Do Operations in Corrupt Foreign Countries Affect Auditor Behavior

Auditors are required by the Foreign Corrupt Practices Act and other rules to evaluate the probability that a firm’s management bribes foreign government officials. If the auditors comply with these rules by assessing higher audit risk for firms with operations in corrupt foreign countries, we would expect to observe a positive association between operations in corrupt foreign countries and auditor effort evident in higher audit fees. However, in the other direction, a firm may generate considerable economic benefits by committing foreign bribery. Such economic benefits reduce an auditor’s perceived business risk of the firm, potentially leading to lower audit fees. In analyzing a sample of U.S. multinational firms, we document that having operations in more corrupt foreign countries is negatively associated with audit fees. In cross-sectional evidence consistent with expectations, we find that the negative link between operations in corrupt countries and audit pricing is concentrated in firms with strong political connections known to lighten enforcement, poor internal controls conducive to hiding foreign bribery, and subsidiaries in host countries that refrain from joining a major international anti-corruption cooperation agreement. Our research has implications for the PCAOB which is considering issuing additional guidance concerning auditors’ responsibilities surrounding clients’ possible illegal acts.