Government Quality, the Adoption of IFRS and Auditor Choice: A Cross Country Analysis

Abstract

We examine the association between country-level government quality and firms’ choice of external auditors. We use a firm’s choice of a Big 4 auditor as a proxy for the demand for high-quality financial reporting. Using a cross-sectional sample of 142,193 firm-year observations from 46 countries over 1998-2007, we show that government quality of a country has a significant positive effect on the likelihood of choosing Big 4 auditors by firms in that country. We also show that firms in countries with strong governments that have adopted the IFRS are more likely to choose Big 4 than non-Big 4 auditors. To our knowledge, this is the first study of its kind to provide direct evidence on the role of government quality in firms’ choice of external auditors. The results provide insights for policy makers on the importance of government quality toward improving financial reporting quality in a country.