Auditors’ assessment of the capital market liability of foreignness

• Published in: Review of accounting & finance 2018-01, Vol.17 (1), p.109-129
• Main Authors: Smith, Deborah Drummond, Gleason, Kimberly C, Wiggenhorn, Joan, Kannan, Yezen H
• Format: Article
• Language: English
• Subjects: Accounting; Accounting firms; Asymmetry; Audit fees; Audit quality; Audit risk; Audited financial statements; Auditors; Bias; Capital markets; Corporate governance; Costs; Cultural differences; Fees & charges; Foreign business; International business; International Financial Reporting Standards; Investments; Liability; Litigation; Perceptions; Regulation; Reporting requirements; Stockholders
• ISSN: 1475-7702; 1758-7700
• DOI: 10.1108/RAF-06-2016-0090

Purpose This paper aims to apply the Capital Market Liability of Foreignness (CMLOF) framework to the audit fees of a sample of foreign firms listed on US exchanges to examine whether American auditors price foreignness. Design/methodology/approach The four components of the CMLOF are institutional distance (civil versus common law system and enforcement), information asymmetry (disclosures and mandatory IFRS adoption), unfamiliarity (exports, English language and geographical distance) and cultural difference [Hofstede (1980) dimensions of culture]. These variables are examined in a regression model that explains audit fees to determine the auditor perception of risk associated with the CMLOF. Findings Examining the factors that mitigate perceived agency costs, this investigation determines that auditors price risk according to each component of the liability of foreignness. Audit fees are higher for shareholders of firms headquartered in countries exhibiting greater institutional distance, unfamiliarity and cultural distance. Audit fees are higher for firms when their home country requires additional disclosures or the adoption of IFRS to reduce information asymmetry. Practical implications CMLOF is costly for capital market participants and has implications for auditors, shareholders of foreign firms and managers considering listing in the US Auditors, and investors should carefully assess this risk for pricing and valuation, and managers should take action, to the extent possible, to reduce the firm-specific level of unfamiliarity and increase transparency. Originality/value This paper is the first to apply the CMLOF to examine whether auditors price aspects of foreignness of their non-US-headquartered clients.