US-listed Foreign Companies’ Choice of a US-based vs. Home Country-based Big N Principal Auditor and the Effect on Audit Fees and Earnings Quality

We examine why US-listed foreign companies choose to have a US-based (rather than home country-based) Big N firm as their principal auditor for SEC reporting purposes and the effects of that choice for audit fees and earnings quality. We find that the likelihood of the Big N principal auditor being US-based is decreasing in client size and the level of investor protection in the home country, and increasing in the proportion of income earned outside the home country. We also find compelling evidence that US-based Big N auditors are associated with higher quality earnings (albeit for a higher fee), despite two factors – the greater distance between the US-based (vis-à-vis home country-based) Big N auditor and the client, and the likelihood that much of the audit work is done outside the US – which potentially could lower the earnings quality of the US-listed foreign client when the Big N principal auditor is US-based. Overall, our study suggests that the higher fees associated with a US-based Big N principal auditor is not just price protection; rather, US-based Big N principal auditors are also improving the financial reporting environment by reporting higher quality audited earnings for their US-listed foreign clients