Essays in audit quality and earnings quality in business groups

The aim of this thesis is to fill some of the gaps in the audit quality/pricing and financial reporting quality literatures by showing how group audit composition and parent-subsidiary relationships can explain group-level outcomes. Empirical proxies we observe for constructs such as audit risk, audit quality and earnings quality depend on the regulatory setting, and on the management/auditor decisions and incentives in both the parent company and group subsidiaries. Yet, the majority of accounting and auditing research has focused on group-level outcomes largely due to the non-availability of granular financial reporting or audit data at the subsidiary level, especially in the United States. In this thesis, I exploit the availability of private company subsidiary data in Europe to answer three main research questions that can be of interest to both regulators and financial statements’ users. In the first chapter, I investigate whether and how unaudited subsidiaries affect the overall group audit quality. I find that unaudited subsidiaries impair group audit quality and that this result is likely driven by group auditors underestimating audit risks when selecting the subsidiaries to be audited in a group. In the second chapter (co-authored), we try to understand whether group fee disclosure requirements and the misalignment between the parent auditor and subsidiary auditors can explain one of the most robust findings in the audit pricing literature, i.e., the audit fee low balling. We show that the first-year audit fee discount (low balling) is an artifact of a higher subsidiary auditor misalignment in the first year of the parent auditor’s appointment, with the fees paid to misaligned subsidiary auditors not being included and reported in group audit fees. In the last chapter, I show how the parent companies of listed domestic groups can conveniently locate earnings management in their domestic subsidiaries in order to manage group earnings, and I model the factors determining the location choice. I find that the earnings management location in the subsidiaries of domestic groups depends on the opportunities and risks of earnings management detection that subsidiaries have compared to the parent company.