Foreign Operations’ Effect on the Audit Quality Of US Multinational Corporations: Evidence from PCAOB International Inspections
Yuyuan Chang, Yangyang Fan, and Duanping Hong
Coles Working Paper Series, SPRING20-03, March 2020
Overview The audit of a multinational corporation (MNC) is an international group audit where a domestic principal auditor audits the MNC’s domestic operations and coordinates the work of foreign participating auditors that audit the MNC’s foreign subsidiaries. The variable quality of the participating auditors’ work can affect the overall quality of the MNC’s audited financial statements (i.e., audit quality). This study examines how US MNCs’ audit quality is affected by their operations in foreign countries that prohibit the Public Company Accounting Oversight Board (PCAOB) from inspecting their local auditors. We measure audit quality by (1) whether the MNC subsequently restates its financial statements, an indicator of lower audit quality, and (2) how strongly the stock market reacts to the MNC's announcement of audited earnings. We find that (1) MNCs with a relatively greater presence in no-inspection countries are more likely to issue restatements, and (2) their investors have smaller stock-price reactions to earnings. Overall, our results suggest that the more operations an MNC conducts in countries without PCAOB inspections, the poorer its quality of audited financial statements.
32 | Working Papers
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