How Does U.S. Multinational Firms’ Foreign Corruption Risk Affect Auditor Behavior?

• In Event: Archival Studies of Auditor Behavior

Abstract

This study examines how U.S. multinational firms’ foreign corruption risk affects audit behavior. Auditors are required by the Foreign Corrupt Practices Act of 1977, Auditing Standard 2405 and other security laws to assess the risk and probability that a public firm’s management bribes a foreign government official. If the auditors follow such rules, we would observe a positive association between foreign corruption risk and audit effort. However, on the other hand, prior literature suggests that a firm may gain significant economic benefits through foreign bribery. Such economic benefits (e.g., permits to open new stores) reduces an auditor’s perceived business risk of the firm, leading to audit risk and audit effort. Therefore, the effect of foreign corruption risk on auditor behavior is an empirical research question. Using a sample of U.S. multinational firms from 2000 to 2014, we find that foreign corruption risk is negatively associated with audit fees and the probability of receiving a going concern opinion. Also, higher foreign corruption risk is associated with lower bankruptcy risk. Further, the negative effects of foreign corruption risk on audit fees and going concern opinions are more pronounced for firms with stronger political connections and those with weaker governance. Overall, auditors do not seem to respond to foreign corruption risk as required by the FCPA. Our findings have significant implications for the PCAOB, which is currently considering whether there is a need to provide better guidance to auditors regarding their responsibilities with respect to clients’ possible illegal acts.

Authors

• Yangyang Fan, Hong Kong Polytechnic University

• Mark Ma, American University

• Jeffrey Pittman, Memorial University of Newfoundland