The Use and Characteristics of Component Auditors: Implications for U.S. Audits

Abstract

This paper investigates the common, yet previously opaque, practice of using foreign audit firms (component auditors) to conduct portions of audit work for U.S. public companies. U.S. regulators have expressed concern for the transparency and quality of audits using component auditors. Employing data disclosed in the newly-mandated PCAOB Form AP, we find that component auditor use is largely structural, determined by the size and complexity of clients’ multinational operations. We do not find the mere use of component auditors is detrimental to audit outcomes, rather, the amount of work conducted by component auditors is associated with lower audit quality (i.e., higher likelihood of misstatement), higher likelihood of non-timely reporting, and higher audit fees, which collectively suggest that component auditor engagements are associated with adverse outcomes. Further, we find that only work performed by less competent component auditors and those facing geographic and cultural/language barriers, including significant geographic and cultural distance, weak rule of law, and low English language proficiency, are associated with adverse audit outcomes. Overall, these findings provide initial archival evidence that the use of certain component auditors on U.S. multinational audits is associated with audit coordination issues, which suggests that PCAOB Form AP disclosures provide relevant information.