With the global expansion of business operations, many U.S. corporations now operate internationally. While these multinational corporations (MNCs) rely on information about their operations to allocate resources, this information is likely dispersed within the firm, leading to internal information asymmetry between top executives and divisional managers. Meanwhile, audits of these geographically dispersed MNCs are challenging, and parts of these audits are sometimes outsourced to local foreign auditors who have no experience serving as opinion-issuing auditors for U.S. issuers (“inexperienced component auditors”). In this article, we examine whether involving such inexperienced component auditors is associated with MNCs’ internal information environment. We find that, relative to a matched control sample, Securities and Exchange Commission (SEC) issuers with the participation of inexperienced component auditors have higher internal information asymmetry and lower internal capital allocation efficiency. Our results suggest that audit quality matters not only to a firm’s external financial statement users but also to its internal users.
BaeG. S.DhaliwalD. S.LamoreauxP. T. (2017). Auditors and client investment efficiency. The Accounting Review, 92(2), 19–40.
3.
BensD.MonahanS. (2004). Disclosure quality and the excess value of diversification. Journal of Accounting Research, 42(4), 691–730.
4.
BergerP.OfekE. (1995). Diversification’s effect on firm value. Journal of Financial Economics, 37(1), 39–65.
5.
BernardoA. E.CaiH.LuoJ. (2004). Capital budgeting in multidivision firms: Information, agency, and incentives. The Review of Financial Studies, 17(3), 739–767.
6.
BiddleG.HilaryG. (2006). Accounting quality and firm-level capital investment. The Accounting Review, 81(5), 963–982.
7.
BiddleG.HilaryG.VerdiR. S. (2009). How does financial reporting quality relate to investment efficiency?Journal of Accounting and Economics, 48(2–3), 112–131.
8.
BillettM.MauerD. (2003). Cross-subsidies, external financing constraints, and the contribution of the internal capital market to firm value. The Review of Financial Studies, 16(4), 1167–1201.
9.
BlayA. D.GeigerM. A.NorthD. S. (2011). The auditor’s going-concern opinion as a communication of risk. Auditing: A Journal of Practice & Theory, 30(2), 77–102.
10.
BurkeJ.HoitashR.HoitashU. (2020). The use and characteristics of foreign component auditors in U.S. multinational audits: Insights from Form AP disclosures. Contemporary Accounting Research, 37(4), 2398–2437.
11.
CarsonE.SimnettR.VanstraelenA.TrompeterG. (2016). Assessing initiatives to improve the quality of group audits involving other auditors [Working paper]. University of New South Wales Australia, Maastricht University, University of Central Florida.
12.
Center for Audit Quality. (2017). Form AP auditor reporting of certain participants: A tool for audit committees. https://www.thecaq.org
ChenC.MartinX.RoychowdhuryS.WangX.BilletM. T. (2017). Clarity begins at home: Internal information asymmetry and external communication quality. The Accounting Review, 93(1), 71–101.
15.
ChengM.DhaliwalD. S.ZhangY. (2013). Does investment efficiency improve after the disclosure of material weakness in internal control over financial reporting?Journal of Accounting and Economics, 56(1), 1–18.
16.
ChoY. J. (2015). Segment disclosure transparency and internal capital market efficiency: Evidence from SFAS No. 131. Journal of Accounting Research, 53(4), 669–723.
17.
CohenL.MalloyC.PomorskiL. (2012). Decoding inside information. Journal of Finance, 67(3), 1009–1043.
18.
CommentR.JarrellG. (1995). Corporate focus and stock returns. Journal of Financial Economics, 37, 67–87.
19.
DeeC. C.LulsegedA.ZhangT. (2015). Who did the audit? Audit quality and disclosures of other audit participants in PCAOB filings. The Accounting Review, 90(5), 1939–1967.
20.
DhaliwalD. S.HoganC.TrezevantR.WilkinsM. (2011). Internal control disclosures, monitoring, and the cost of debt. The Accounting Review, 86(4), 1131–1156.
21.
DhaliwalD. S.LamoreauxP. T.LitovL.NeylandJ. (2016). Shared auditors in mergers and acquisitions. Journal of Accounting and Economics, 61(1), 49–76.
22.
D’MelloR.GaoX.JiaY. (2017). Internal control and internal capital allocation: Evidence from internal capital markets and multi-segment firms. Review of Accounting Studies, 22(1), 251–287.
23.
DocimoW.GunnJ.LiC.MichasP. (2021). Do foreign component auditors harm financial reporting quality? A subsidiary-level analysis of foreign component auditor use. Contemporary Accounting Research, 38(4), 3113–3145.
24.
DowneyD.BedardJ. (2019). Coordination and communication challenges in global group audits. Auditing: A Journal of Practice & Theory, 38(1), 123–147.
25.
DowneyD.WestermannK. (2021). Challenging global group audits: The perspective of US group audit leads. Contemporary Accounting Research, 38(2), 1395–1433.
26.
DuchinR.SosyuraD. (2013). Divisional managers and internal capital markets. The Journal of Finance, 68(2), 387–429.
EgeM.KimY.WangD. (2020). Do global audit firm networks apply consistent audit methodologies across jurisdictions? Evidence from financial reporting comparability. The Accounting Review, 95(6), 151–179.
29.
GallemoreJ.LabroE. (2015). The importance of the internal information environment for tax avoidance. Journal of Accounting and Economics, 60(1), 149–167.
30.
GertnerR. H.ScharfsteinD. S.SteinJ. C. (1994). Internal versus external capital markets. The Quarterly Journal of Economics, 109(4), 1211–1230.
31.
GloverS. M.WoodD. A. (2014). The effects of group audit oversight on subsidiary entity audits and reporting [Working paper]. Brigham Young University.
32.
International Auditing and Assurance Standards Board. (2015). Staff audit practice alert: Responsibilities of the engagement partner in circumstances when the engagement partner is not located where the majority of the audit work is performed. http://archive.is/JTROB
33.
JensenM. C.MecklingW. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360.
34.
JiaN.LiD. (2016). An analysis of US accounting firms’ cross-country audit quality of China concepts stocks. China Journal of Accounting Studies, 4(2), 183–204.
35.
KausarA.ShroffN.WhiteH. (2016). Real effects of the audit choice. Journal of Accounting and Economics, 62(1), 157–181.
36.
KrishnanG.MaoJ.ZhangJ. (2020). Component auditors and lenders’ perception of audit quality [Working paper]. Bentley University, University of Texas at San Antonio, University of Colorado Denver.
37.
LangL.StulzR. (1994). Tobin’s Q, corporate diversification, and firm performance. Journal of Political Economy, 102(6), 1248–1280.
38.
LennoxC. S.PittmanJ. A. (2011). Voluntary audits versus mandatory audits. The Accounting Review, 86(5), 1655–1678.
LundholmR. J.RogoR.ZhangJ. L. (2014). Restoring the Tower of Babel: How foreign firms communicate with U.S. investors. The Accounting Review, 89(4), 1453–1485.
41.
MayerT.ZignagoS. (2011). Notes on CEPII’s distance measures: The GeoDist database [Working paper]. The French Centre for Research and Studies on the World Economy.
42.
McNicholsM. F.StubbenS. R. (2008). Does earnings management affect firms’ investment decisions?The Accounting Review, 83(6), 1571–1603.
43.
MinnisM. (2011). The value of financial statement verification in debt financing: Evidence from private U.S. firms. Journal of Accounting Research, 49(2), 457–506.
RajanR.ServaesH.ZingalesL. (2000). The cost of diversity: The diversification discount and inefficient investment. Journal of Finance, 55(1), 35–80.
48.
RavinaE.SapienzaP. (2010). What do independent directors know? Evidence from their trading. Review of Financial Studies, 23(3), 962–1003.
49.
ScharfsteinD. S.SteinJ. C. (2000). The dark side of internal capital markets: Divisional rent-seeking and inefficient investment. The Journal of Finance, 55(6), 2537–2564.
50.
ServaesH. (1996). The value of diversification during the conglomerate merger wave. Journal of Finance, 51(4), 1201–1225.
51.
ShroffN. (2016). Corporate investment and changes in GAAP. Review of Accounting Studies, 22(1), 1–63.
52.
ShroffN.VerdiR.YuG. (2014). Information environment and the investment decisions of multinational corporations. The Accounting Review, 89(2), 759–790.
53.
SunderlandD.TrompeterG. M. (2017). Multinational group audits: Problems faced in practice and opportunities for research. Auditing: A Journal of Practice & Theory, 36(3), 159–183.
54.
WeberD.ZhengK. (2017). Internal information quality and capital allocation within conglomerates [Working paper]. University of Connecticut.
Please find the following supplemental material available below.
For Open Access articles published under a Creative Commons License, all supplemental material carries the same license as the article it is associated with.
For non-Open Access articles published, all supplemental material carries a non-exclusive license, and permission requests for re-use of supplemental material or any part of supplemental material shall be sent directly to the copyright owner as specified in the copyright notice associated with the article.
