2015. U.S.-Listed Foreign Companies' Choice of a U.S.-Based versus Home Country-Based Big N Principal Auditor and the Effect on Audit Fees and Earnings Quality. Accounting Horizons 29 (3): 631-666.

    Keywords:
    audit fees, Big N auditor, outsourcing, PCAOB, quality of audited earnings, U.S.-listed foreign
    Purpose of the Study:

    In this paper, the authors examine why U.S.-listed foreign companies choose to have a U.S.-based (rather than home country-based) Big N firm as their principal auditor for SEC reporting purposes. They also investigate whether the choice of a U.S.-based Big N principal auditor impacts audit pricing and the quality of audited earnings for these U.S.-listed foreign companies. In effect, the authors examine whether these foreign companies can provide additional assurance (i.e., assurance over and above that provided by the U.S.-listing decision itself) by utilizing a U.S.-based rather than home country-based Big N principal auditor for SEC reporting purposes.

    Audit markets are country specific due to country-level regulation and licensing of auditors, as well as restrictions on the cross-border flow of labor. Further, to comply with country-specific regulations, which mandate that audit firms be controlled and owned by locally licensed professionals, the Big N are structured as an international network of independent national member partnerships. In other words, for a U.S.-listed foreign client employing a home country-based Big N auditor for SEC reporting purposes, the U.S.-based Big N firm (i.e., the U.S. affiliate) is essentially protected from the failures of the home country-based Big N firm (i.e., the home country affiliate).

    Design/Method/ Approach:

    The authors follow the sample selection procedure in Srinivasan et al. (2015). They use Audit Analytics, Compustat and CRSP to gather data for the period 20002012. This procedure leaves the authors with a sample of 5,164 client year observations for 628 unique clients from 49 countries.

    Findings:
    • The findings suggest that client size, the proportion of income earned abroad, and investor protection in the home country are all associated with the likelihood of selecting a U.S.-based (versus home country-based) Big N auditor.
    • Results suggest U.S.-based (relative to home country-based) Big N auditors charge higher audit fees for U.S.-listed foreign clients.
    • The results suggest that the higher fees reflect additional assurance in that U.S.-based (vis-a` -vis home country-based) Big N principal auditors are associated with higher earnings qualityas measured by lower income-increasing discretionary accruals, a reduced likelihood of reporting a small profit, or a small increase in earnings, as well as more timely loss reportingfor their U.S.-listed foreign clients.
    • U.S.-listed foreign clients’ reported earnings have greater explanatory power for stock returns when they are audited by a U.S.- based (versus home country-based) Big N principal auditor. 
    • The overall findings to suggest that for U.S.-listed foreign companies the quality of audited earnings is higher when the Big N principal auditor is U.S.-based rather than home country-based.
    Category:
    Client Acceptance and Continuance, International Matters
    Sub-category:
    Audit Fee Decisions