The Impact of Group Audit Arrangements on Audit Pricing and Audit Quality

Elizabeth Carson

University of New South Wales

Roger Simnett

University of New South Wales

Greg Trompeter

University of Central Florida

Ann Vanstraelen

Maastricht University

Please do not quote without permission of the authors.

We thank Ashna Prasad, Dale Fu and Lin Liao for research assistance, and appreciate the comments of Ronen Gal-Or, Karla Johnstone, Bill Kinney and Per Christen Tronnes as well as participants at workshops at Boston College, Maastricht University, the University of Melbourne, the University of New South Wales, University of Texas, University of Western Australia and the European Accounting Association Annual Meeting and American Accounting Association Annual Meeting. We also acknowledge the financial support of the Australian Research Council.

The Impact of Group Audit Arrangements on Audit Pricing and Audit Quality

Abstract

Regulators have raised concerns about audits of financial statements of groups. Of particular

concern are engagements in which parts of the audit are not undertaken by the principal auditor

but involve the use of other component auditors. These component auditors may be either

affiliated or unaffiliated with the principal audit firm signing the audit report. Using unique disclosure requirements for Australian listed firms, we examine the incidence of such arrangements and their impact on audit fees and audit quality. We find that relative to group audits conducted solely by principal auditors, audit fees are higher when other auditors, either within or outside the network, are involved. Further we find that where other component auditors are engaged, audit fees are higher when the principal auditor’s network is involved relative to unaffiliated auditors. Using a range of proxies, we find some evidence of differences in audit quality related to group audit arrangements.

1. Introduction

Significant concerns have been raised by regulators about the quality of the auditing of corporate

groups (e.g., the Australian Securities and Investments Commission (ASIC), the United States

Public Company Accounting Oversight Board (PCAOB), the International Forum of

Independent Audit Regulators (IFIAR) and the European Commission (EC), all since 2010).

Such audits generally involve corporate structures comprised of multiple components (e.g.,

subsidiaries and joint ventures) facing complex accounting issues and which are often

geographically dispersed. Audits of such entities also commonly require the signing auditor to

coordinate other audit firms that are involved in providing audit evidence on individual

components of the consolidated entity (‘other component auditors’). This may involve

coordination and evaluation of the work of other member firms within the audit network1 (e.g.,

PwC Australia signs the audit report, whilst PwC USA conducts audit work on the US subsidiary) or the use of other audit firms that are not members of the signing auditor’s network

(e.g., PwC Australia signs the audit report, KPMG USA conducts audit work on the US subsidiary).

The difficulties in auditing such groups have been highlighted by major international audit failures, such as Parmalat in Italy, Royal Ahold in The Netherlands (Knapp and Knapp 2007), and Satyam Corporation in India (SEC 2011), each of which have been associated with poor quality work undertaken by component auditors as part of the group audit. Currently, the identity and extent of involvement of other component auditors is not identified in the standard audit

1 “Network” is defined and used in Section 290 of the IFAC Code of Ethics for Professional Accountants (revised July 2006) as “a larger structure: (a) That is aimed at co-operation, and (b) That is clearly aimed at profit or cost sharing or shares common ownership, control or management, common quality control policies and procedures, common business strategy, the use of a common brandname, or a significant part of professional resources”. More detailed guidance on networks is provided in Section 290, paragraphs 16 to 26.

report of the International Auditing and Assurance Standards Board (IAASB) but it has been proposed that this be rectified (IAASB 2012)2. Concerns have been raised by the PCAOB (2010,

2011) with respect to such audits where other component auditors have been strategically

selected for reason of low price.3

As well as addressing an issue which regulators have identified as being of great concern, this

paper contributes to a growing body of research studying factors associated with engagement- level audit quality. As explained by Francis (2011) there are multiple drivers of audit quality and research is required at all levels of analysis (i.e. audit inputs, audit process, accounting firms, audit industry, audit markets and institutions). We focus in this paper on a, to the best of our knowledge, unexplored engagement-specific factor, which is the group audit structure.

Specifically, we examine whether the way in which the audit of a group is structured (i.e. wholly audited by the principal auditor; partly audited within the network of the principal auditor; or parts of the group audited by unaffiliated auditors) affects the audit quality of the overall group audit. This paper also contributes to the extensive literature on audit fees (see Hay, Knechel and

Wong, 2006 for a review) by considering whether differences in group audit structure can explain differences in audit fees, which to our knowledge has not been previously addressed.

This paper further highlights that a maintained assumption in the auditing research literature, that the audit firm which signs the audit opinion on these group financial statements has conducted the audit of all the entities within the group, is not correct. This maintained assumption could

2 The proposed inclusion in the audit report in the IAASB Invitation to Comment on ISA 700 is “…At our request, other auditors performed procedures on the financial information of certain subsidiaries to obtain audit evidence in support of our audit opinion. The work of audit firms with which we are affiliated constituted approximately [percentage of audit measured by, for example, audit hours] of our audit and the work of other non-affiliated audit firms constituted approximately [percentage of audit measured by, for example, audit hours] of our audit…” 3 The PCAOB (2011) has proposed additional disclosures when auditing firms, other than the signing firm, are involved with an engagement. Specifically, the Board has proposed that such audits disclose the identity, location and extent of involvement (defined as percent of total audit hours) of all firms taking part in the audit engagement (potentially subject to a minimum threshold).

lead to potentially erroneous conclusions as the quality of the financial statements has been

assumed to be directly related to the identity of the firm signing the audit opinion.

We take advantage of a unique disclosure rule that requires Australian listed companies to

publicly disclose extensive audit fee information, including the audit fees paid to the principal

(signing) audit firm, the audit fees paid to other member firms within the signing firm’s network,

and any fees paid to ‘other’ auditors outside the network for audit work4. The incidence of group audits in Australia that are subject to ISA 600 is identified as high as the majority of companies listed on the Australian Stock Exchange in 2008-2011 were found to be groups with multiple subsidiaries. We find that the use of multiple audit firms in the audit of such corporate groups in

Australia is also a significant issue, evidenced by the fact that 30% of group audits are not conducted solely by the principal signing auditor, with at least part of each of these audits being conducted by unaffiliated audit firms or by members of the principal auditor’s network other than the principal auditor’s firm (or both). We find that group audits conducted wholly by the principal auditor are cheaper relative to audits undertaken within the audit firm network or when unaffiliated auditors are involved. Further, we find that audits undertaken using the auditor’s network are more expensive than those using unaffiliated auditors. In relation to audit quality, we find differences across our proxies for audit quality (discretionary accruals and going concern issuance) between types of group audit arrangements. Overall, given their high incidence and impact on audit fees and quality, our evidence is supportive of calls for greater disclosure of identity and responsibilities of other component auditors involved in group audits.

4 The Australian disclosure is much more comprehensive than that provided by SEC registrants which presently disclose two years of audit fee data in their DEF14a proxy statements, or Form 10-K filings, pursuant to SEC Release 33-8183 (January 28, 2003) with no categorisation by type of auditor.

The remainder of this paper is organized as follows. Section 2 provides the relevant background for this study. In Section 3, we develop our hypotheses. Section 4 describes the methodology and empirical models. In Section 5, we present the descriptive statistics and results of the main analyses, sensitivity analyses and robustness tests. Section 6 concludes and provides suggestions for future research.

2. Background Information

For a group audit, the principal auditor must determine the extent to which other component auditors should be involved in the engagement. This is considered as part of accepting a group audit engagement. Under International Standards on Auditing (ISA), in particular ISA 600, if part of the group audit work is undertaken by other component auditors (whether related to the principal auditor or not), the principal auditor remains ultimately responsible for the group audit opinion. Paragraph 11 of ISA 600 states that “the group engagement partner is responsible for the direction, supervision and performance of the group audit engagement in compliance with professional standards and applicable legal and regulatory requirements, and whether the auditor’s report that is issued is appropriate in the circumstances”. The group auditor therefore must be able to satisfy themselves that the use of other component auditors means that the level of audit quality is not compromised. There are a number of ways in which this quality can be reached, which involves relying on the work of other component auditors to varying degrees.

This can range from the group auditor putting themselves in a position, and undertaking sufficient quality checking, through supervision, direction and evaluation of quality control processes, to enable them to place reliance on the work of other component auditors through to not placing reliance on their work at all, and effectively undertaking the work themselves.

Therefore the decision to involve other component auditors involves an economic trade-off for the auditor. On the one hand, if the decision is made to rely on work conducted by other auditors as part of a group audit, arguably because it reduces costs, and the ability to assess the quality of service provided is limited, a principal-agent problem arises with potential information asymmetry between the principal and the agent. In this case, the principal runs the risk of low performance, low audit quality and thus risk of litigation. On the other hand, if the auditor decides not to rely on the work of other auditors, this may well result in a more costly and inefficient audit and the auditor runs the potential risk of client loss in the future if the client recognizes this and is able to negotiate a lower total fee for the group audit with a competitor.

The purpose of this study is to firstly document the prevalence and combinations of the involvement of other component auditors in group audits, about which little is currently known5.

Secondly, we examine the extent to which fee and quality differences (if any) arise when the

signing auditor relies on other component auditors, either affiliated (part of the audit firm’s network), or unaffiliated (no relationship to the signing audit firm), to conduct portions of the audit engagement.

With the exception of Harris et al. (2013) and Lyubimov (2013), there is little research into the use of multiple auditors in the conduct of group audits. Each of those two studies focused on the relation between audit quality and the election to issue an AU-C 600 opinion. Unlike ISA 600 which requires the signing auditor to accept responsibility for the entire audit engagement, the

PCAOB’s AU-C 600 allows the signing auditor to share responsibility for the engagement.

5 There is an emerging body of research evaluating the European experience of joint audits (for example, Francis et al, 2009). We distinguish joint audits (where two audit firms both sign the audit report and take joint responsibility for the assurance provided on the financial statements) from group audits where a single audit firm signs the audit report and takes responsibility for the audit of the group financial statements potentially relying on the work of other audit firms whose existence or role is not disclosed.

Specifically, the US requirements allow the principal auditor to disclaim responsibility for a

portion of the audit, an option not available in any other jurisdiction. The US standard allows the

signing partner to avoid assuming responsibility for the work of another firm by simply

referencing the work of the other auditor in the audit opinion for the group financial statements.

Both Harris et al. (2013) and Lyubimov (2013) find that audit quality is lower when the principal

auditor does not accept responsibility for the entire engagement.6 While these findings are useful

in examining the effect of accepting responsibility for the audit engagement, their relevance is

limited as this option is not available under ISA 600 (that is, in the over 100 countries other than the US where ISAs are adopted) where the signing partner is always required to accept full responsibility for the entire engagement.

Recently, the Public Company Accounting Oversight Board (PCAOB), the national auditor regulator in the United States, has released a practice alert identifying its concerns about the conduct of audits of group financial statements, particularly when other component auditors are involved. In July 2010, Staff Audit Practice Alert No. 6 (2010) was released noting the increasing prevalence of audit reports issued by registered public accounting firms of varying sizes located in the United States on financial statements by entities that have substantially all of their operations outside of the United States.7 Specifically, the Alert: “…identified situations in which U.S. firms auditing companies with substantially all of their operations in another country appeared not to have appropriately executed their responsibilities with respect to the work of

6 Also of note regarding the US-based work is the fact that relatively few US companies receive AU-C Section 600 opinions. For example, out of the thousands of SEC registrants, less than 50 per year (on average) receive an AU-C 600 opinion (Harris et al. 2013). Further, firms that do receive these opinions tend to be small. Given this, the extent to which one could generalize from these findings to the larger population of group audits is not clear. 7 In a 27-month period ending March 31, 2010, the PCAOB report that at least 40 United States registered public accounting firms with fewer than five partners and fewer than ten professional staff issued audit reports on financial statements filed with the SEC by companies whose operations were substantially all in the China region.

assistants engaged from outside of the firm.”8 Staff Audit Practice Alert No. 6 (2010) notes that

“the knowledge, skill and ability of personnel assigned significant engagement responsibilities

should be commensurate with the auditor’s assessment of risk for the engagement, including the

risk of material misstatement due to fraud. Ordinarily, higher risk requires the assignment of

more experienced personnel or additional persons with specialized skills and knowledge”. Both these Alerts suggest that there are potential concerns expressed by regulators with respect to the quality of group audits due to their inherent riskiness as well as the risk associated with evaluating work conducted by another component auditor.

In a keynote address on the reliability, role and relevance of the audit, James Doty (2011), current chair of the PCAOB, stated, in relation to multinational audits:

“My first concern is investor and public awareness. I have been surprised to encounter many savvy business people and senior policy makers who are unaware of the fact that an audit report that is signed by a large U.S. firm may be based, in large part, on the work of affiliated firms that are completely separate legal entities in other countries. For many large, multi-national companies, a significant portion of the audit may be conducted abroad — even half of the total audit hours. In theory, when a networked firm signs the opinion, the audit is supposed to be seamless and of consistently high quality. In practice, that is often not the case. This gets to my second concern. Based on our inspections, I can say the challenges of managing a multi-national audit are great. As our international inspections program matures, we have begun to evaluate the various pieces of the audit performed by different registered firms in multiple jurisdictions. 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.”

8 For example, in one situation, a U.S. firm retained the services of a consulting firm that had personnel who could read, write, and speak the language of the area, in the China region, in which the issuer's operations were located. Those consultants planned the audit, communicated with the issuer's management, and travelled to the China region to complete a substantial portion of the audit. None of the U.S. firm's partners or employees travelled to the China region or planned, performed, supervised, or meaningfully reviewed the audit work. Procedures performed by the U.S. firm's engagement partner consisted primarily of reviewing certain work papers prepared by the consultants as well as issuer-prepared draft financial statements and lead schedules that had been translated into English. The PCAOB’s inspection staff concluded that the level of the firm's involvement in the audit work performed by the consultants was not sufficient for the firm to assert that an audit had been performed by the firm and that the audit provided a reasonable basis for the firm to have an opinion on the financial statements. Refer Staff Audit Practice Alert No. 6 (July 2010): http://pcaobus.org/Standards/QandA/2010-07-12_APA_6.pdf.

Chairman Doty’s observations are consistent with those expressed in Europe. A Green Paper from the European Commission (October 2010) also outlines specific concerns with both the cost and quality of group audits. It states:

“Audits of large groups which operate in multiple jurisdictions are usually carried out by large global networks in view of the high level of resources such audits require. The Commission shares the concerns of a number of audit oversight bodies around the world which consider that the role of the group auditor needs to be reinforced. Arrangements need to be put in place to allow the group auditor to assume its role and responsibilities. Group auditors should have access to the reports and other documentation of all auditors reviewing sub-entities of the group. Group auditors should be involved in and have a clear overview of the complete audit process to be able to support and defend the group audit opinion.”

Both these regulators demonstrate consistent concerns about the quality of group audits, particularly where there are other component auditors involved.

Global Audit Firm Networks and Group Audits

Although branded (and commonly thought of) as a single global entity, a global audit firm network (hereafter, GAFN) is typically organized as an association of national partnerships that agree to affiliate and operate under a single global brand.9 In most countries, the authority to practice as an accounting firm is not granted to an international entity. Rather, that right is reserved for national firms in which local professionals have majority or full ownership.

Consequently, GAFNs are typically organized as cooperatives or partnerships where membership is comprised of national firms where each member firm serves its geographic area

9 For example, in the US, global audit firm networks do not register with the PCAOB but individual member firms must register. Thus, each of the Big 4 firms has over 40 member firms registered with the PCAOB. A review of the PCAOB’s registry list reveals Ernst & Young firms from Ireland, China, France, Germany and approximately 50 other countries.

and is subject to the laws and professional regulations of the country (or countries) in which it

operates (Carson 2009). Whilst standards for accounting and auditing practices are increasingly

driven by global standards, the enforcement of such standards is undertaken at the national level.

This presents a potential regulatory gap for audits of groups conducted in multiple jurisdictions by multiple audit firms, whether or not they are members of the same global audit firm network.

However, the involvement of other component auditors in a group audit creates a principal agent

problem. Specifically, the principal auditor runs a risk by accepting responsibility for work

conducted by another auditor because there may be information asymmetry. Further, this

information asymmetry is likely to be more severe when unaffiliated auditors are involved (as

compared to engagements where the other component auditors are members of the signing firm’s

network). For example, different national practices, different standards or different

interpretations of standards may create problems. Issues related to poor coordination and control

could also lead to sub-standard auditing. Equally, the principal auditors may over rely on the

work of affiliated component auditors who are members of their network. The familiarity of the

principal auditor with network members is such that the principal auditor may assume (rather

than check) that the work of fellow network members is of similar quality to their own. It is these

difficulties that have been observed by the regulators and that have led to concerns about the

quality of group audits.

In understanding this complex principal-agent relationship, it is helpful to consider who determines the appointment of the auditors for the different components of the group. The terms of the engagement, including the use of other component auditors, their required access to component information and explanations from those charged with governance and management, and the expected fees should be agreed with the client and set out in the engagement letter (ISA

600.14)10. In certain situations management of a component of a client will appoint an auditor

for that component. This includes situations where components of a group have a separate audit

requirement, (for example, a listed overseas subsidiary), or sometimes, although not required,

component management determines that there are advantages to the component’s financial

statements being independently audited (Carey, Simnett and Tanewski 2000). In these situations

the auditor of the consolidated entity has the ability to use the audit evidence on which the

component’s audit opinion on the financial statements is based, outline additional testing for this

auditor to undertake on the component (for example where an accounting method is used for the

component, such as LIFO of inventory for a U.S. subsidiary, but which requires alternative

accounting treatment for IFRS based consolidated accounts), or may decide that the audit

evidence collected by the other component auditor is unreliable or does not suit their purposes,

and that other audit evidence needs to be collected (ISA 600.3).

In other situations it is the principal auditor who determines that there are components of a group

that require audit attention. For example, the auditor may identify that there are unaudited

components of multinational group that are significant to the group11, and the auditor must

determine how best to gather the required audit evidence for these components. This may

involve greater work by the signing auditor, getting other parts of the network to undertake

additional audit work, or requesting additional audit work from unaffiliated auditors.12

10 We have confirmed in discussions with audit partners that this is the case in practice. 11A significant component is defined in ISA600.9 (m) as “A component identified by the group engagement team (i) that is of individual financial significnace to the group, or (ii) that, due to its specific nature or circumstances, is likely to include significant risks of material misstatement of the group financial statements.” 12 There are incentives to align auditors from a network across a group audit. Research shows takeovers commonly results in the aligning of auditors of acquirees to the auditors of acquirors over time (Anderson, Stokes and Zimmer 1993). Closer alignment of auditors across a group audit is expected to result in lower co-ordination effort and monitoring costs (other components of a GAFN will be better known and there are commonly quality control reports available within a GAFN for different components of the network), and GAFNs encourage referrals within the network, and expect reciprocation.

The amount of work to be undertaken on the group audit will depend on the materiality for the group financial statements as a whole when establising the overall audit strategy. This will be by definition greater that the materiality level of the individual components of the group.

However, for components that are deemed significant due to their individual financial significance, the group auditor is expected to use the materiality level that is used by the component auditor (ISA 600.26). Also, if there are potential misstatements for which lesser amounts than the materiality level could be reasonably expected to affect the decision making of users taken on the basis of the group financial statements, the group auditor will need to apply a lower materiality level (ISA 600.21). However, in some of the first research undertaken on group audits, Stewart and Kinney (2012) identify that the standards are silent about how these amounts should be determined and that methods being used in practice vary widely, lack theoretical support, and may either fail to meet the audit objective or do so at excessive cost.

They therefore develop and outline a Bayesian group audit model that generalizes and extends the single-component audit risk model to aggregate assurance across multiple components.

A global audit firm network commonly becomes the auditor of natural choice for groups, particularly multinational groups. Although the global network itself does not provide client services—that is done by the individual national firms - the network serves as a coordinating entity between member firms. Its role will typically include tasks such as promoting a global brand, developing a uniform audit methodology and coordinating peer review to ensure uniform application of risk and quality standards by member firms worldwide13.

13 One way in which this occurs is via the Forum of Firms was established in 2002 by BDO, Deloitte Touche Tohmatsu, Ernst & Young, Grant Thornton, KPMG and PricewaterhouseCoopers as “an association of international networks of accounting firms that perform transnational audits of financial statements that are or may be used across national borders”. The members of the Forum of Firms, which stands at 24 members and two affiliates as at November 2013, have “committed to adhere to and promote the consistent application of high-quality audit practices worldwide” (Forum of Firms 2013). The Forum of Firms’ executive arm, the Transnational Auditor Committee, is a

To ensure quality, the GAFNs invest heavily in training, development of increasingly efficient

and effective audit methods and the maintenance of well-staffed groups of technical experts

worldwide. Further, they expend great effort to ensure consistency across member firms. For

example, when new audit methods are introduced, they are introduced worldwide to all of the

GAFN member firms. Such effort should result in greater uniformity across member firms. To

the extent that GAFN member firms provide uniform quality audits, there should be no

difference between the quality of work performed by members of the principal auditor and that

performed by other members within the global audit firm network.

Our hypotheses developed in the next section investigate the impact of involvement of members

of the principal auditor’s network and unaffiliated auditors (versus a group audit conducted

solely by the principal auditor) on audit fees and proxies for group audit quality (magnitude of

discretionary accruals and going concern issuance). Australian data are unique to examine these

issues since listed companies in Australia are required to publicly disclose audit fees with

categorization by type of auditor (i.e. fees paid to principal auditor, affiliated auditor and

unaffiliated auditor), and their multinational group audits are subject to ISA 600. 14

3. Hypothesis Development

We build our hypotheses around the incentives and risks that principal auditors face when

making decisions about the conduct of group audits. It is often suggested in the literature that

committee of the International Federation of Accountants (IFAC) which allows the Forum of Firms and IFAC to work together with respect to standard setting, dialogue with the regulatory community and promotion of convergence to international standards. 14 ISA 600 (IAASB 2007) superseded ISA 600 “Using the Work of Another Auditor” (IAASB 2002), but maintained the same assumption that the audit partner of the principal firm takes responsibility for the audit opinion expressed on the financial statements of the corporate group. The revised ISA 600 was operative for financial reporting periods commencing on or after 1 January 2010. The major difference between the two standards is that the current ISA600 has a much greater recognition of different types of audit firm networks, and more detailed prescription of the work required to be undertaken by the signing audit partner and his/her responsibilities in relation to work undertaken by network member firms and unaffiliated audit firms.

rational auditors are confronted with economic trade-offs in their decisions (e.g., Louwers,

1998). On the one hand, they face higher risk of litigation and loss of reputation in cases where they provide low audit quality. On the other hand, they face the risk of client loss if the client is dissatisfied by the quality of the audit work or where the audit fee is too high. Applied to our case of the group audit, the auditor has to make a choice between whether or not to rely on the work of other auditors over which they assume ultimate responsibility. If the auditor decides to rely on the work of other auditors, arguably because it will result in reduced costs compared with undertaking the work within the audit firm, a principal agent problem arises with potential information asymmetry between the principal and the agent, and the principal runs the risk of low performance, low audit quality and thus risk of litigation. If the auditor decides not to rely on the work of other auditors, this is likely to result in a more costly audit and the auditor runs the risk of client loss as the client may be able to negotiate a lower fee with a competitor in the future. We develop our hypotheses around these two main issues: cost and quality.

Group Audit Arrangements and Audit Costs

When considering the market for group audit services, it is important to keep in mind that the principal auditor is, while maintaining required audit quality, seeking to minimize the costs to the client in order to offer the engagement at an attractive (i.e., competitive) fee. As outlined earlier, the audit fees are negotiated between signing auditor and client before the start of the engagement and are contained in the engagement letter. The audit fees for the group will consist of the audit fees paid to the principal auditor, and amounts where the client contracts for and directly pays for the services of other component auditors. The principal auditor has a responsibility to ensure that there is sufficient appropriate evidence for the overall audit, and this involves collecting evidence on significant components, that may either require an audit or not.

Thus the principal auditor may have to undertake further audit work on the work of other component auditors, plus also arrange for the collection of audit evidence of significant components of the multinational group that are unaudited. For components that are not significant, the principal auditor is expected to perform analytical procedures at a group level, and then follow up any risks of material misstatement (ISA 600.28-.29). In addition, the principal auditor is expected to gather evidence that the consolidation process of the financial information from each of the components is appropriately undertaken (ISA 600.32-.37).

The economically rational approach to achieve this is to select that combination of auditors

(principal audit firm, other auditors affiliated with the principal auditor’s network, unaffiliated auditors) which is able to complete the group audit at the required quality and at the lowest cost.

The relevant consideration is whether engagement costs will be saved by the choice of an other component auditor compared with if the principal auditor conducted the audit in its entirety.

While it is always theoretically possible for a principal audit firm to audit a group in its entirety,

16 such an approach will usually incur additional costs. One obvious area for achieving lower costs when collecting audit evidence for an overseas component of a group is engaging a local audit team in order to reduce the out-of-pocket expenditures related to international travel, and other costs incurred by paying for audit staff from the principal auditor. In addition, and perhaps more substantially, local auditors may be more efficient as they are likely better versed in local regulations such as tax, corporate and securities laws, saving time spent on the audit, and may know the local component, environment and management and the most efficient ways of gaining appropriate evidence better than staff from the principal auditor. The principal auditor will have incentives to secure the services of an other component auditor if the cost savings from the use of the other component auditor compared with the use of audit staff from the principal auditor are greater than the additional contracting and monitoring costs associated with hiring the other component auditor. It is expected that at least some of these realized cost savings will be passed on to the client in the form of reduced audit fees, in order to maintain the auditor-client relationship. In order to test this expectation we hypothesize the following:

H1: The cost of group audits conducted wholly by principal auditors is lower than those involving other component auditors (networks or unaffiliated)

There are two possible groups of ‘other component auditors’ which can be involved in the conduct of the audit, audit firms affiliated with the signing auditor as a member of their global audit firm network or alternatively unaffiliated auditors who have no relationship with the principal auditor. Using the global audit firm network is more efficient in time (through the use of common communications and standards/methodology) and also should involve reduced contracting and monitoring costs than would incurred by involved an unaffiliated auditor.

Members of a global network are used to interacting with other members of the network on a

regular basis. Global audit firm networks invest heavily in training, development of efficient and

effective audit methods and the maintenance of well-staffed groups of technical experts worldwide. Further, they expend great effort to ensure consistency across member firms. For example, when new audit methods are introduced, they are introduced worldwide to all of the member firms of the network. Such effort should result in greater efficiency across member firms. Member firms of GAFNs are also encouraged to share business across the network, and there is expected to be reciprocation between network member firms. These further build up knowledge of other parts of the network and reduce contracting and monitoring costs. However, consistent with the observations of regulators, the selection of an unaffiliated auditor is likely to be for reasons of cost. The cost structures of unaffiliated audit firms are likely to be lower than networked audit firms. Accordingly we test the following directional hypothesis:

H2: The cost of group audits involving other members of the principal auditor’s network is higher than those involving unaffiliated auditors

Group Audit Arrangements and Audit Quality

As outlined earlier, the major international standard-setting initiative responding to concerns about the quality of multinational corporate group audits is the revised ISA 600 (IAASB 2007).

Applicable for financial periods commencing after 1 January 2010, ISA 600 requires that the audit partner of the principal firm take responsibility for the audit opinion expressed on the financial statements of the corporate group regardless of whether that work was conducted by the principal network firm, affiliated members of the network firm or unaffiliated auditors. The expectation under ISA 600 is that the signing partner has put themselves in a position where they are satisfied that the consolidated accounts as a whole appropriately reflect the financial position and performance of the multinational group structure. Thus, it is incumbent for the signing

partner to ensure that all aspects of an engagement are conducted at a similarly high level of quality. Large clients, particularly those with multinational operations, demand consistent auditing throughout the world. If global audit firms are effective at maintaining uniform audit quality throughout the network, and (as per ISA 600) they are effective at maintaining uniform audit quality when making use of unaffiliated firms, then equivalent or baseline audit quality should be achieved from all components.

The other component auditor also has incentives to achieve the required audit quality. For example, if the other component auditor is a small local firm that fails to produce audit evidence of the expected quality, or the principal auditor incurs too much time in contracting, monitoring and reperformance, it is unlikely that the relationship will continue. It is recognized that this expectation is different to the concerns raised by regulators. However, while regulators have pointed to specific instances of reduced quality, there has been no testing as to whether this reduced quality is systematic across instances of the use of other component auditors.

However, the involvement of other auditors in a group audit creates a principal agent problem for the signing partner. Specifically, the principal auditor runs a risk by accepting responsibility for

work conducted by another auditor because there may be information asymmetry about the extent and quality of the work performed. Further, the variability in the extent and quality of the work performed is likely to be more severe when unaffiliated auditors are involved (as compared to engagements where the other auditors are other members of the signing firm’s network that

have met the quality threshold set by the network). For example, different national practices,

different standards or different interpretations of standards may create problems. Issues related to

poor coordination and control could lead to sub-standard auditing. It is especially these

difficulties that have been observed by the regulators and that have led to the concerns about the

19 quality of group audits. Given these legal and reputational incentives to maintain high quality audits, the following hypotheses are stated in the null form:

H3: There is no difference in the quality of group audits conducted wholly by principal auditors compared to those involving other component auditors.

4. Methodology

Using a sample of Australian listed companies with more than one subsidiary over the period

2008-2011, we examine differences in the costs group audits across different group auditor combinations. Unlike other jurisdictions (for example, the United States), reporting guidelines in

Australia require listed entities to disclose their audit fees as follows:

• The fee paid to the principal auditor (i.e. signing auditor).

• The fee paid to audit firms related to the principal auditor (i.e., affiliated firms

that are members of the principal auditor’s network).

• The fee paid to other auditors (i.e., unaffiliated firms that are not members of the

principal auditor’s network).

This reporting requirement allows for an assessment of the portion of the engagement that has been completed by the principal auditor, other members of the principal auditor’s network and unaffiliated auditors. This, in turn, presents an opportunity to test the impact on total audit costs

(from the perspective of the client incurring such costs) where other component auditors are engaged to complete the group audit as well as the impact of different combinations of auditors on the quality of the group audit.

As ISA 600 does not cover the conduct of joint audits (that is, where more than one audit firm signs the audit opinion), instances of joint audits were removed from the population of listed

companies to identify our group audit sample. Consistent with the approach in the prior literature

firms in the financial industry were also deleted. We eliminated observations with missing data,

no subsidiaries and firms with less than $1 million in total assets. This left us with 4,335 group audit observations over the period 2008-2011 which fall into the following categories15:

• All components audited by the principal auditor: 3,056 (70% of observations)

• Components audited by principal auditor and other members of the principal

auditor’s audit firm network only: 466 (11% of observations)

• Components audited by principal auditor and by unaffiliated auditors only: 813

(19% of observations)

The percentage of the total audit fee paid to the principal auditor for group audits ranges from

13% to 100%. For the 30% of audits involving other component auditors, on average 27% of the

total audit fee is paid to the network or unaffiliated firms respectively. For over 90% of these

observations the proportion of the total audit fee paid to other component auditors exceeds 5%

suggesting that the components we identify are material to the overall group audit.

Empirical Models

To address the potential issue of selection with regards to group audit arrangements we use two

approaches. Firstly we employ a two stage approach, the first stage of which is an auditor choice

model to predict the choice of principal auditor (versus the use of other auditors), where the

inverse mills ratio resulting is included in our subsequent audit fee and audit quality models. The

two stage inverse mills ratio is estimated using a probit model as follows (omitting firm and time

subscripts):

15 There were 178 observations where components were audited by the principal auditor, its network and unaffiliated auditors, these observations are eliminated from the main analyses.

CHOICE = α + β1LTA + β2LSUB + β3CATA + β4QUICK + β5LEVERAGE + β6ROI +

β7FOREIGN + β8 LOSS + β9MINING + β10BIG4 + β11DPctSUBAustralia + β12DPctSUBAfrica +

β13DPctSUBPacific + β14DPctSUBSouthAmerica + β15DPctSUBNorthAmerica +

β16DPctSUBEurope + β17DPctSUBAsia + ε

Where CHOICE is defined as principal only = 0, other auditor = 1 (whether unaffiliated or not),

other variables are defined in Table 1.

Secondly, we employ a propensity score matching technique similar to Lawrence et al. (2011),

where a one to one matching was undertaken between the principal auditor and other categories

and then within the other auditor category. A caliper or distance between matched observations of 0.03 was adopted. The model is as follows (omitting firm and time subscripts):

CHOICE = α + β1LTA + β2LSUB + β3CATA + β4QUICK + β5LEVERAGE + β6ROI +

β7FOREIGN + β8 LOSS + β9MINING + β10BIG4 + β11DPctSUBAustralia + β12DPctSUBAfrica +

β13DPctSUBPacific + β14DPctSUBSouthAmerica + β15DPctSUBNorthAmerica +

β16DPctSUBEurope + β17DPctSUBAsia + Year Indicators + Industry Indicators + ε

Where CHOICE is defined as principal only = 0, other auditor =1 and other variables are defined

in Table 1.

Audit fee model

To test hypotheses 1 and 2, we employ an audit fee model. The model is derived from Craswell

et al. (1995), Ferguson et al. (2003) and Carson and Fargher (2007). The resulting OLS

regression model is specified as follows (ignoring subscripts):

LAF = α + β1LTA + β2LSUB + β3CATA + β4QUICK + β5LEVERAGE + β6ROI + β7FOREIGN +

β8 OPINION + β9 YE + β10 LOSS + β11BIG4 + β12 LARGENONBIGN+β13MINING +

β14SUBGDP + β15SUBPROX + β16AGROWTH + β17ADTCHANGE + β18LAMBDA +

β19NETWORK(%) + β20UNAFFILIATED(%) + ε

Where the dependent variable and independent variables are as defined in Table 1. To test hypothesis 1, after modelling the auditor choice decision, we examine group audit fees and compare audits involving other component auditors with those principal auditors included in the intercept. To test hypothesis 2, we examine a sub-sample of group audits all involving other component auditors and compare those auditors involving the network of the principal auditor with fees charged by unaffiliated auditors which are included in the intercept. We further test our hypotheses using a propensity score matched sample.

Measures of Group Audit Quality

To test hypothesis 3 on the issue of differences in audit quality related to group audit arrangements we use two approaches, discretionary accruals and, for a sub-sample of financially distressed firms, going concern issuance after controlling for auditor choice. In addition, we use a propensity score matched sample. We use the performance-adjusted cross-sectional modified

Jones model (Jones, 1991; Dechow et al. 1995; Kothari et al. 2005) to measure discretionary accruals. Similar models have been widely used in the international auditing literature to measure audit quality across a range of countries (e.g. Kwon et al. 2007), across regions (e.g. Europe: Van de Poel and Vanstraelen, 2011) and also within countries (e.g., Australia: Carey and Simnett,

2006). We follow Kothari et al. (2005) and Ashbaugh et al. (2003) and use performance-adjusted

discretionary accruals under the premise that extreme performance impacts the accruals- generation process. Discretionary accruals are measured by the residual term ( ) by industry-

푖푡 year (by two-digit GIC sector code with a minimum of eight firm-years per sector휀 16) using the

following model:

ACCt = α0 + α1(∆Salest - ∆RECt) + α2PPEt + α3ROAt + εt (1) where:

ACC is the net profit after tax before extraordinary items less cash flows from operations;

∆Sales is the change in net sales revenue; ∆REC is the change in net receivables; PPE is net

property, plant and equipment17 and; ROA is return on assets. All variables are scaled by average

total assets (except ROA). We also examine separately signed accruals as positive income-

increasing accruals are likely to have different consequences to negative income-decreasing

accruals for auditors.

The empirical model used to test our hypotheses is as follows:

ABSDAt = β0 + β1AGEt+ β2GROWTHt + β3INDGROWTHt + β4PERFORMt+ β5LTAt +

β6LEVERAGEt + β7LOSSt + β8PPEGROWTHt + β9BIG4t + β10LARGENONBIGNt + β11MININGt

+β12SUBGDPt + β13SUBPROXt + β14LAMBDAt +β15NETWORK(%)t +

β16UNAFFILIATED(%)t + εt

16 US studies typically impose a minimum of 20 firm-years per industry sector, but due to our more limited sample size, a 20 firm-year minimum per industry would be unduly restrictive. 17 We use Net Property, Plant and Equipment as we are unable to reliably calculate Gross Property, Plant and Equipment using Aspect Financials for this period.

Control variables are defined in Table 1. The variables of interest are NETWORK(%) and

UNAFFILIATED(%) defined as continuous variables based on the audit fees charged by the network and unaffiliated auditors (respectively) as a percentage of total group audit fees.

We also use going-concern issuance as an additional test of audit quality. Hopwood et al. (1994) suggest that investigations of auditor reporting behavior with respect to decisions to issue a going concern opinion should be conducted on samples that have been partitioned into stressed and non-stressed categories because auditors’ decision processes are different for stressed and non- stressed companies. Consistent with this, and in line with prior research, the sample is restricted to potentially financially distressed firms, defined as firms with a current year loss (e.g. DeFond et al. 2002; Geiger and Rama 2003; Carey and Simnett 2006). The financially distressed sample with sufficient financial and audit data exists consists of 2,843 observations. Following prior literature (e.g. Menon and Schwartz 1987; Mutchler and Williams 1990; Bell and Tabor 1991;

Hopwood et al. 1994; Carcello et al. 1995; Mutchler et al. 1997; Carcello and Neal 2000; Geiger and Raghunandan 2002; DeFond et al. 2002; Carey and Simnett 2006; Carson et al. 2013), we will use the following logit model to test the hypothesis proposed. The probability to observe a going concern modification is taken to be a function of the following variables:

Pr(Y=OPINION | x) =F(β0+ β1PBANK + β2LTA + β3LEVERAGE + β4∆LEV + β5CURRENT +

β6WC + β7QUICK + β8ROA + β9NEGEQ + β10BIGN + β11LARGENONBIGN + β12MINING +

β13SUBGDP + β14SUBPROX + β15LAMBDA + β16NETWORK(%) + β17UNAFFILIATED(%) +

∑β Year Fixed Effects + ∑β Industry Fixed Effects)

Where: F(x) =1/(1 + exp(−βx)) and the variables are defined in Table 1.

The choice of control variables is based on consideration of the prior literature and a deliberation

of which factors may be correlated with the variables of interest and the auditor’s decision to

issue a going concern modification or not. The explanatory variables have also been used in prior

research (see Dopuch et al. 1987; Mutchler et al. 1997; Reynolds and Francis 2000; DeFond et al.

2002; Carey and Simnett 2006, Carson et al. 2013). PBANK, CURRENT, ROA are winsorised at

5%, ∆LEV and WC are winsorized at 1%.

The degree of financial distress is an important factor mentioned in the relevant auditing

standards. The magnitude of financial distress is related to the probability of bankruptcy

(Hopwood et al. 1994). PBANK explicitly measures the probability of bankruptcy using the

Zmijewski (1984) model.18 LEV and ∆LEV are included in the model because debt covenant

violations are positively associated with the probability of issuing a going concern opinion

(Mutchler et al. 1997; DeFond et al. 2002). Specifically, LEV is included to capture the

proximity to covenant violation as firms with high leverage are likely to be close to violations

(Beneish and Press 1993). ∆LEV is included because an increase in leverage is likely to move

firms closer to violation of debt covenants (Reynolds and Francis 2000; DeFond et al. 2002).

Current year loss as an indicator variable is not included in the model because the sample-

selection criterion is based on the firm incurring a loss in the current year. However, ROA is

included because the more severe the current year loss, the more likely the firm is to receive a going concern modification. NEGEQ is included because firms with negative shareholders’ equity are more likely to be in financial distress and therefore also more likely to receive a going concern opinion (Ohlson 1980).

18 The probability of bankruptcy using the Zmijewski model is calculated as: probability of bankruptcy = Φ[-4.803 - 3.599(return on assets) + 5.406(leverage) -0.100(current ratio)], where Φ is the cumulative distribution function of the standard/unit normal distribution

The model also includes several factors that are likely to impact the probability of receiving a

going concern opinion. SIZE (log of total assets in U.S. millions) is included because larger firms

have more negotiating power when they are in financial difficulty and are therefore more likely

to avoid bankruptcy and consequently less likely to receive a going concern opinion (Campbell

1996; Reynolds and Francis 2000; DeFond et al 2002). CURRENT, WC and QUICK are

included in the model as liquidity measures that capture the availability of funds and the ability to

quickly raise funds in relation to the firm’s short term obligations (DeFond et al. 2002). High

liquidity suggests that firms are more likely to avoid bankruptcy and therefore less likely to

receive a going concern opinion. The model also includes indicator variables for industry sectors

(as defined by two-digit GICS codes) and for financial year. Industry sector indicator variables

are included to control for industry fixed effects associated with firms’ operation, as firms’ industry affiliation has been shown to be associated with auditors’ going concern judgments

(Butterworth and Houghton 1995; Raghunandan and Rama 1999; Carey and Simnett 2006). Prior models based on similar variables prove to have acceptable explanatory power (see Menon and

Schwartz 1987; DeFond et al. 2002; Carey and Simnett 2006).

INSERT TABLE 1

5. Results

Table 2 presents the descriptive statistics for all the variables in the analyses conducted in the

study for overall sample of group audits, our propensity score matched sample split by our sub-

samples of interest: principal only audits, networks and unaffiliated. We winsorized AGE, CFO,

LEVERAGE and ROI variables at the 1% and 99% levels (QUICK and GROWTH are winsorized

at the 5% levels due to extreme skewness). Over the period 2008-2011 for our sample of group

audits, the average absolute value of discretionary accruals are 10% of assets and the average

group reports losses and negative cash flows from operations. This reflects that the time period over which the study is conducted includes the global financial crisis. As outlined earlier, the majority of group audits are conducted wholly by the principal signing auditor (70%) and a further 11% are conducted within a single audit firm network. For these audits, 41% are audited by the Big N and 42% by the large non-Big N firms. 40% of the groups are from the mining industry. The average period since listing for a group is approximately 14 years. We tabulate but do not report the correlation matrix for our control variables and variables of interest. As expected, large correlations are observed between measures of firm size, number of subsidiaries, performance and audit fees.

INSERT TABLE 2

In Table 3 we present our analysis of the first of our audit cost hypotheses (Hypothesis 1). The descriptive statistics for the variables included in the audit fee model are reported in Table 2.

Hypothesis 1 predicts that the cost of group audits conducted wholly by principal auditors is lower than those involving other component auditors, irrespective of the type of other auditor.

We find strong support for Hypothesis 1 suggesting that as the extent of involvement of other auditors increases in the group audit, audit costs increase irrespective of whether the other auditor is a network or is unaffiliated (in both cases, p<0.001, two-tailed). This supports the view that the involvement of other component auditors, irrespective of their affiliation increases the cost of the group audit.

INSERT TABLE 3

Hypothesis Two predicts that the cost of group audits involving other members of the principal

auditor’s network is higher than those involving unaffiliated auditors. In Column 1 of Table 4 we

test this hypothesis on the sub-sample of group auditors where other component auditors are

involved. We find strong support for our proposition that total audit costs are higher when the

principal auditor’s network is involved in the conduct of the audit (p<0.01, two-tailed). This

supports the view that audit firm networks are more expensive at delivering audit services

despite their well developed modes and means of communication, common protocols and

methodologies in a multi-location setting relative to those that would be incurred when a local

unaffiliated auditor is involved.

INSERT TABLE 4

Regardless of the composition of the engagement team, and irrespective of any differences in

cost ISA 600 requires that the signing partner accept full responsibility for all components of the

engagement. The assumption under ISA 600 is that the signing partner has put themselves in a

position where they are satisfied that the consolidated accounts as a whole appropriately reflect

the financial position and performance of the multinational group structure. Accordingly,

Hypothesis 3 predicts that there will be no difference in audit quality associated with the

combination of group auditors. We utilize two metrics of audit quality, firstly discretionary

accruals and secondly, going-concern issuance.

In Table 5 we present our analyses of absolute discretionary accruals, income-increasing and income-decreasing accruals for group audits. We observe a strong positive association between the involvement of networks in group audits and higher levels of absolute value discretionary accruals (p<0.01, two-tailed). This implies that as the involvement of networks increases earnings quality is lower. We also find an association between income-increasing associated with

network involvement in group audits (p<0.05, two-tailed). We also do not find an association between income-decreasing discretionary accruals and network auditors, not do we find any association between discretionary accruals and the role of unaffiliated auditors. This provides evidence to support that the objectives of ISA 600 are not being achieved in all combinations that use other component auditors, that is, there are differences in the earnings quality of groups associated with the choice of auditors involved in the group audit. In particular, this suggests that the involvement of other member firms of the network is associated with lower audit quality.

This may be related to a tendency for principal auditors to over rely on the work of member firms in their networks whereas professional scepticism is maintained where the work of unaffiliated auditors requires monitoring. These findings are supported by our propensity score matched sample.

INSERT TABLE 5

In our second test related to audit quality we consider a financially distressed sub-sample of loss- making multinational group audits. In Table 6, Column 1 we fail to find evidence of going concern issuance relative to principal only audits. In Table 6, Column 2 find that, for a propensity score matched sample audits where an unaffiliated auditor is involved in the group audit, relative to principal only audits, we find weak evidence that the audit opinion is more

likely to be modified for reasons of going concern (p<0.10). In Columns 3 and 4, we use a sub- sample of financially distressed audits where other component auditors are involved and find, relative to unaffiliated auditors that network auditors are less likely to issue going concern opinions (p<0.05). This is consistent with our findings in relation to earnings quality in that

higher absolute value and income-increasing accruals are permitted by principal auditors when the network is involved in the group audit.

INSERT TABLE 6

Additional Analysis

Audit Firm Type

Countering the potential for these problems, at least with respect to the Big N firms, it can be argued that the Big N firms have significant resources to maintain sufficient audit quality regardless of the existence or identity of the component auditor. Specifically, while maintaining acceptable levels of quality across engagements may require additional resources for supervision, communication and coordination, the Big N firms have invested heavily in infrastructure to permit such efforts. Further, given their visibility and heightened exposure to reputation loss and global legal liability (see DeAngelo 1981), the Big N firms also have the strong incentives to maintain sufficient audit quality regardless of how the work is allocated (within or outside of the

GAFN).

The mandates of ISA 600 notwithstanding, the extent to which non-Big N firms can provide

uniform audit quality across a global engagement team is not clear. First, as a group, these firms

are less homogeneous. The non-Big N segment of the audit market includes long standing,

billion dollar global GAFNs like BDO and Grant Thornton and smaller more loosely knit global

federations that may have more recently joined forces, as well as small local firms with few, and

relatively small, clients. Coordination of multi-location audit engagements can pose very

different issues for these different types of firms and, as such, subdivide this group of firms into

two market segments—large non-Big N GAFNs and small non-Big N firms which are more

locally-branded firms. In Table 3, Columns 2 and 4 we report an interaction term with Big N for each of our experimental variables. We find that the increase in audit fees for network auditor involvement is strongest for clients of the Big 4 (p<0.01 in our total sample and p<0.10 in our propensity score matched sample). In addition, we find overall fees are comparatively lower for clients of the Big 4 when an unaffiliated auditor is involved, suggesting that when setting fees for the group audit the Big 4 are sensitive to the competitive pressure of having an unaffiliated

auditor involved in the engagement. Table 4 provides some contradictory evidence suggesting

that fees are comparatively higher for unaffiliated auditors are involved. Our analyses in Table 5

are sensitive to the addition of Big N interaction terms with the significance (but not the signs) of

our variables reducing to below conventional levels. We are unable to conclude that the observed

differences in audit quality measures are associated with a particular type of audit firm.

Multinational Group Audits

We also consider the subset of clients for whom these issues are most important, multinational

clients. We define multinational group audits as groups with more than one foreign subsidiary.

We observe that the incidence of involvement of other auditors in multinational group audits is

higher than for group audits overall. In 55% of cases, the audit is undertaken solely by the

principal auditor, the principal auditor’s network is involved in 17% and unaffiliated auditors are

involved in 28% of multinational group audits. In relation to cost we find support for both our

hypotheses (p<0.01, two-tailed) and confirm our previous results. In relation to quality consistent

with our previously reported results we find higher levels of absolute value and income-

increasing accruals where network auditors are used but do not find differences attributable to

unaffiliated auditors. For going concern issuance we find that unaffiliated auditors are associated

with increased propensity to issue going concern opinions (p<0.05). Accordingly we find that

our results are robust when confined to multinational groups.

Sensitivity Analyses and Robustness Tests

We re-perform our analyses using indicator rather than continuous variables for the involvement

of networks and of unaffiliated auditors. Our results are qualitatively unchanged to those

reported. We also further refine our continuous variable to identify material involvement of

networks and unaffiliated auditors and code all observations with less than 5% of the total audit

fee as zero. Our results are similar to those we report, with higher levels of significance in some

cases. Due to high levels of multicollinearity between SUBPROX, SUBGDP and SUBLITIG we

are unable to include them in a model at the same time. Substitution of SUBLITIG, our measure

of litigation risk associated with location of subsidiaries for SUBGDP, our measure of cost levels

in countries where subsidiaries are located, does not change our reported results.

6. Conclusions and Future Research

A commonly expressed concern by regulators is that other auditors are being strategically

selected for reasons of low cost and that the quality of group audits is potentially lower when

they involve coordinating the work of other component auditors. This would mean that the

requirements of international auditing standards, in particular ISA 600, are not being met, in that

the group auditor has not satisfied themselves the level of audit quality has not been

compromised in these situations. We find that, after controlling for auditor choice, audit fees for clients where the group audit is undertaken entirely by the principal audit firm are higher than those charged when other component auditors—either affiliated or unaffiliated—were responsible for conducting a portion of the engagement. This is consistent with the argument that in a competitive market, the use of an unaffiliated auditor will be mainly driven by reasons

33 related to cost. We find that there is some evidence to suggest that there are differences in audit quality associated with type of auditor involvement which may indicate that the requirements of

ISA 600 are not being met. When combined with our findings on audit quality, this may be of concern to regulators.

Our findings also highlight that a maintained assumption in the auditing literature that the audit firm which signs the audit opinion on these group financial statements has conducted the audit of all the entities within the group is not correct. This maintained assumption could lead to potentially erroneous conclusions as the quality of the financial statements has been assumed to be directly related to the identity of the firm signing the audit opinion. Our approach is novel in that it explicitly takes into account the actual involvement of one or more audit firms in undertaking a group audit and examines the impact on audit costs and audit quality of taking this into consideration.

While our research has benefitted from the unique Australian disclosures regarding the amount of fees paid to other component auditors, our ability to comment further is limited by the fact that the exact identity and extent of involvement of the other component auditors is not identified in the standard audit report. As we outlined earlier it has been proposed by the IAASB (2012) that this be rectified. In particular the IAASB has requested comment on the suggestion of including disclosure about the involvement of other component auditors in the group audit. The suggested wording for comment includes “…At our request, other auditors performed procedures on the financial information of certain subsidiaries to obtain audit evidence in support of our audit opinion. The work of audit firms with which we are affiliated constituted approximately

[percentage of audit measured by, for example, audit hours] of our audit and the work of other non-affiliated audit firms constituted approximately [percentage of audit measured by, for

example, audit hours] of our audit…” Our research would support the inclusion of such

disclosures as being important in understanding the overall quality of the financial information,

although the requirements to disclose such information could possibly be better achieved as a

footnote disclosure within the financial statements rather than in the audit report. This would

have the advantage of not raising unfounded concerns or confusion about the quality of the audit,

while providing necessary disclosures so that the structure by which the audit is undertaken can

be better understood.

This study is subject to the following limitations. We acknowledge that discretionary accruals

and going-concern issuance are only two possible aspects of audit quality that could be examined. We plan to examine other proxies for audit quality in future versions of this study.

Further, it is not clear to what extent our results with regard to audit quality are attributable to the

relatively strong Australian institutional setting in terms of for example investor protection,

enforcement and public oversight. The inclusion of a control variable for quality of legal

enforcement in the jurisdictions in which the subsidiaries operate provides some comfort on this

issue. Similarly, Australia is a country with a relatively high cost of living which may magnify

the difference in fees between group audits conducted solely by a principal auditor and audits

involving component auditors outside Australia. Again, we control for GDP based on the

locations of the subsidiaries involved in the group audit. Hence, it seems warranted for future

research, as data become available, to investigate whether the results also hold in other settings

with a relatively low cost of living and with weaker institutions and enforcement to ensure audit

quality. Future research could examine such issues.

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Table 1 Variable Descriptions

ABSDA = absolute value of discretionary accruals scaled by average total assets; AGE = the number of years the client firm has been listed on the ASX; GROWTH = Total Assetst / Total Assetst-1; INDGROWTH = ∑ Total Assetsi,t / ∑ Total Assetsi,t-1 by two-digit GIC code; PPEGROWTH = Percentage change in gross property plant and equipment; PERFORM = operating cash flow scaled by total assets; LTA = natural log of total assets at year end ($ millions); LAF is natural log of sum of total audit fees paid to the principal auditor, network of the principal auditor and unaffiliated auditors ($ thousands); LSUB is the natural log of the number of subsidiaries; CATA is the ratio of current assets to total assets; QUICK is the ratio of current assets less inventories to current liabilities; LEVERAGE is the ratio of total liabilities to total assets; ROI is the ratio of earnings before interest and tax to total assets; FOREIGN is the proportion of subsidiaries that represent foreign operations; SUBGDP = country of each subsidiary multiplied by the yearly USD GDP per Capita, summed and scaled by the number of foreign subsidiaries; SUBLITIG = country of each subsidiary multiplied by the yearly Kaufmann Rule of Law Index, summed and scaled by the number of foreign subsidiaries; SUBPROX = country of each subsidiary multiplied by the distance in kilometers between location of subsidiary and Australia, summed and scaled by the number of foreign subsidiaries; NETWORK (%) is a continuous variable based on the audit fees charged by the network as a percentage of total group audit fees; UNAFFILIATED (%) is a continuous variable based on the audit fees charged by unaffiliated auditors as a percentage of total group audit fees; BIGN = indicator variable, 1 if the audit firm is a Big N auditor, 0 otherwise; LARGENONBIGN = indicator variable, 1 if audit firm is BDO, Bentleys, Crowe Horwath, Grant Thornton, HLB Mann, PKF, RSM, Stantons, WHK, 0 otherwise; MINING = indicator variable, 1 if client firm is in the mining industry, 0 otherwise; OPINION is an indicator variable with a value of one for a qualified or modified opinion; YE is an indicator variable with a value of one for non-June fiscal year end; LOSS is an indicator variable with a value of one for a loss in the current year; 2008, 2009, 2010 and 2011 are year indicator variables; GICS Sector variables are industry indicator variables.

Table 2 Descriptive Statistics

Total Sample PSM Sample Group Audits Principal Only Network Unaffiliated Group Audits Principal Only Network Unaffiliated (n=4335) (n=3056) (n=466) (n=813) (n=1858) (n=927) (n=297) (n=634) Variables Mean/Median Mean/Median Mean/Median Mean/Median Mean/Median Mean/Median Mean/Median Mean/Median (S.D.) (S.D.) (S.D.) (S.D.) (S.D.) (S.D.) (S.D.) (S.D.) Panel A: Continuous Variables 0.1/0.06 0.11/0.07 0.09/0.05 0.1/0.07 0.1/0.06 0.11/0.06 0.1/0.06 0.1/0.07 ABSDA (0.11) (0.11) (0.10) (0.11) (0.11) (0.12) (0.11) (0.11) 4.47/4.26 4.2/4.02 5.84/5.68 4.69/4.53 4.68/4.5 4.54/4.31 5.37/5.27 4.56/4.41 LAF (1.11) (0.95) (1.23) (0.97) (1.07) (1.13) (0.96) (0.88) 200/63.4 160/55.52 520/210 160/61.80 200/74 230/74.10 270/140 120/56.45 AUDFEE (1700.00) (2000.00) (870.00) (350.00) (500.00) (640.00) (330.00) (250.00) 26.92/0 0/0 250/56.28 0/0 14.89/0 0/0 92.83/36.20 0/0 RP_AUDFEE (190.00) (0.00) (510.00) (0.00) (100.00) (0.00) (240.00) (0.00) 8.26/0 0/0 0/0 44.34/23.31 12.21/0 0/0 0/0 35.97/20.48 OA_AUDFEE (36.05) (0.00) (0.00) (73.33) (41.21) (0.00) (0.00) (64.44) 3.5/3.22 3.21/2.98 5.4/5.12 3.48/3.24 3.74/3.38 3.72/3.33 4.72/4.5 3.3/3.04 LTA (1.93) (1.76) (2.13) (1.75) (1.95) (2.06) (1.81) (1.66) 0.32/0.22 0.3/0.19 0.41/0.41 0.33/0.26 0.34/0.26 0.34/0.24 0.39/0.37 0.31/0.22 LEVERAGE (0.40) (0.42) (0.33) (0.35) (0.39) (0.41) (0.38) (0.36) 0.01/0 0/0 0/0 0.01/0.01 0.01/0 0/0 0/-0.01 0.01/0.01 CHGLEV (0.19) (0.20) (0.15) (0.18) (0.19) (0.20) (0.17) (0.18) 7.05/2.61 7.6/3.05 4.11/1.81 6.66/2.28 6.48/2.31 6.56/2.49 4.6/1.86 7.26/2.52 CURRENT (11.53) (11.85) (8.76) (11.47) (11.07) (10.73) (9.25) (12.20) 0.22/0.19 0.23/0.2 0.17/0.15 0.23/0.19 0.22/0.18 0.23/0.19 0.17/0.15 0.23/0.19 WC (0.33) (0.34) (0.25) (0.32) (0.32) (0.34) (0.27) (0.32) 6/2.21 6.53/2.72 3.26/1.29 5.59/1.84 5.48/1.9 5.67/2.14 3.72/1.39 6.03/2.2 QUICK (8.21) (8.48) (5.86) (8.01) (7.85) (7.87) (6.42) (8.33) -0.25/-0.08 -0.26/-0.09 -0.08/0.02 -0.28/-0.09 -0.25/-0.07 -0.26/-0.06 -0.12/0 -0.3/-0.1 ROA (0.54) (0.55) (0.38) (0.57) (0.57) (0.59) (0.45) (0.58) 0.04/0 0.04/0 0.04/0 0.06/0 0.05/0 0.04/0 0.04/0 0.05/0 PBANK (0.09) (0.09) (0.08) (0.11) (0.10) (0.09) (0.08) (0.11) 21.86/21.51 21.61/21.35 23.61/23.6 21.8/21.49 22.09/21.75 22.1/21.69 22.93/22.76 21.69/21.39 MKTVAL (1.93) (1.78) (2.25) (1.74) (1.93) (1.99) (1.97) (1.69) 1.64/1.61 1.43/1.39 2.73/2.56 1.84/1.79 1.87/1.79 1.85/1.79 2.33/2.2 1.69/1.61 LSUB (1.12) (0.97) (1.30) (1.10) (1.10) (1.12) (1.13) (1.00) 0.43/0.39 0.43/0.39 0.41/0.38 0.45/0.42 0.44/0.41 0.45/0.41 0.42/0.41 0.44/0.41 CATA (0.27) (0.27) (0.23) (0.27) (0.27) (0.28) (0.23) (0.26) -0.23/-0.08 -0.26/-0.1 -0.04/0.06 -0.24/-0.09 -0.23/-0.07 -0.25/-0.07 -0.1/0.03 -0.26/-0.1 ROI (0.57) (0.59) (0.46) (0.53) (0.58) (0.61) (0.56) (0.54) 0.31/0.18 0.22/0 0.5/0.5 0.53/0.5 0.47/0.5 0.48/0.5 0.45/0.44 0.47/0.5 FOREIGN (0.34) (0.31) (0.28) (0.34) (0.35) (0.37) (0.28) (0.34) 14.17/9 13.23/9 20.04/12 14.29/10 14.89/10 14.18/10 18.17/12 14.4/10 AGE (13.90) (12.71) (19.82) (13.20) (14.47) (14.03) (17.21) (13.47) 1.28/1.05 1.29/1.05 1.15/1.03 1.3/1.05 1.28/1.05 1.29/1.05 1.19/1.04 1.32/1.05 GROWTH (0.71) (0.73) (0.52) (0.75) (0.73) (0.74) (0.58) (0.78) 1.12/1.11 1.12/1.11 1.1/1.04 1.12/1.11 1.11/1.09 1.11/1.09 1.1/1.04 1.12/1.11 INDGROWTH (0.14) (0.14) (0.14) (0.14) (0.14) (0.14) (0.13) (0.14) -0.1/-0.05 -0.11/-0.06 0.03/0.06 -0.1/-0.05 -0.09/-0.04 -0.09/-0.03 0/0.03 -0.11/-0.06 PERFORMANCE (0.29) (0.30) (0.20) (0.27) (0.29) (0.31) (0.23) (0.27) -0.09/0.03 -0.08/0.04 -0.04/0.04 -0.15/0.01 -0.09/0.03 -0.08/0.04 -0.06/0.04 -0.13/0.01 PPEGROWTH (0.84) (0.85) (0.61) (0.90) (0.85) (0.85) (0.70) (0.91) 43811/46168 46304/48958 40074/41602 36567/40561 39883/42995 40352/43878 41355/42333 38497/42333 SUBGDP (12848) (11292) (11753) (15463) (14261) (14429) (11560) (15051) 1.5/1.74 1.6/1.74 1.4/1.6 1.21/1.52 1.35/1.64 1.38/1.66 1.44/1.66 1.26/1.6 SUBLITIG (0.50) (0.40) (0.47) (0.70) (0.61) (0.59) (0.46) (0.71) 2401/1195 1697/0 4211/3367 4009/3502 3673/2888 3673/2852 4063/2989 3489/2821 SUBPROX (3043) (2659) (3239) (3235) (3320) (3328) (3584) (3165) 0.05/0 0/0 0/0 0.27/0.24 0.09/0 0/0 0/0 0.27/0.24 Unaffiliated (%) (0.13) (0.00) (0.00) (0.18) (0.16) (0.00) (0.00) (0.18) 0.03/0 0/0 0.27/0.22 0/0 0.04/0 0/0 0.23/0.19 0/0 Network (%) (0.10) (0.00) (0.19) (0.00) (0.11) (0.00) (0.17) (0.00) 0.92/1 1/1 0.73/0.78 0.73/0.76 0.87/1 1/1 0.77/0.81 0.73/0.76 Principal (%) (0.16) (0.00) (0.19) (0.18) (0.18) (0.00) (0.17) (0.18)

Panel B: Categorical Variables Total Sample PSM Sample Variables Group Audits Principal Only Network Unaffiliated Group Audits Principal Only Network Unaffiliated Mean Mean Mean Mean Mean Mean Mean Mean OPINION 25% 26% 15% 30% 25% 23% 20% 32% BEATS_LYR 9% 9% 14% 9% 10% 11% 13% 9% MISSES_LYR 7% 7% 10% 7% 7% 7% 9% 7% BEATS_BE 4% 4% 8% 3% 4% 4% 7% 3% MISSES_BE 3% 3% 3% 2% 3% 3% 4% 2% GICS_sector10 15% 15% 12% 15% 16% 16% 14% 17% GICS_sector20 12% 11% 18% 13% 14% 14% 17% 13% GICS_sector25 11% 10% 19% 10% 12% 12% 18% 9% GICS_sector30 3% 3% 6% 1% 2% 2% 3% 1% GICS_sector35 9% 8% 9% 10% 9% 10% 7% 10% GICS_sector45 7% 6% 9% 8% 7% 7% 10% 7% GICS_sector50 2% 2% 0% 2% 2% 1% 0% 3% GICS_sector55 2% 2% 1% 2% 2% 2% 1% 2% y2008 23% 24% 23% 22% 23% 23% 23% 24% y2009 26% 26% 26% 25% 25% 25% 26% 24% y2010 26% 25% 26% 29% 27% 27% 27% 27% y2011 25% 25% 25% 24% 25% 25% 24% 25% LOSS 65% 69% 43% 65% 62% 62% 50% 69% NEGEQ 3% 3% 2% 2% 2% 3% 2% 2% MINING 40% 43% 27% 38% 35% 36% 29% 38% YE 12% 10% 20% 14% 14% 13% 20% 12% LOSS 65% 69% 43% 65% 62% 62% 50% 69% BIG4 41% 38% 79% 30% 44% 44% 73% 29% LARGENONBIGN 42% 44% 18% 50% 42% 41% 24% 52% SMALLNONBIGN 17% 18% 2% 20% 14% 16% 3% 18% Unaffiliated 19% 0% 0% 100% 34% 0% 0% 100% Network 11% 0% 100% 0% 16% 0% 100% 0% Principal 70% 100% 0% 0% 50% 100% 0% 0% D_pF_AustraliaPacific 41% 31% 73% 58% 56% 52% 66% 58% D_pF_MiddleEast 0% 0% 1% 1% 0% 0% 0% 0% D_pF_Other 8% 6% 14% 11% 10% 11% 9% 10% D_pF_ASIA 8% 4% 21% 17% 11% 12% 11% 11% D_pF_EUROPE 8% 4% 19% 14% 11% 12% 12% 10% D_pF_AFRICA 3% 1% 3% 7% 4% 4% 2% 4% D_pF_NORTHAMERICA 11% 7% 26% 18% 17% 17% 17% 16% D_pF_SOUTHAMERICA 1% 1% 3% 3% 2% 2% 2% 2%

Table 3: Group Audit Fee Models for Total Sample and Total Propensity Score Matched Sample

Total Sample PSM Sample Groups Groups Groups Groups

(n=4,335) (n=4,335) (n=1,852) (n=1,852) 0.459 0.521 2.061*** 2.071*** Intercept (1.403) (1.582) (14.03) (13.76) 0.387*** 0.384*** 0.364*** 0.360*** LTA (33.59) (33.63) (24.33) (24.49) 0.348*** 0.343*** 0.164*** 0.166*** LSUB (10.27) (9.987) (9.540) (9.463) 0.447*** 0.443*** 0.264*** 0.265*** CATA (11.97) (11.80) (6.623) (6.868) -0.0164*** -0.0163*** -0.0115*** -0.0116*** QUICK (-13.62) (-13.22) (-6.249) (-6.632) 0.105*** 0.105*** 0.176*** 0.169*** LEVERAGE (3.644) (3.498) (5.974) (5.331) -0.0888*** -0.0894*** -0.0935*** -0.0960*** ROI (-4.775) (-4.769) (-4.282) (-4.902) 1.227*** 1.181*** 0.320*** 0.291*** FOREIGN (6.119) (5.909) (4.435) (3.824) 0.146*** 0.147*** 0.171*** 0.172*** OPINION (9.019) (8.649) (6.689) (7.001) 0.0483 0.0492 0.0774* 0.0762* YE (1.359) (1.394) (1.775) (1.846) -0.0318 -0.0310 0.0208 0.0200 LOSS (-1.021) (-0.991) (0.480) (0.486) 0.317*** 0.328*** 0.315*** 0.348*** BIG4 (6.162) (7.185) (3.898) (4.812) 0.0429 0.0451 -0.00437 -0.000470 LARGENONBIGN (1.304) (1.365) (-0.123) (-0.0128) 0.125*** 0.121*** 0.0593 0.0613 MINING (4.116) (3.941) (1.039) (1.088) 1.87e-06 1.82e-06 2.07e-06 1.94e-06 SUBGDP (1.560) (1.502) (1.612) (1.476) -5.08e-06 -4.46e-06 -3.16e-06 -2.57e-06 SUBPROX (-1.016) (-0.896) (-0.607) (-0.512) -0.0212*** -0.0213*** -0.0195* -0.0194* AGROWTH (-3.023) (-2.913) (-1.945) (-1.816) 0.173*** 0.173*** 0.267*** 0.265*** ABSDA (2.677) (2.673) (5.755) (5.018) -0.121*** -0.117*** -0.125* -0.112 ADTCHANGE (-2.592) (-2.639) (-1.658) (-1.570) 0.704*** 0.679*** LAMBDA (5.570) (5.374) 1.172*** 0.888*** 0.967*** 0.676*** NETWORK (%) (13.70) (9.390) (8.947) (5.258) 0.819*** 0.894*** 0.854*** 0.983*** UNAFFILIATED (%) (10.54) (15.21) (8.543) (13.87) 0.365*** 0.422* NETWORK (%) × BIG4 (2.663) (1.651) -0.354 -0.639** UNAFFILIATED (%) × BIG4 (-1.579) (-2.108) Year and Industry Fixed Effects Yes Yes Yes Yes Adjusted R-squared 83.50% 83.60% 81.70% 81.90%

Table 4: Group Audit Fee Models for Other Component Auditor and Propensity Score Matched Sample Other Auditor Sample PSM Sample Other Auditors Other Auditors Other Auditors Other Auditors

(n=1,279) (n=1,279) (n=568) (n=568) 0.934** 1.042** 2.035*** 2.004*** Intercept (2.220) (2.569) (10.06) (11.66) 0.403*** 0.400*** 0.371*** 0.372*** LTA (15.18) (15.29) (13.23) (13.10) 0.328*** 0.319*** 0.257*** 0.256*** LSUB (8.234) (8.036) (6.526) (6.448) 0.354*** 0.355*** 0.246** 0.269** CATA (5.314) (5.248) (2.167) (2.407) -0.0177*** -0.0176*** -0.0159*** -0.0146*** QUICK (-7.915) (-8.124) (-8.427) (-7.387) 0.0943** 0.0904** 0.0700 0.0720 LEVERAGE (2.237) (2.374) (0.784) (0.817) -0.0671 -0.0717 -0.0620 -0.0745 ROI (-1.422) (-1.548) (-0.973) (-1.147) 1.332*** 1.239*** 0.747*** 0.650*** FOREIGN (5.092) (4.863) (7.707) (6.132) 0.145*** 0.152*** 0.203*** 0.222*** OPINION (3.035) (3.077) (3.134) (3.129) 0.00308 0.0117 -0.000998 0.00288 YE (0.0644) (0.252) (-0.0201) (0.0544) 0.0168 0.0183 0.0331 0.0187 LOSS (0.336) (0.353) (0.533) (0.288) 0.155** 0.116 0.255** 0.177 BIG4 (1.976) (1.410) (2.205) (1.505) -0.0183 -0.00867 -0.00838 0.00838 LARGENONBIGN (-0.367) (-0.168) (-0.0595) (0.0551) 0.133*** 0.123*** 0.0654 0.0509 MINING (2.804) (2.698) (0.746) (0.594) 4.17e-06*** 4.23e-06*** 2.88e-06*** 3.04e-06*** SUBGDP (3.008) (2.963) (2.771) (2.624) -2.27e-05*** -2.03e-05*** -1.92e-05** -1.32e-05 SUBPROX (-3.961) (-3.474) (-2.291) (-1.642) -0.0272*** -0.0272*** -0.0199 -0.0229 AGROWTH (-2.873) (-2.722) (-1.074) (-1.355) 0.217 0.230 0.320 0.320 ABSDA (1.389) (1.587) (1.459) (1.524) -0.102** -0.106** -0.169*** -0.197*** ADTCHANGE (-2.038) (-2.009) (-3.840) (-4.475) 0.570*** 0.532*** LAMBDA (3.386) (3.265) 0.600*** 0.154 0.467*** 0.352 NETWORK (%) (6.793) (1.133) (4.083) (1.445) 0.210 UNAFFILIATED (%) (1.237) 0.642*** 0.499* NETWORK (%) × BIG4 (3.531) (1.891) 0.422*** UNAFFILIATED (%) × BIG4 (2.782) Year and Industry Fixed Effects Yes Yes Yes Yes Adjusted R-squared 86.00% 86.10% 82.90% 83.20%

Variables are defined in Table 1. *** p<0.01, ** p<0.05, * p<0.10. All tests are two-tailed. Industry indicator variables are included but are not reported. All models are estimated using robust standard errors clustered by client and year (Petersen 2009). 42

Table 5: Discretionary Accruals Models for Total Sample and Propensity Score Matched Sample Total Sample PSM Sample

(n=4,335) (n=2,209) (n=2,126) (n=1,852) (n=915) (n=937) 0.169*** 0.155*** 0.131*** 0.122*** 0.0519 0.102*** Intercept (6.039) (4.170) (4.663) (4.759) (1.169) (2.984) -0.000257*** -0.000126 -0.000278* -0.000221** -1.93e-05 -0.000359* AGE (-2.869) (-1.532) (-1.703) (-2.507) (-0.0902) (-1.945) 0.00383** 0.00314 0.0106*** 0.000880 -0.000676 0.00966** GROWTH (2.467) (0.980) (17.86) (0.524) (-0.129) (2.166) 0.00755 0.00161 0.0204* 0.0431* 0.0731*** 0.0325* INDGROWTH (0.793) (0.473) (1.919) (1.961) (5.810) (1.779) -0.120*** -0.245*** 0.0728*** -0.118*** -0.251*** 0.0484** Performance (-10.03) (-12.30) (3.812) (-6.187) (-7.734) (2.546) -0.0149*** -0.00688*** -0.0214*** -0.0132*** -0.00537** -0.0168*** LTA (-9.027) (-4.375) (-7.971) (-6.271) (-2.133) (-4.937) 0.0489*** 0.00338 0.0655*** 0.0404*** 0.0123 0.0616*** LEVERAGE (7.089) (0.283) (8.150) (9.132) (0.901) (5.668) -0.0359*** -0.0755*** 0.0179 -0.0433*** -0.0842*** 0.00899 LOSS (-3.984) (-15.68) (1.200) (-5.733) (-18.55) (0.544) -0.00970*** -0.00593** -0.0125*** -0.00997*** -0.00612** -0.0153*** PPEGrowth (-4.465) (-2.519) (-12.53) (-5.711) (-2.143) (-4.661) 0.00795 -0.00618 0.0175*** 0.00171 -0.00856 0.00283 BIG4 (1.374) (-1.177) (3.205) (0.235) (-1.048) (0.188) 0.00843** 0.00440 0.0107** 0.00640 0.00250 0.00246 LARGENONBIGN (2.334) (0.918) (1.969) (0.930) (0.302) (0.564) -0.0161*** -0.0164*** -0.00834** -0.0268*** -0.0170* -0.0200*** MINING (-5.778) (-4.033) (-2.113) (-4.362) (-1.716) (-3.066) 6.54e-07*** 4.95e-07*** 8.28e-07*** 4.87e-07* 4.35e-07* 6.13e-07** SUBGDP (3.708) (2.628) (4.026) (1.945) (1.815) (2.046) -1.68e-08 -2.83e-07 4.86e-08 1.07e-06 6.51e-07 1.50e-06 SUBPROX (-0.0136) (-0.156) (0.0547) (0.932) (0.380) (1.384) -0.0207*** -0.0141* -0.0283*** LAMBDA (-4.383) (-1.760) (-3.499) 0.0211*** 0.0520** 0.00893 0.0329* 0.0552*** 0.0265 NETWORK (%) (4.305) (2.532) (0.681) (1.805) (2.585) (1.613) -0.0101 -0.00447 -0.00676 -0.0251 -0.0169 -0.0198 UNAFFILIATED (%) (-0.833) (-0.296) (-0.208) (-1.411) (-0.791) (-0.583)

Year and Industry Fixed Effects Yes Yes Yes Yes Yes Yes Adjusted R-squared 21.10% 43.90% 17.50% 21.20% 43.10% 18.00%

Table 6: Going Concern Models for Total Sample and Other Component Auditor Sample

PSM Financially Financially Financially PSM Financially Distressed Distressed Distressed Other Distressed Other Groups Groups Groups Groups (n=2,843) (n=1,155) (n=734) (n=294) 0.676 0.942* 0.414 1.880 Intercept (1.564) (1.927) (0.560) (1.585) 1.729*** 1.781** 2.035** 5.453*** PBANK (3.337) (2.300) (2.133) (3.080) -0.312*** -0.397*** -0.372*** -0.648*** LTA (-6.608) (-5.582) (-3.931) (-4.477) 0.344 0.890 0.116 -0.0314 LEVERAGE (1.086) (1.561) (0.181) (-0.0274) -0.980*** -0.884 0.236 -1.193 CHGLEV (-3.307) (-1.630) (0.337) (-0.884) 0.0383*** -0.00661 -0.0656* -0.0113 CURRENT (2.752) (-0.293) (-1.902) (-0.271) -2.500*** -2.368*** -2.618*** -4.973*** WC (-10.21) (-6.135) (-5.086) (-5.900) -0.102*** -0.0350 0.0359 -0.00715 QUICK (-4.394) (-0.992) (0.777) (-0.0992) -0.597*** -0.621*** -0.592** -0.502 ROA (-5.283) (-3.337) (-2.197) (-1.100) -0.0494 -0.666 0.477 -0.310 NEGEQ (-0.110) (-0.845) (0.523) (-0.236) -0.288** -0.141 0.0210 0.0712 BIG4 (-2.005) (-0.598) (0.0659) (0.101) -0.0620 0.0627 0.467* 0.760 LARGENONBIGN (-0.484) (0.301) (1.653) (1.059) 0.0195 0.0975 -0.0234 -0.193 MINING (0.146) (0.473) (-0.0933) (-0.400) -9.78e-06* -1.03e-05* -1.10e-05 -1.70e-05 SUBGDP (-1.874) (-1.715) (-1.337) (-1.290) 4.48e-05* 2.72e-05 9.46e-05*** 0.000129** SUBPROX (1.783) (1.059) (2.649) (2.362) 0.259* 0.368 LAMBDA (1.664) (1.141) -0.715 -0.0241 -1.352** -2.495** NETWORK (%) (-1.311) (-0.0353) (-2.051) (-2.540) 0.531 0.727* UNAFFILIATED (%) (1.544) (1.762) Year and Industry Fixed Effects Yes Yes Yes Yes Pseudo R -squared 23.00% 23.60% 24.70% 37.00%