Involvement of Component Auditors in Multinational Group Audits: Determinants, Audit Quality, and Audit Fees

• Published date: 01 September 2022
• Author: ELIZABETH CARSON,ROGER SIMNETT,ULRIKE THÜRHEIMER,ANN VANSTRAELEN
• Date: 01 September 2022
• DOI: http://doi.org/10.1111/1475-679X.12418

DOI: 10.1111/1475-679X.12418

Journal of Accounting Research

Vol. 60 No. 4 September 2022

Printed in U.S.A.

Involvement of Component

Auditors in Multinational Group

Audits: Determinants, Audit

Quality, and Audit Fees

ELIZABETH CARSON,∗ROGER SIMNETT,†

ULRIKE THÜRHEIMER,∗AND ANN VANSTRAELEN‡

Received 1 May 2017; accepted 25 April 2021

ABSTRACT

We study what determines the involvement of component auditors in multi-

national enterprise (MNE) group audits and the association with audit quality

∗UNSW Sydney; †Deakin University and UNSW Sydney; ‡Maastricht University and Univer-

sity of Antwerp

Accepted by Christian Leuz. The authors would like to acknowledge the contribution of

Greg Trompeterwho significantly contributed to the early development of this project and was

a co-author on early versions of the paper. Weappreciate the helpful comments of two anony-

mous reviewers. We thank Cecilia Chiu, Dale Fu, Hien Hoang, Lin Liao, Ashna Prasad, Yi Shi,

Yang Xu, and Yitang Yang for research assistance, and appreciate the comments of Ronen

Gal-Or,Karla Johnstone, Bill Kinney, Phil Lamoreaux, Clive Lennox, Sarah Stein, Per Christen

Tronnes, and Michael Willenborg. This paper has benefited from presentation at The Public

Company Accounting Oversight Board/Journal of Accounting Research Conference on Auditing

and Capital Markets, the European Accounting Association Annual Meeting, American

Accounting Association Annual Meeting, American Accounting Association Auditing Section

Mid-Year Meeting, and Accounting and Finance Association of Australia and New Zealand An-

nual Meeting as well as workshops at Boston College, Deakin University, Florida International

University, Maastricht University,Monash University, University of Central Florida, University

of Melbourne, University of Texas, University of Western Australia, UNSW Sydney and Vil-

lanova University. We acknowledge the financial support of the Australian Research Council

and UNSW Business School. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting- research/online-

supplements.

Email: a.vanstraelen@maastrichtuniversity.nl

1419

© 2021 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1420 e. carson, r. simnett, u. thürheimer, and a. vanstraelen

and audit fees. Using unique Australian disclosures of group audit fees paid to

the principal and component auditors, we first document that MNE complex-

ity, MNE internationalization, and auditor characteristics are associated with

component auditor involvement, and extent and type of component auditor

involvement. Next, we find that involvement of component auditors benefits

audit quality as long as the principal auditor conducts a substantial amount of

work. Once the involvement of component auditors exceeds a certain level,

audit quality decreases. We also document that audit fees are higher in the

presence of a component auditor and increase with the extent of involve-

ment, irrespective of component auditor type. Our results contribute to the

emerging literature on group audits and provide empirical evidence on reg-

ulatory concerns about group audit quality.

JEL codes: G18, L84, M40, M41, M42

Keywords: group audit; component auditor; multinational audit; audit

quality; audit fees

1. Introduction

The quality of multinational enterprise (MNE) group audits has become

a key concern for standard-setters and regulators (International Auditing

and Assurance Standards Board (IAASB) [2015a, b, 2019], Public Com-

pany Accounting Oversight Board (PCAOB) [2016, 2017], International

Forum of Independent Audit Regulators (IFIAR) [2018]).1This concern

stems, in part, from audit inspections by regulators that have identified

numerous examples of poor coordination and oversight when component

auditors—and particularly foreign component auditors—are involved in an

MNE group audit (e.g., Doty [2011, 2017], IFIAR [2018]). Problems with

the quality of group audits have also been highlighted by major interna-

tional audit failures, including Parmalat, Royal Ahold, Satyam Corporation,

and, more recently, British Telecom.

To understand the reasons for these failures, research into MNE group

audits is required; until recently this has been limited, primarily due to

data constraints. Dee et al. [2015] is the first archival study documenting

negative market reactions and a decline in earnings response coefficients

(ERCs) for their small sample of U.S. companies whose principal auditor

disclosed for the first time substantial participation of other auditors in

PCAOB filings. From a survey of group audit leaders, Downey and Bedard

[2019] identify coordination and communication issues as key challenges

in global group audits. In a concurrent study, Burke et al. [2020] examine

1For example, James Doty, former chairman of the PCAOB, said in 2011 in relation to

multinational group audits: “Our inspectors often see more than the principal auditor—or

signing firm—does. In many cases principal auditors rely on high-level reports from subsidiary

auditors. They often don’t review the work papers of the other auditors. Our inspectors do.

And they often find problems in that work.” Internationally, IFIAR’s 2017 inspection findings

reveal frequent adverse findings for group audits at the engagement level (IFIAR [2018]).

component auditors in multinational group audits 1421

factors associated with component auditor use and audit outcomes in the

U.S. setting, where the PCAOB has recently mandated disclosure about the

identity and extent of work of audit firms other than that of the principal

auditor involved in audits of U.S.-listed companies.

Our study uses large-scale longitudinal data to investigate what deter-

mines involvement and extent of involvement of component auditors and

any association with audit quality and fees in Australian MNE group au-

dits. Our study is distinct from the research done by Burke et al. [2020]

and contributes to the literature in several ways. First, the international

auditing standard that applies in our setting requires the principal audi-

tor to take full responsibility for the work performed by component audi-

tors; in the United States, by contrast, responsibility can be divided between

principal and component auditors.2Second, using longstanding Australian

disclosures of group audit fees in the notes to the financial statements,

we identify the extent of principal and component auditor involvement

(including whether a component auditor is a member of the same audit

firm network as the principal auditor or is unaffiliated with the principal

auditor) in MNE group audits over a multi-year period.3The longstand-

ing disclosure of group audit fees paid to the principal and the two types

of component auditors in Australia allows us to analyze questions that can-

not be answered in the U.S. setting, where audit hours are disclosed only

since 2017. Audit fees are a different and more comprehensive measure

than audit hours as they capture audit hours, hourly rates, as well as a

potential risk premium. Further, Australian audit fee disclosures do not

dictate a minimum threshold for the identification of fees paid to compo-

nent auditors, allowing all such instances to be identified, whereas in the

United States, only significant work conducted by component auditors is

disclosed on Form AP (submitted to the PCAOB and available on its Web

site).4Third, we observe more variation in the type of component auditors

2The division of responsibility for U.S. multinational group audits is not uncommon. For

example, Mao et al. [2020] report that almost 30% of U.S. group audits refer to other auditors

and decline responsibility for the work undertaken by other auditors. Their results suggest that

lead auditors who accept responsibility for work done by other auditors charge higher audit

fees but that these audits are not of higher quality, and in some cases are of lower quality.

3We refer to component auditors who are members of the same international audit firm

network as the principal auditor as network component auditors. Although the two firms in

the network are legally independent, they share at least the same international brand name,

and typically the same global audit methodology, contractual commitments between network

firms, and have profit-sharing arrangements in place (Carson [2009]). Component auditors

who are not members of the same audit firm network as the principal auditor are referred to

as unaffiliated component auditors.

4PCAOB Rule 3211 on Form AP (Auditor reporting of certain audit participants), effective

for audit reports issued on or after June 30, 2017. Form AP requires identification of com-

ponent auditors conducting significant (i.e., at least 5%) audit work, and the number and

aggregate percentage of other accounting firms that individually represent less than 5% of

total audit hours.