Do global audit firm networks apply consistent audit methodologies across jurisdictions evidence from financial reporting comparability

THE ACCOUNTING REVIEW Vol 95, No November 2020 pp 151–179 American Accounting Association DOI: 10.2308/tar-2018-0294 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? Evidence from Financial Reporting Comparability Matthew S Ege Texas A&M University Young Hoon Kim George Mason University Dechun Wang Texas A&M University ABSTRACT: Brand name audit firms are global networks of local audit firms These networks claim to enforce consistent audit methodologies across their member firms, which, if true, should systematically affect client financial reporting We find that clients from different countries have more (less) comparable accruals when they are audited by local audit firms from the same global network (different global networks) Furthermore, inferences are similar when we examine client accrual comparability around audit firm switches induced by the failure of Andersen, which serves as a shock that helps improve identification In falsification tests, having auditors from the same global network is not associated with differences in operating cash flows Results also suggest that the role of global network methodologies in global financial reporting comparability is more pronounced across stronger investor protection jurisdictions and across jurisdictions that have adopted International Standards on Auditing JEL Classifications: M41; M42 Keywords: audit firm networks; comparability; investor protection; ISAs I INTRODUCTION T he largest audit firms have formed international networks so that each appears as one global firm, despite being a network of legally independent, individual firms The objective of these global networks is to coordinate the development and enforcement of a given audit firm’s global strategies, standards, policies, and governance For example, PricewaterhouseCoopers (PwC) International Limited states that the network’s common ‘‘methodologies, technologies, and materials are designed to help member firms, partners and staff perform their work more consistently, and support their compliance with the way PwC does business.’’1 In this study, we examine whether global networks enforce unique global audit methodologies across their affiliates The authors acknowledge helpful comments from Michael Willenborg (editor), two anonymous reviewers, Richard Hanus, John McNamara, Joe Schroeder, and workshop participants at Texas A&M University and the 2018 Deloitte/University of Kansas Auditing Symposium All authors acknowledge support from the Mays Business School Matthew S Ege, Texas A&M University, Mays Business School, Department of Accounting, College Station, TX, USA; Young Hoon Kim, George Mason University, School of Business, Accounting Area, Fairfax, VA, USA; Dechun Wang, Texas A&M University, Mays Business School, Department of Accounting, College Station, TX, USA Editor’s note: Accepted by Michael Willenborg Submitted: May 2019 Accepted: November 2019 Published Online: November 2019 See: https://www.pwc.com/gx/en/about/global-annual-review-2017/how-we-do-it.html 151 152 Ege, Kim, and Wang Auditors use judgment when following auditing standards because these standards ‘‘are generally principles-based rather than prescriptive’’ (Sunderland and Trompeter 2017, 160) Audit firms develop methodologies to provide guidance on how to adhere to auditing standards and enable their network-wide enforcement.2 Otherwise, each local audit firm would be free to audit based on local incentives, potentially resulting in undesired variation in audit quality across jurisdictions Enforcing a consistent audit methodology across borders is important to the U.S equity market because foreign affiliates of global networks regularly audit Securities and Exchange Commission (SEC) registrants The Public Company Accounting Oversight Board (PCAOB) has identified many instances of insufficient auditing during inspections of foreign affiliates.3 The PCAOB’s (2015) concerns about insufficient audit quality partially drove the recent requirement to disclose foreign affiliate participation in audits of SEC registrants International markets have also experienced instances of insufficient auditing that not comply with global network standards, such as in the corporate failures at Parmalat in Italy and Satyam in India (Carson 2014) Challenges related to the consistent application of global audit methodologies include local incentives, differences in litigation risk and culture, and network coordination problems (Lenz and James 2007; Sunderland and Trompeter 2017; Bik and Hooghiemstra 2018; Financial Reporting Council [FRC] 2018) On top of this, there is no global enforcer of auditing standards or quality (Carson 2014), and prior literature documents variation in audit quality across countries (e.g., Michas 2011; Francis, Michas, and Seavey 2013) and across and within global networks (e.g., Carson 2009; Dee, Lulseged, and Zhang 2015; Downey and Bedard 2019) This suggests that global networks may be unable to ensure consistent application of their unique audit methodologies across their affiliates We focus our study on the global networks of BDO, Deloitte, Ernst & Young (EY), Grant Thornton, KPMG, and PwC (hereafter, the Big 6) because (1) each describes its global reach and global audit methodology on its respective website, and (2) regulators, such as the PCAOB, identify these six as ‘‘global networks.’’4 Each has a unique audit methodology that is supported by resources such as ‘‘global knowledge management databases and common industry-specific work programs and training’’ (Carson 2009, 356) Also, the Big have formal monitoring mechanisms to enforce the consistent application of their audit methodologies across their affiliates.5 If each global network does enforce a unique audit methodology, then client financials of affiliates within a network should be more comparable, relative to those of affiliates of different global networks.6 Comparability is one of the four qualitative characteristics that enhance the fundamental qualities of financial reporting (Financial Accounting Standards Board [FASB] 2010).7 Higher comparability significantly improves the decision usefulness of accounting information, especially with respect to capital allocation across countries (DeFond, Hu, Hung, and Li 2011; Barth, Landsman, Lang, and Williams 2018) Global network enforcement of a unique audit methodology should result in greater comparability because the ‘‘unique character of audit methodologies implies that each firm’s audit approach will systematically detect or not detect the same client errors, including GAAP implementation errors’’ (Francis, Pinnuck, and Watanabe 2014, 609) We follow Francis et al (2014, 606) and define comparability as ‘‘the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms.’’ Auditors have more influence over the accounting for accruals than cash flows, given the judgment required in the accruals processes (Nelson, Elliott, and Tarpley 2003; Jones 1991; Dechow and Dichev 2002) Therefore, we test whether the Big networks enforce global audit methodologies by using four accruals-based measures of comparability Three of these are based For example, upon the merger of Price Waterhouse and Coopers & Lybrand, firm leadership developed a global methodology that addressed ‘‘the need to have one consistent global approach’’ (Winograd, Gerson, and Berlin 2000, 175) For example, see Ferguson (2015), PCAOB (2015), and Goelzer (2011) Also, in 2016, it fined Deloitte Brazil $8 million for issuing false audit reports, suggesting that Deloitte failed to monitor and enforce its global methodology within its Brazilian affiliate In 2018, the PCAOB sanctioned Deloitte Mexico partners who misrepresented the nature of the audit procedures they performed to Deloitte U.S (PCAOB 2018) See: https://pcaobus.org/Registration/Firms/Pages/GlobalNetworkFirms.aspx (last accessed September 23, 2019) Each of the six global networks has affiliate firms in at least 140 countries based on disclosures from their websites However, not all of these are registered with the PCAOB According to the PCAOB website, the number of global network affiliate firms that are registered with the PCAOB as of 2017 are: BDO (54), Deloitte (62), EY (70), Grant Thornton (47), KPMG (52), PwC (64) For example, EY (2017a, 5) has a ‘‘Global Audit Quality Committee [that] monitors and oversees quality globally.’’ If auditors consistently implement a set of procedures, then the output should be consistent accounting treatments for similar economic transactions Although consistently implemented procedures could result in overall low-quality financial reporting, this seems unlikely due to market forces (e.g., regulatory oversight, market demand) Thus, we think it is appropriate to conclude that greater cross-country financial reporting comparability among a global network’s clientele is evidence of the auditor enforcing a consistent audit methodology, which should promote high-quality audits This does not mean that audit quality will always be sufficient for regulators or markets because the audit methodology could consistently miss certain types of errors or consistently treat a certain transaction in a way that is inconsistent with a financial reporting framework However, if global networks did not enforce (at least to a certain extent) a global audit methodology, then local audit firms would have much more leeway to audit according to local incentives, all else equal This would not result in increased financial reporting comparability or high audit quality across the auditor’s global network Specifically, FASB (2010, 29) states that ‘‘one of the most important reasons that financial reporting standards are needed is to increase the comparability of reported financial information However, even if it is not readily comparable, relevant and faithfully represented information is still useful Comparable information, however, is not useful if it is not relevant and may mislead if it is not faithfully represented Therefore, comparability is considered an enhancing qualitative characteristic instead of a fundamental qualitative characteristic.’’ The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 153 on differences in actual or predicted accruals The fourth is based on the covariance of accruals over 16 quarters We compare these measures between cross-jurisdictional client-pairs that use audit firms from the same versus different global networks Our sample comes from the Compustat, Global Compustat, and Capital IQ databases and comprises 83,455 client-years from 93 countries for years 2003 to 2016 This results in 2,123,959 client-year pairs, of which 429,348 have auditors that are affiliates of the same global network Using multiple regression analysis, we find consistent evidence that two companies from different jurisdictions have more comparable accruals when their auditors are from the same global network From an economic perspective, client-pairs that have affiliate auditors from the same network have comparability measures that are 1.1 percent to 7.5 percent higher than the median To help rule out the alternative explanation that results are due to clients selecting auditors based upon audit methodology (i.e., client-auditor matching), we use the failure of Andersen U.S as a shock Upon the failure of Andersen U.S., its foreign affiliates joined other global networks, resulting in their clients being subject to new audit methodologies We find that differences in accruals between former Andersen clients and clients of the audit firm that audits these former Andersen clients become smaller after Andersen’s demise Additionally, for a broader sample of switches where client-pairs come to have affiliate auditors from the same (different) global network, we find some evidence that accruals comparability increases (decreases) after the audit firm change Because investor protection affects financial reporting characteristics (e.g., Ball, Kothari, and Robin 2000), we next consider whether investor protection strength affects the magnitude of the effect of global audit methodologies on client financial reporting comparability The repercussions to audit firms for not following audit methodologies are more severe in stronger investor protection regimes, but stronger investor protection potentially affects earnings quality, such that the audit methodologies of global networks may matter less for client financials In 18 of 24 specifications, we find evidence consistent with global network methodologies playing more of a role in financial reporting comparability across jurisdictions with higher investor protection We also consider whether the adoption of International Standards on Auditing (ISAs) affects the extent that local affiliates implement global network audit methodologies The global networks base their audit methodologies on the ISAs Therefore, in jurisdictions that implement ISAs, local auditors are encouraged to follow ISAs both by their jurisdiction and their global network Our results suggest that network methodologies play more (less) of a role in financial reporting comparability across jurisdictions that have adopted (have not adopted) ISAs As a falsification test, we examine whether client-pairs having auditors from the same global network are associated with differences in operating cash flows Global audit methodologies are less likely to include unique procedures for the audit of cash, which requires much less judgment to audit versus accruals Thus, global audit methodologies should have little, if any, effect on the comparability of cash flows We find no effect of client-pairs having auditors from the same global network on differences in operating cash flows Finally, we execute several additional tests that provide insights into the robustness of the results We contribute to the international audit literature in important ways This literature has primarily focused on how international expertise (e.g., Carson 2009; Gunn and Michas 2018) and country-specific institutional factors (e.g., Choi, Kim, Liu, and Simunic 2008; Francis and Wang 2008; Michas 2011; Francis et al 2013; Bronson, Ghosh, and Hogan 2017) affect audit quality However, we know little about whether global networks seek to ensure worldwide audit quality, which matters because of the growing number of audit engagements involving multiple global network affiliates Our paper also extends Francis et al (2014), who find evidence that suggests that the Big have unique audit methodologies within the United States Enforcing a unique audit methodology across jurisdictions is challenging (Lenz and James 2007; Sunderland and Trompeter 2017; Bik and Hooghiemstra 2018; FRC 2018) We provide evidence that suggests that global networks enforce unique global audit methodologies, and that enforcement varies across jurisdictions This paper also contributes to the literature on cross-country comparability (e.g., Barth, Landsman, Lang, and Williams 2012; Fang, Maffett, and Zhang 2015) We examine the role of global auditors, as economic agents that directly participate in the production of financial information, in the comparability of reported earnings across countries Thus, we contribute to U.S.based evidence of the role of common auditors in information production (Cai, Kim, Park, and White 2016; Dhaliwal, Lamoreaux, Litov, and Neyland 2016; Francis et al 2014) Our results should be of interest to academics, auditors, standard setters, and regulators For example, the International Auditing and Assurance Standards Board (IAASB 2014 is dedicated to ‘‘enhancing the quality and consistency of practice throughout the world’’ (emphasis added) Also, both the PCAOB and the Financial Reporting Council (FRC 2018) of the United Kingdom have expressed concerns about the audit quality of global network affiliates Our evidence suggests that while global networks enforce, on average, a consistent audit methodology that should provide a foundation on which to execute high-quality audits, there is potentially variation in execution across jurisdictions Without enforcement of global auditing standards by a uniform global regulator, audit firm networks become the quasi-enforcer of these standards globally (Carson 2014) As Carson (2014, 28) points out, ‘‘Of particular importance to both IFAC and the IAASB are the global firm networks that hold the main responsibility for implementation of the standards developed as well as the moral guidance and leadership of the audit profession, especially in countries where the quality of audit practice has been regarded as sub-optimal.’’ The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 154 II INSTITUTIONAL BACKGROUND AND HYPOTHESIS DEVELOPMENT Global Audit Firm Networks The largest six global audit firm networks are BDO, Deloitte, EY, Grant Thornton, KPMG, and PwC.8 Their reach expanded significantly during the 1980s and 1990s, when numerous local audit firms joined the international networks (Nobes and Parker 2008).9 The members (also known as affiliate firms) of these networks are locally owned and operated and maintain legal and economic independence (Lenz and James 2007) For example, Deloitte U.S and Deloitte Norway are member firms of Deloitte Touche Tohmatsu Limited (DTTL) All the member firms of DTTL ‘‘are legally separate and independent entities, which cannot obligate each other DTTL and each DTTL member firm are liable only for their own acts and omissions’’ (Deloitte 2017) Members must adopt network policies and abide by governance rules and codes of conduct.10 Each network has a unique audit methodology and a system of quality controls to monitor adherence to it For example, each is a member of the Forum of Firms and has committed to ‘‘promote the consistent application of high-quality audit practices and standards worldwide’’ and ‘‘maintain quality control standards in accordance with the International Standards on Quality Control’’ (see: https://www.ifac org/about-ifac/forum-firms-and-transnational-auditors-committee/forum-firms-membership).11 As part of their global quality control standards, each network executes internal inspections of affiliates for compliance with global policies and procedures.12 Through inspection of affiliates, consistent use of technology, and common training, each global network seeks to ensure the consistent application of its global audit methodology The global methodologies contain ‘‘different steps [that] are narrowly defined and detailed prescriptions for the approach to auditing; for instance, descriptions of the planning process, the process of evaluating risks, the approach to testing’’ (Nobes and Parker 2008, 487).13 The global networks are ‘‘where accounting practices emerge, become standardized and regulated, where accounting rules and standards are translated into practice, and where professional identities are mediated, formed and transformed’’ (Cooper and Robson 2006, 416) Thus, the goal of these methodologies is to facilitate the delivery of consistent, high-quality audits across all member firms.14 Related Literature and Hypotheses Development Global Audit Firm Networks and Financial Reporting Comparability Our research question primarily relates to two streams of literature The first explores variation in audit quality of affiliates of large global audit firms and finds that audit quality varies across countries and across and within the global networks For example, the development of the audit profession within emerging market countries is positively associated with audit quality (Michas 2011); auditor multinational expertise of U.S audit offices is positively associated with audit quality for U.S multinational clients (Gunn and Michas 2018); and Big market share in a country is positively associated with audit quality, but concentration within the Big in a country is negatively associated with audit quality (Francis et al 2013) 10 11 12 13 14 A global audit network is defined as ‘‘a contractual cooperation between legally and economically autonomous national audit firms, which are organized based on partnership principles under the strategic leadership of one or more member firms for the joint fulfilment of international client needs’’ (Lenz and James 2007) There were also several mergers between international networks that occurred during this time frame, as well as the failure of Andersen, which has resulted in the six networks noted here Lenz and James (2007) discuss in detail the responsibilities of member firms as they relate to the global network The Big networks were also ‘‘Founder Members’’ of the Forum of Firms (International Federation of Accountants [IFAC] 2015; Carson 2009, footnote 15) Global networks monitor compliance with numerous network-wide policies For example, in its annual review report, PwC (2017) states that ‘‘each PwC member firm’s Territory Senior Partner signs an annual confirmation of compliance with PwC’s standards These confirmations cover a range of areas, including independence, ethics and business conduct, enterprise risk management, governance, anti-corruption, anti-money laundering, anti-trust, insider trading and information protection.’’ There are different auditing standards throughout the world The ISAs are the most widely adopted, with 125 countries committed to their use (based on http://www.iaasb.org/clarity-center/support-and-guidance [last accessed April 2, 2018]) Other standards exist, such as standards for U.S public company audits from the PCAOB Global networks create their global audit methodologies based on ISAs and supplement the methodologies with requirements from local standards where applicable (e.g., PCAOB internal control testing for U.S public companies) While audit teams may have to adapt global audit methodologies for specific audits, our understanding is that this is rare and does not affect clients in the vast majority of markets As an example of the goal of consistency, EY (2017b, 22) has developed a Sustainable Audit Quality program that is implemented across all member firms and ‘‘helps drive consistency in execution.’’ EY (2017b) states that the program includes ‘‘technology, tools and training, accountability metrics, evaluating and rewarding our people.’’ Additionally, within 100 days of the merger of Price Waterhouse and Coopers & Lybrand, ‘‘all 60,000 Assurance professionals in 150 countries were trained on the [PwC Audit Approach] through a three-day training course delivered at the localoffice’’ (Winograd et al 2000, 176) The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 155 The second line of literature examines the determinants of financial reporting comparability and has focused on accounting standards and monitoring of economic agents For example, the adoption of international financial reporting standards (IFRS) by non-U.S companies is positively associated with financial reporting comparability with U.S companies (Barth et al 2012), and IFRS adoption is positively associated with financial reporting comparability within European Union countries (Yip and Young 2012) Fang et al (2015) find that foreign institutional ownership is positively associated with financial reporting comparability in emerging markets, as it relates to U.S companies, and that hiring Big auditors is a potential mechanism through which financial reporting becomes more comparable Francis et al (2014) find that client-pairs from the same U.S Big auditor have more comparable earnings compared to client-pairs from different U.S Big auditors, which is consistent with each of these auditors enforcing a unique audit methodology or ‘‘style.’’ Our focus is on whether global networks enforce their unique global audit methodologies across their affiliates Our expectation is that they and, therefore, we expect to observe greater comparability within cross-country client-pairs with auditors from the same global network versus with auditors from different global networks Our expectation is based on two reasons First, ‘‘each accounting firm must devise its own in-house working rules for the efficient and consistent implementation of [generally accepted auditing standards]’’ (Francis et al 2014, 609) Global networks develop these rules, which become part of their audit methodologies Relatedly, global networks provide access to an expanded set of resources, such as training, experts, and tools, that become part of each network’s global audit methodology For example, Carson (2009) finds that industry expertise in a global network is positively associated with audit fees This is consistent with expertise being embedded within global network audit methodologies, which then results in affiliates being able to charge more for this expertise Thus, we expect expertise related to how to account for and audit specific transactions to transfer across a global network via global audit methodologies, such that auditors from different affiliates from the same global network would audit similar transactions similarly This should lead to greater financial reporting comparability across clients of affiliate firms from the same global network Second, the networks have mechanisms and incentives to enforce the consistent application of their audit methodologies For example, global networks have quality control procedures (e.g., inspections across affiliates, common training, technology that monitors independence) Additionally, clients of non-Andersen U.S affiliates experienced negative abnormal returns on two key dates (i.e., January 10, 2002 and February 2, 2002) that revealed reputation-damaging news for the Andersen U.S affiliate (Cahan, Emanuel, and Sun 2009) This is consistent with reputation damage for one global network affiliate spilling over to other affiliates, which suggests that the networks have reputation incentives to enforce the consistent application of their methodologies.15 Therefore, affiliate auditors from the same global network are more likely to make similar judgments for similar transactions and consistently identify or miss certain errors for similar transactions based upon guidance in their network’s audit methodologies Our first hypothesis is stated in the alternative, as follows: H1: A pair of companies from different countries that are audited by affiliates of the same Big global audit firm network will have more comparable financial reporting than a pair of companies from different countries that are audited by affiliates of different Big global audit firm networks While we expect the Big global networks to enforce consistent audit methodologies across their affiliates, they may be unable to achieve this goal For example, their governance can be difficult and complicated (Lenz and James 2007), and local auditors may apply audit procedures through different cultural lenses, resulting in inconsistencies (Bik and Hooghiemstra 2018) Moreover, a global network mainly serves as a coordinating platform because the member firms are legally independent As such, and despite the presence of network-wide policies, members may have incentives to deviate from these policies.16 The Moderating Effect of Investor Protection Prior studies have shown that country-specific investor protection environment affects financial reporting and audit quality (e.g., Choi and Wong 2007; Fan and Wong 2005; Francis and Wang 2008; Leuz, Nanda, and Wysocki 2003) However, ex ante, it is unclear how investor protection affects the extent to which global networks implement global audit methodologies In stronger investor protection regimes, regulators and other forces shape earnings quality, such that companies and their local auditors consistently enforce accounting standards in accordance with the preferences of the local regime This leaves less room for the internal policies and rules of a particular global audit network to be observable in financial reporting outcomes This is consistent with Fang et al (2015), who find that in emerging markets where investor protection in weak, foreign equity 15 16 Nelson, Price, and Rountree (2008) find that the negative stock price reaction to the failure of Andersen U.S is attributable to confounding factors and not to reputation damage Thus, it is possible that the market response documented in Cahan et al (2009) is due to the market misinterpreting the failure of Andersen U.S as reputation-damaging See footnote for evidence that suggests that members have failed to comply with global audit methodologies The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 156 ownership by U.S institutional shareholders is positively associated with financial reporting comparability However, such a relation does not exist in developed countries where investor protection is strong Fang et al (2015, 598) propose that monitoring by institutional owners plays less of a role in ‘‘developed markets where regulatory institutions provide strong incentives for firms to voluntarily commit to high-quality reporting.’’ This suggests that there is more room for global network audit methodologies to affect financial reporting in weak investor protection regimes, where there are likely fewer local auditing and accounting rules However, auditors likely face greater repercussions for failing to follow their audit methodologies in stronger investor protection regimes For example, Francis and Wang (2008) suggest that large auditors increase audit quality as investor protection becomes stricter, because they have significant reputational and equity capital that is at risk when investors are better protected Thus, in low-investor protection regimes, local affiliates of global networks may have little incentive to properly execute audit procedures, suggesting that auditors would be more likely to adhere to global network audit methodologies as investor protection increases Thus, the effect of investor protection on audit firm adherence to global audit methodologies is unclear Our second hypothesis is non-directional and stated as follows: H2a: The extent of financial reporting comparability between a pair of companies from different countries that are audited by affiliates of the same Big global audit firm network does not vary with country-specific investor protection The Moderating Effect of International Standards of Auditing (ISAs) The ISAs are issued by the International Auditing and Assurance Standards Board (IAASB) As stated on the IAASB website, the IAASB issues ‘‘high-quality international standards for auditing’’ to enhance ‘‘the quality and consistency of practice throughout the world.’’17 Therefore, we expect that the adoption of ISAs should enhance global networks’ ability to better implement consistent audit methodologies across jurisdictions Specifically, if ISAs are adopted by local regulators, then the local auditor is encouraged by both the global network and the local jurisdiction to audit in accordance with ISAs This follows because the audit methodologies of the global networks are based on ISAs However, if ISAs are not required by the local regulators, then auditors may focus on the requirements of the local jurisdiction and be less likely to follow the prescriptions of their network audit methodology This logic suggests that the effect of having an auditor from the same global network on cross-country financial reporting comparability would be higher when clients are from jurisdictions that require ISAs However, and in contrast to the above, the effect of unique global network audit methodologies may be more significant across jurisdictions that not require ISAs When jurisdictions require ISAs, local audit firms may focus on jurisdictionspecific interpretations of ISAs If interpretations of ISAs are similar across jurisdictions, then there could be a reduction in differences in audit execution between affiliates from different global networks In other words, there could be more opportunity for a global network audit methodology to affect client financial reporting in jurisdictions that not enforce a particular set of auditing standards (e.g., ISAs) Our last hypothesis is non-directional and stated as follows: H2b: Financial reporting comparability between a pair of companies from different countries that are audited by affiliates of the same Big global audit firm network is no different when both countries have adopted ISAs compared to when both countries have not adopted ISAs III RESEARCH DESIGN Measure of Comparability Following Francis et al (2014, 606), we define comparability as ‘‘the closeness of two firms’ reported earnings due to the consistency with which rules are applied across firms.’’ We compare, across jurisdictions, the closeness of reported earnings for similar client-pairs due to the consistency with which rules are applied We create pairs of two client-years that are from different countries, yet are in the same industry, have the same fiscal year-ends, and are in the same country-year quintile rank of size Empirically, we compare the closeness of the level of accruals of client-pairs We focus on accruals because accruals have been viewed as the most discretionary (not necessarily opportunistic) component of earnings that can be more easily affected by 17 See: https://www.iaasb.org/about-iaasb The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 157 accounting policies and estimation errors (e.g., Jones 1991; Dechow and Dichev 2002) In other words, auditors can affect accruals more than cash flows.18 We measure accruals comparability in four ways First, following Francis et al (2014), we measure financial statement comparability using differences in total accruals and differences in abnormal accruals: À Á ð1Þ Diff TACCijt ¼ absolute value TACCit À TACCjt À Á Diff DACCijt ¼ absolute value DACCit À DACCjt ð2Þ where subscripts i and j denote two clients in a pair and t denotes year, respectively For parsimony, detailed variable definitions are provided in Appendix A Abnormal accruals (DACC) are measured using a linear expectation model, following DeFond and Park (2001) and Francis and Wang (2008).19 We provide an example of the calculations for each of the four comparability measures within Appendix B Next, because the prior two measures may capture the similarity of accounting outcomes, rather than the similarity of accounting systems (i.e., the mapping of transactions to accounting outcomes), we construct a measure capturing accounting system comparability, following the logic of Barth et al (2012).20 Specifically, we follow the basic idea of Dechow and Dichev (2002) and estimate the accounting mapping from past, present, and future operating cash flows to current accruals at the country-industry-auditor level.21 First, we estimate the relation between current accruals and past, current, and future operating cash flows separately at the country-industry-auditor level, as follows: CFA CFA CFA ỵ bCFA CACCit ẳ bCFA CFOi;t1 ỵ b2 CFOit ỵ b3 CFOi;tỵ1 ỵ eit 3aị This regression estimates the relation between current accruals and operating cash flows using company-years that are in the same country and industry and have the same auditor Superscripts denoted C, F, and A refer to country, industry (Fama-French 30), and auditor, respectively.22 We require each country-industry-auditor to have at least ten company-year observations Second, for each company in a client-pair, we calculate predicted current accruals using the coefficients from its own country-industry-auditor level estimation, and predicted current accruals using the coefficients from the paired company’s country-industry-auditor level estimation For example, for pair i-j, we calculate two predicted current accruals of company i, d CFAi and CACC d CFAj , using different vectors of coefficients bbCFAi and b^CFAj as follows: CACC it it d CFAi ẳ bbCFAi ỵ bbCFAi CFOi;t1 ỵ bbCFAi CFOit þ bbCFAi CFOi;tþ1 CACC it ð3bÞ d CFAj ẳ bbCFAj ỵ bbCFAj CFOi;t1 ỵ bbCFAj CFOit þ bbCFAj CFOi;tþ1 CACC it ð3cÞ Following the logic of Barth et al (2012), we assume that the estimated coefficients capture an auditor’s unique methodology   (i.e., their effect on the mapping of cash flows to accruals) The predicted current accruals for client i d CFAi are the expected outcome of the auditor who audits client i’s country-industry-auditor group In comparison, CACC it d CFAj represents hypothetical expected current accruals had client i been audited by the auditor who audits the countryCACC it industry-auditor group of client j If the methodologies of the auditors who audit client i’s and j’s country-industry-auditor d CFAi ¼ CACC d CFAj ) group are the same, then the expected current accruals should be the same (i.e., CACC it it 18 19 20 21 22 It is possible to measure financial statement comparability using input-based measures or output-based measures Input-based measures require examining specific accounting choices made by each firm and aggregating them into an overall index at the country level (e.g., Ashbaugh and Pincus 2001) Because it is practically difficult to determine accounting inputs of global companies, we rely on output-based measures of accounting comparability A cross-sectional modified Jones (1991) model is not practical when using international data (Francis and Wang 2008, 168; Wysocki 2004, 464–467) See Barth et al (2012, Appendix A) for details Country and industry factors affect the mapping of cash flows to accruals Additionally, auditors’ audit methodologies should also affect the mapping of cash flows to accruals (e.g., Francis et al 2014) Thus, we estimate the mapping of cash flows to accruals at the country-industry-auditor level We utilize the Fama-French 30 for industry classifications throughout the paper Inferences remain the same using two-digit SIC for industry classifications The potential benefit of using a model based on Dechow and Dichev (2002) is that cash flows are used as proxies of economic events, as indicated by Barth et al (2012) While De Franco, Kothari, and Verdi (2011) use returns to capture economic events, we focus on nonmarket-based economic events mainly because market efficiency is likely different across the jurisdictions in our sample In addition, returns capture changes in expected future cash flows that are not necessarily recognized in accounting outcomes Nonetheless, in additional analyses, we show that our results are robust to using market-based comparability measures The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 158 In the same way, we calculate two predicted current accruals of company j, as follows d CFAj ¼ bbCFAj ỵ bbCFAj CFOj;t1 ỵ bbCFAj CFOjt ỵ bbCFAj CFOj;tỵ1 CACC jt 3dị d CFAi ẳ bbCFAi ỵ bbCFAi CFOj;t1 ỵ bbCFAi CFOjt ỵ bbCFAi CFOj;tỵ1 CACC jt ð3eÞ Last, for each pair, we calculate the absolute value of À the differenceÁ between the predicted accruals from the previous steps and take the average to get the comparability measure Diff CACCijt for pair i-j at year t, as follows:    d CFAi d CFAj  CACC diff ijt ¼ CACC À CACC ð3fÞ it it    d CFAj d CFAi  À CACC CACC diff jit ¼ CACC jt jt 3gị   Diff CACCijt ẳ 0:5 CACC diff ijt ỵ CACC diff jit 3hị Taken together, the above methodology captures the differences between client i’s predicted current accruals when audited by its true auditor versus when audited by the auditor of client j Similarly, it also captures the differences between client j’s predicted current accruals when audited by its true auditor versus when audited by the auditor of client i Another feature of the above approach is that by estimating two predicted current accruals based on coefficients from two auditors, we hold the economic events (cash flows) constant, consistent with the definition of accounting comparability of De Franco et al (2011) For our last comparability measure, we examine the degree to which accruals for two clients covary over time, following Francis et al (2014).23 Specifically, we measure the level of covariance as the adjusted R2 from the following regression: TACCiq ẳ b0ij ỵ b1ij TACCjq ỵ eijq ð4Þ The model is estimated over the prior 16 consecutive quarters for all unique pairs i-j-t.À To facilitate Áa directionally consistent interpretation with the other comparability measures, we multiply the adjusted R2 by À1 TACC Covijt Thus, smaller values of TACC_Cov indicate greater comparability between client-pairs Primary Research Design To formally test our hypotheses, we estimate the following equation using ordinary least squares (OLS) regressions: Compijt ¼ b0 þ b1 Shared Auditorijt þ c Controlsijt þ eijt ; ð5Þ where subscripts i and j denote two clients in a pair and t denotes year, respectively Our dependent variable Compijt is one of the four measures of client-pair comparability.24 Our independent variable of interest is Shared Auditorijt, which is coded when two clients, i and j at year t, have auditors that are affiliates of the same global network If networks maintain and enforce consistent audit methodologies and, accordingly, increase the financial statement comparability of their clients across jurisdictions, then we expect a negative coefficient on Shared Auditorijt (b1) for each comparability measure Francis et al (2014), citing Lang, Maffett, and Owens (2010), state that there is no theoretical or empirical guidance for controls for an earnings comparability regression Thus, we follow both papers and include control variables that capture various pair-specific characteristics, including differences and minimum of size, leverage, market-to-book, operating cash flows, losses, standard deviation of sales, standard deviation of cash flows, and sales growth We control for the same accounting standard because studies have documented that the same and similar accounting standards improve financial reporting comparability across countries (Barth et al 2012; Lang et al 2010) Additionally, we include year, industry (Fama-French 30), and country fixed effects Standard errors are clustered at the client-pair level (Francis et al 2014; Aobdia 2015) 23 24 While Francis et al (2014) examine earnings co-movement, we examine accruals co-movement because audit methodologies are less likely to affect cash flows Because our dependent variables range from to 1, we employ fractional response methodology (using Stata commands fracreg logit/probit), following Papke and Wooldridge (1996), as a robustness check Inferences remain the same using this methodology (untabulated) The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 159 IV SAMPLE SELECTION AND DESCRIPTIVE STATISTICS Sample Selection We begin with Compustat companies (Global Compustat for international companies) from 2003 through 2016, where necessary accounting information to calculate control variables is nonmissing We collect audit firm information from the Compustat North America database for U.S and Canadian companies and from Capital IQ for all other companies We then retain company-years for clients of the Big global audit networks with fiscal year-ends in March, June, September, and December, and from industries (Fama-French 30) with at least 50 company-years We delete companies with names containing ‘‘Holding’’ and ‘‘LLP’’ and also exclude financial institutions We also require at least ten company-years for a given countryindustry-auditor We remove client-years that report fewer than eight quarters of quarterly accounting information during the last 16 quarters.25 Finally, we truncate total accruals (TACC), abnormal accruals (DACC), and current accruals (CACC) at the 2nd and 98th percentiles based on country-year combinations.26 This results in 83,455 client-years from 93 countries Table 1, Panel A presents the sample selection details, and Panels B and C present the number of client-year observations in our study by country and global network We then create pairs of two clients that are from different countries, are in the same industry, and have the same fiscal yearends Furthermore, we require the size (total assets) of two clients in a pair to be in the same quintile rank of size Quintile rank of size is calculated for each country-year combination.27 This process results in 2,123,959 total client-year pairs (see Table 1).28 Descriptive Statistics and Univariate Results Table presents descriptive statistics and univariate results Continuous variables have been winsorized at the 1st and 99th percentiles Out of 2,123,959 client-pairs in our sample, 20.2 percent of pairs are shared auditor pairs (i.e., pairs of clients that are audited by affiliates of the same global network) Average differences in TACC, DACC, and CACC between client-pairs are 8.5 percent, 7.7 percent, and 3.4 percent of total assets, respectively The average covariance of accruals between two clientpairs is 0.178 Per the last column of Table 2, shared auditor pairs have statistically smaller differences in accruals and higher accruals covariance (or lower negative covariance) than nonshared auditor pairs, on average V TEST RESULTS Main Results Table presents the results of estimating Equation (5) The coefficients on Shared_Auditor are negative and statistically significant across all model specifications From an economic perspective, the coefficients on Shared_Auditor represent between 1.1 and 7.5 percent of the median comparability measures.29 The signs of the coefficients on the control variables are overall consistent with those of Francis et al (2014) These initial results are consistent with H1, that global audit networks 25 26 27 28 29 We conduct analyses at the client-year-pair level However, one of our comparability measures (TACC_Cov) and some control variables (i.e., Loss_ prob_diff, Loss_prob_min, STD_sales_diff, STD_sales_min, STD_CFO_diff, STD_CFO_min, STD_sales_gr_diff, STD_sales_gr_min, and Ret_Cov) require quarterly data for construction Therefore, we remove client-years from the sample that not have enough quarterly observations Also, when we use TACC_COVijt as a dependent variable, we exclude client-year pairs where either client switched its auditor within the last four years, so that the measure is not influenced by either client being audited by more than one auditor Accounting studies often truncate (e.g., Ball et al 2000; Burgstahler, Hail, and Leuz 2006; Easton and Sommers 2007; Lang et al 2010) or winsorize (e.g., Fang et al 2015; Barth et al 2018) variables to address effects of outliers These choices are arbitrary Inferences remain similar when truncating at the percent and 99 percent levels, winsorizing at the percent and 98 percent levels, using robust regression (rreg in Stata), excluding observations with a Cook’s distance greater than 4/n, or excluding observations where the absolute value of studentized residuals is greater than Research suggests that client size captures many client characteristics that are correlated with measures of audit quality (e.g., Lawrence, Minutti-Meza, and Zhang 2011) We acknowledge that there is no perfect way to match on size In addition to matching on size, we also control for size differences in all models For example, assume that there are four U.S companies, three Australian companies, and two Brazilian companies that are in the same industry and the same size quintile rank in a given fiscal year-end From these nine company-years from three countries, we can construct 26 cross-country pairs (4 3 þ þ 3 2) More generally, let ni (nj) denote Pthe number of companies in country i ( j) in a given industry, size rank, and year-end Within a given industry, size rank, and year-end, we construct i j ni nj pairs, where i; j ½1; 93Š The median values of Diff_TACC, Diff_DACC, Diff_CACC, and TACC_Cov are 0.064, 0.056, 0.024, and À0.087, respectively Accordingly, the coefficients on Shared_Auditor per each model represent 1.6 percent (0.001/0.064), 1.1 percent (0.0006/0.056), 7.5 percent (0.0018/0.024), and 5.9 percent (0.0051/0.087) of the median comparability measures More specifically, because the first three measures (i.e., Diff_TACC, Diff_DACC, and Diff_CACC) are each an absolute value of the difference in accruals scaled by total assets between a client-pair, the above magnitudes represent the extent of increased closeness in reported accruals as a result of sharing a global network auditor The fourth measure (i.e., TACC_Cov) is the covariation of accruals between a client-pair Thus, the 5.9 percent economic magnitude indicates that accruals’ covariation increases by 5.9 percent as a result of sharing a global network auditor The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 160 TABLE Sample Composition Panel A: Sample Selection Criteria Criteria Observations Total number of company-year observations in Compustat North America and Compustat Global from 2003 through 2016 that have necessary accounting information to calculate control variables Less observations whose auditor is not one of the Big global network auditors.a Less observations with fiscal year-ends not in March, June, September, or December Less observations with ‘‘Holdings’’ and ‘‘LLP’’ in company name, in the finance industry, or in a given industry with less than 50 observations Less observations in a given country and industry when the number of clients per each auditor is less than ten Less observations that not report quarterly accounting information for at least eight of the last 16 quarters Truncate accruals at percent and 98 percent by country-year Total company-years in our sample (93 countries) b (189,055) (17,046) (22,352) (13,403) (94,477) (9,045) 83,455 Total number of cross-country pairs (same industry, fiscal year-ends, and quintile rank of size) without missing variables.b a 428,833 2,123,959 Auditors for non-U.S and non-Canadian clients are obtained from Capital IQ Let ni (nj) (denote P the number of companies in country i ( j) in a given industry, size rank, and year-end Within a given industry, size rank, and year-end, we construct i j ni nj pairs where i; j ½1; 93Š See the sample selection section for further details Panel B: The Number of Client-Years by Country Country United States Taiwan Australia United Kingdom Canada China Malaysia France Germany Singapore Sweden Thailand Cayman Islands Bermuda South Korea Brazil Israel Switzerland Norway Italy Finland Poland South Africa Chile Sri Lanka Philippines The Netherlands Number of Company-Years 24,641 6,797 4,571 4,394 4,171 3,598 2,965 2,219 2,161 1,928 1,895 1,776 1,685 1,509 1,448 1,121 1,072 895 880 806 795 749 739 720 676 588 571 (continued on next page) The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 166 negative and significant coefficients on Post in two of four specifications using Diff_TACC and Diff_CACC as the dependent variable Next, we examine a sample of client-pairs where at least one client switches its auditor, resulting in the client-pairs switching from having auditors from the same global network to having auditors from different networks We call these clientpairs ‘‘D_switch’’ pairs and test whether there is a decrease in comparability after the switch Table 5, Panel B presents the results We find evidence of a decrease in comparability after these auditor switches, as evidenced by positive and significant coefficients on Post in seven specifications In Panel C of Table 5, we test for differences in the coefficients between the S_switch and D_switch samples In eight out of 12 cases, we find that the coefficients in the S_switch sample are statistically different from the corresponding coefficients in the D_switch sample Overall, the strongest results from the switch tests are found when using Diff_CACC as the dependent variable This may be due to Diff_CACC capturing the auditor’s methodology effect on the mapping of transactions to accounting outcomes, whereas Diff_TACC and Diff_DACC more directly capture the similarity of accounting outcomes Overall, the S_switch and D_ switch results provide some evidence that client-pairs increase (decrease) in comparability after clients come to have (cease having) auditors from the same global network The Moderating Effect of Investor Protection To test H2a, we empirically examine the moderating effect of investor protection using six measures from the studies by La Porta, Lopez-De-Silanes, Shleifer, and Vishny (1998), La Porta, Lopez-De-Silanes, and Shleifer (2006), Djankov, La Porta, Lopez-De-Silanes, and Shleifer (2008), and Bronson et al (2017) because investor protection is multi-dimensional For each measure, we partition client-pairs into two subsamples, high-high investor protection pairs and low-low investor protection pairs, by using a threshold that makes the client-pair size of the two subsamples as balanced as possible Twenty-two (ten) of 24 coefficients on Shared_Auditor in the high-high (low-low) pairs are significant in the predicted direction (see Table 6) Tests for mean differences in the coefficients across high-high and low-low pairs reveal that the magnitude of high-high coefficients is larger than the corresponding low-low coefficients in 18 of 24 model specifications in Table (noted by the coefficients shown in bold) None of the low-low coefficients are more statistically significant than the corresponding high-high coefficients Overall, these results suggest that the effects of global audit methodologies are present in both strong and weak investor protection regimes However, the evidence suggests that global audit networks are more able to consistently implement their global audit methodologies within strong investor protection jurisdictions The Moderating Effect of ISAs To test H2b, we first gather ISA adoption status for each jurisdiction within our sample We code a country as an ISA adopter when ISAs are required by law, have been adopted by a national standard setter, or are the national standards (see IFAC 2012) We then partition client-pairs into two subsamples, ISA/ISA pairs and non-ISA/non-ISA pairs Our tests include clientpairs from 2012 to 2016 because the IFAC data are as of 2012 Table presents coefficient estimates on Shared_Auditor from these regressions Tests for mean differences in the coefficients across ISA/ISA pairs and non-ISA/non-ISA pairs in Table reveal that the magnitude of coefficients is statistically larger in the former pairs than in the latter ones for three of four specifications This suggests that local adoption of ISAs further encourages local auditors to follow their global network’s auditing methodology In other words, the networks are more able to consistently implement their audit methodologies within jurisdictions that require ISAs VI ADDITIONAL ANALYSES Cash Flows from Operations In this section, we consider a falsification test aimed at examining accounting information that is arguably less likely to be uniquely affected by global network audit methodologies The guidance within global audit methodologies for auditing cash is likely more similar across the Big compared to the guidance for auditing accruals Therefore, we expect to find little, if any, effect of having auditors from the same global network on differences in cash flows We reestimate Equation (5) after including the difference in cash flows from operations as the dependent variable (see Table 8) The coefficient on Shared_Auditor is insignificant, suggesting that our primary results capture the application of global network audit methodologies, and that global audit methodologies affect comparability through auditing of accruals and not through auditing cash The Accounting Review Volume 95, Number 6, 2020 The Accounting Review Volume 95, Number 6, 2020 À0.0022*** (À10.03) 305,096 À0.0000 (À0.12) 296,907 À0.0073*** (À3.60) 188,639 À0.0036* (À1.88) 258,472 À0.0049** (À2.01) 190,993 À0.0067*** (À3.76) 313,003 À0.0051*** (À2.58) 241,655 À0.0053*** (À3.27) 387,995 TACC_Cov À0.0001 (À0.41) 700,731 À0.0003 (À1.57) 502,997 À0.0012*** (À6.97) 743,123 À0.0002 (À1.08) 428,221 À0.0004** (À2.05) 531,477 À0.0003 (À1.44) 368,460 Diff_TACC 0.0000 (0.11) 635,637 À0.0000 (À0.16) 453,260 À0.0004** (À2.34) 676,684 0.0001 (0.25) 386,948 À0.0000 (À0.10) 480,538 À0.0001 (À0.40) 330,377 Diff_DACC À0.0014*** (À10.05) 629,100 À0.0009*** (À6.37) 474,875 À0.0017*** (À12.20) 711,154 À0.0009*** (À5.35) 405,825 À0.0009*** (À6.21) 502,523 À0.0008*** (À4.97) 350,599 Diff_CACC Low-Low Pairs À0.0012 (À0.84) 426,276 À0.0002 (À0.14) 300,245 À0.0059*** (À4.42) 414,966 0.0001 (0.09) 257,031 À0.0008 (À0.51) 317,955 0.0009 (0.51) 209,508 TACC_Cov *, **, *** Denote significance at the 10 percent, percent, and percent levels, respectively, based on two-tailed tests Table presents regression results with subsamples based on investor protection regimes The coefficients shown in bold in High-High pairs note the coefficients on Shared_Auditor that are significantly more negative than corresponding coefficients in Low-Low pairs The four dependent variables are the absolute value of the difference in total accruals (Diff_TACC), the absolute value of the difference in discretionary accruals (Diff_DACC), the average of absolute differences in predicted current accruals (Diff_CACC), and negative co-movement of total accruals for the prior 16-quarter period (TACC_Cov), respectively The test variable Shared_Auditor is coded if two clients in a client-pair have auditors that are affiliates of the same global network Controls and year and industry fixed effects included in the main tests are included, but not tabulated for the sake of brevity t-statistics based on robust standard errors clustered at the client-pair level are reported in parentheses Detailed definitions of variables are in Appendix A À0.0017*** (À9.09) 393,572 À0.0021*** (À12.24) 475,359 À0.0007*** (À2.83) 409,517 À0.0010*** (À4.48) 492,488 À0.0011*** (À4.63) 528,680 À0.0018*** (À8.72) 367,160 À0.0014*** (À7.14) 261,004 À0.0008*** (À3.19) 382,799 À0.0010*** (À3.67) 409,026 À0.0016*** (À9.64) 566,378 Diff_CACC À0.0002 (À0.55) 277,007 À0.0008*** (À3.80) 588,162 Diff_DACC À0.0012*** (À5.34) 631,554 À0.0006* (À1.96) n 299,632 Disclosure Requirement Shared_Auditor À0.0010*** (À3.80) n 436,960 Regulatory Power over Auditors Shared_Auditor À0.0007*** (À2.58) n 318,634 n Common Law Shared_Auditor n Public Enforcement Shared_Auditor n Security Regulation Shared_Auditor Anti-Self-Dealing Shared_Auditor Diff_TACC High-High Pairs Comparability, Shared Auditor, and Investor Protection Regimes TABLE Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 167 À0.0012*** (À4.52) Yes Yes 320,766 0.446 À0.0008*** (À3.18) Diff_DACC Yes Yes 330,785 0.163 À0.0020*** (À10.53) Diff_CACC Yes Yes 195,094 0.223 À0.0050*** (À2.61) TACC_Cov Yes Yes 177,883 0.474 0.0003 (0.93) Diff_TACC Yes Yes 162,005 0.458 0.0003 (1.01) Diff_DACC Yes Yes 163,096 0.286 À0.0007*** (À3.70) Diff_CACC Non-ISA/Non-ISA Yes Yes 122,942 0.185 À0.0057** (À2.37) TACC_Cov *, **, *** Denote significance at the 10 percent, percent, and percent levels, respectively, based on two-tailed tests This table presents regression results with subsamples based on the adoption of International Standards on Auditing (ISAs) The coefficients shown in bold in ISA/ISA pairs note the coefficients on Shared_Auditor that are significantly more negative than corresponding coefficients in non-ISA/non-ISA pairs The four dependent variables are the absolute value of the difference in total accruals (Diff_TACC), the absolute value of the difference in discretionary accruals (Diff_DACC), the average of absolute differences in predicted current accruals (Diff_CACC), and negative co-movement of total accruals for the prior 16-quarter period (TACC_Cov), respectively The test variable Shared_Auditor is coded if two clients in a client-pair have auditors that are affiliates of the same global network Controls and fixed effects included in the main tests are included, but not tabulated for the sake of brevity t-statistics based on robust standard errors clustered at the client-pair level are reported in parentheses Detailed definitions of variables are in Appendix A Controls Yes Year, Industry, and Country FE Yes n 350,909 Adj R2 0.481 Shared_Auditor Diff_TACC ISA/ISA Comparability, Shared Auditor, and Auditing Standards TABLE 168 Ege, Kim, and Wang The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 169 TABLE Shared Auditor and Cash Flow Differences Diff_CFO Shared_Auditor Size_diff Size_min Lev_diff Lev_min MB_diff MB_min CFO_min Loss_prob_diff Loss_prob_min STD_sales_diff STD_sales_min STD_CFO_diff STD_CFO_min STD_sales_gr_diff STD_sales_gr_min Same_Standard Year, Country, Industry FE n Adj R2 0.0000 (0.19) À0.0014*** (À13.87) À0.0083*** (À108.21) 0.0028*** (6.85) À0.0615*** (À88.91) 0.0001*** (38.16) 0.0019*** (46.00) À0.7483*** (À863.22) 0.0009*** (2.62) À0.1622*** (À331.45) À0.0000*** (À25.77) À0.0000*** (À20.15) 0.0000*** (13.98) 0.0001*** (43.44) 0.0003*** (14.45) À0.0565*** (À61.07) 0.0034*** (16.68) Yes 2,123,959 0.637 *, **, *** Denote significance at the 10 percent, percent, and percent levels, respectively, based on two-tailed tests Table presents regression results using operating cash flows The dependent variable is the absolute value of differences in operating cash flows (Diff_ CFO) We truncate cash flows at the percent and 98 percent levels by country-year The test variable Shared_Auditor is coded if two clients in a given client-pair have auditors that are affiliates of the same global network Year, industry, and country fixed effects are included, but not tabulated t-statistics based on robust standard errors clustered at the client-pair level are reported in parentheses Detailed definitions of variables are in Appendix A Other Country Characteristics We next perform several robustness tests aimed at further alleviating concerns regarding country-specific factors that are not controlled for in our primary model First, we control for clients having headquarters in the same continent because auditors from geographically closer areas may enforce similar accounting practices and may implement similar auditing techniques We also control for the difference and minimum of gross domestic product as a way to control for country-specific economic performance The coefficients on Shared_Auditor remain negative and statistically significant (see Panel A of Table 9) The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 170 TABLE Robustness Checks Panel A: Cross-Country Characteristics Diff_TACC Shared_Auditor Same_Region GDP_diff GDP_min GDP_capita_diff GDP_capita_min Controls Year and Industry FE n Adj R2 Diff_DACC À0.0011*** (À8.72) À0.0020*** (À14.38) À0.0017*** (À33.01) À0.0035*** (À65.05) 0.0003** (2.11) À0.0048*** (À37.35) Yes Yes 1,541,575 0.485 À0.0007*** (À5.49) À0.0010*** (À7.38) À0.0015*** (À30.03) À0.0029*** (À56.28) 0.0004*** (2.65) À0.0040*** (À32.22) Yes Yes 1,411,201 0.460 Diff_CACC TACC_Cov À0.0019*** (À19.47) À0.0002** (À2.33) À0.0023*** (À55.92) À0.0040*** (À96.38) 0.0009*** (7.72) À0.0057*** (À54.82) Yes Yes 1,400,388 0.169 À0.0056*** (À5.55) À0.0063*** (À5.95) À0.0003 (À0.87) À0.0065*** (À16.83) À0.0114*** (À11.61) À0.0365*** (À39.95) Yes Yes 882,749 0.217 Panel B: Client-Pairs Excluding U.S Clients Diff_TACC Shared_Auditor Controls Year, Country, Industry FE n Adj R2 À0.0010*** (À7.23) Yes Yes 1,201,512 0.464 Diff_DACC À0.0005*** (À3.49) Yes Yes 1,097,732 0.430 Diff_CACC TACC_Cov À0.0017*** (À16.07) Yes Yes 1,137,426 0.157 À0.0051*** (À4.83) Yes Yes 695,069 0.176 Panel C: European Client-Pairs after IFRS Adoption Diff_TACC Shared_Auditor Controls Year, Country, Industry FE n Adj R2 À0.0001 (À0.21) Yes Yes 171,882 0.489 Diff_DACC À0.0002 (À0.60) Yes Yes 156,704 0.447 Diff_CACC TACC_Cov À0.0019*** (À6.73) Yes Yes 158,885 0.180 À0.0056* (À1.84) Yes Yes 90,947 0.255 (continued on next page) Second, Table 9, Panel B presents results after excluding clients of U.S Big affiliates, which constitute 30 percent of the sample, and results are robust Finally, we only include European client-pairs after the adoption of IFRS (i.e., firm-years after 2004) Inferences remain similar, albeit weaker, in this sample (see Table 9, Panel C) Market-Based Measures of Comparability In our main analyses, we examine accruals comparability using nonmarket-based measures of economic events instead of using market-based measures We this because market efficiency likely differs across the jurisdictions in our sample Next, we examine results using three market-based comparability measures (see Table 9, Panel D) Our inferences are robust to using these measures The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 171 TABLE (continued) Panel D: Market-Based Measures of Comparability Diff_RET Shared_Auditor Controls Year, Country, Industry FE n Adj R2 À0.0011*** (À2.93) Yes Yes 2,029,288 0.113 Diff_CACC2 À0.0011*** (À28.11) Yes Yes 2,004,325 0.117 Diff_TACC2 À0.0020*** (À26.99) Yes Yes 2,029,288 0.145 *, **, *** Denote significance at the 10 percent, percent, and percent levels, respectively, based on two-tailed tests Panel A reports regression results controlling for additional cross-country characteristics instead of including country fixed effects Our sample size is smaller because GDP data are not available for some countries (e.g., Bermuda, Cayman Islands, and Taiwan) Panel B reports regression results after excluding clients in the U.S Panel C reports regression results for client-pairs in Europe after mandatory IFRS adoption Panel D reports regression results using three alternative market-based measures of comparability as dependent variables Controls and fixed effects are included, but not tabulated for the sake of brevity t-statistics based on robust standard errors clustered at the client-pair level are reported in parentheses Detailed definitions of variables are in Appendix A Accrual Comparability among Clients of PCAOB Sanctioned Audit Firms Next, we perform an exploratory analysis aimed at testing whether low-quality global network affiliates are associated with clients that have lower financial reporting comparability We identify low-quality foreign affiliates as those that have been sanctioned by the PCAOB for violations of quality control standards.36 These foreign affiliates include PwC India, BDO Spain and Hungary, and Deloitte Brazil, Mexico, and The Netherlands As there are very few observations within our sample for PwC India and BDO Spain and Hungary, we focus our analysis on cross-country client-pairs of Deloitte affiliates We use the entire sample period because Deloitte Brazil, Mexico, and The Netherlands were each sanctioned in 2016, the last year in the sample Sanction is coded when a client within a Deloitte client-pair is audited by Deloitte Mexico, Brazil, or The Netherlands We then reestimate Equation (5) using the cross-country Deloitte client-pairs If Deloitte Mexico, Brazil, and The Netherlands executed audits that were, on average, not in compliance with Deloitte’s global methodologies, then the coefficient on Sanction should be positive, suggesting that clients of these affiliates had lower financial reporting comparability compared to other Deloitte clients during the sample period In all model specifications, the coefficients on Sanction are positive and significant (see Table 10) Given that Deloitte Mexico, Brazil, and The Netherlands have been sanctioned by the PCAOB for quality control failures, these results suggest that low (high) audit quality results in low (high) financial reporting comparability of clients within a global network Other Robustness Tests In untabulated robustness tests, we find that inferences remain using only Big client-pairs Also, the effect is stronger in Big client-pairs compared to BDO and Grant Thornton client-pairs.37 Inferences also remain when using an auditor fixed effects model, following the design in Francis et al (2014), and after excluding client-pairs that have specialist auditors.38 VII CONCLUSION Each global audit network markets itself under one brand and claims to provide a consistent, high-quality audit methodology worldwide However, local incentives, differences in litigation risk and culture, coordination problems, and the 36 37 38 See: https://pcaobus.org/International/Enforcement/Pages/SettledDisciplinaryOrders.aspx The PCAOB sanctions foreign affiliates for numerous reasons (e.g., failure to timely disclose reportable events), but the PCAOB appears to view deficient quality controls as the most important reason to sanction a firm, likely because quality controls are very important for audit quality As evidence of this, the PCAOB has imposed significant penalties on affiliates that have quality control issues (see, e.g., https://pcaobus.org/Enforcement/Decisions/Documents/105-2016-031-Deloitte-Brazil.pdf ) Specifically, in a Big sample, the coefficients on Shared_Auditor are negative and significant in three of four specifications For client-pairs audited by BDO and Grant Thornton, the coefficient on Shared_Auditor is negative and significant in one of four specifications When comparing the coefficients on Shared_Auditor between the same Big pairs and same BDO/Grant Thornton pairs, following the approach of Francis et al (2014), we find significantly stronger effects for same Big pairs in all four specifications We define industry-specialist auditors in two ways First, if a global network audits more than 30 percent of the total assets of an industry globally, then this network is classified as a global industry specialist Second, if a network audits a majority of clients in an industry based on total assets, then it is classified as global industry specialist We remove client-pairs when a client in a pair has a global industry-specialist auditor The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 172 TABLE 10 PCAOB Sanctioned Audit Firms and Comparability Diff_TACC Sanction Controls Year and Industry FE n Adj R2 0.0013* (1.75) Yes Yes 89,782 0.502 Diff_DACC 0.0026*** (3.66) Yes Yes 83,059 0.471 Diff_CACC 0.0008* (1.66) Yes Yes 83,556 0.195 TACC_Cov 0.0297*** (5.03) Yes Yes 58,306 0.195 *, **, *** Denote significance at the 10 percent, percent, and percent levels, respectively, based on two-tailed tests Table 10 presents regression results with cross-country client-pairs of Deloitte affiliates The four dependent variables are the absolute value of the difference in total accruals (Diff_TACC), the absolute value of the difference in discretionary accruals (Diff_DACC), the average of absolute differences in predicted current accruals (Diff_CACC), and negative co-movement of total accruals for the prior 16-quarter period (TACC_Cov), respectively The test variable Sanction is coded if a client-pair includes a client of Deloitte Mexico, Deloitte Brazil, or Deloitte Netherlands, and otherwise Controls and year and industry fixed effects are included, but not tabulated for the sake of brevity t-statistics based on robust standard errors clustered at the client-pair level are reported in parentheses Detailed definitions of variables are in Appendix A lack of a global auditing regulator create challenges for consistently applying an audit methodology worldwide (Lenz and James 2007; Carson 2014; Bik and Hooghiemstra 2018; FRC 2018) Consistent with these challenges, jurisdiction-specific regulators have expressed concern over the audit quality of global network affiliates (Goelzer 2011; Ferguson 2015; PCAOB 2015, 2018) We examine whether the global networks enforce their audit methodologies across their affiliates We use financial reporting comparability as a setting for the analysis because the consistent execution of an audit methodology should result in consistent accounting treatments for similar economic transactions We find robust evidence that two companies from different jurisdictions have more comparable accruals, on average, when audited by audit firms from the same global network To strengthen our conclusions, we use the failure of Andersen U.S., a broader sample of switches where client-pairs come to have affiliate auditors from the same (different) global network (networks), a falsification test using differences in cash flows, and numerous alternative specifications Overall, these results suggest that the Big global networks consistently execute unique global audit methodologies, which results in similar financial reporting comparability, on average We also consider whether investor protection strength and the use of ISAs moderate the effect of global audit methodologies on financial reporting comparability We find evidence consistent with the role of global network methodologies in global financial reporting comparability being more pronounced across stronger investor protection regimes and across jurisdictions that have adopted ISAs We contribute to the international audit literature in important ways The literature has provided evidence that international expertise and country-specific factors affect audit quality We provide insights into how the global networks operate Also, because we use financial reporting comparability to test whether global networks enforce consistent audit procedures, we also contribute to the literature on cross-country financial reporting comparability Our study is subject to several limitations First, we document an ‘‘on average’’ effect Thus, while our results suggest that global networks enforce their audit methodologies, our results not suggest that affiliates always provide satisfactory audit quality We recommend that future studies examine why and how certain client engagements are not executed in accordance with global network audit methodologies However, our evidence matters because it suggests that global networks are quasi-enforcers of auditing standards (Carson 2014, 28–30) This should be of particular interest to regulators and standard setters, given that there is no global auditing regulator As Carson (2014, 28) points out: ‘‘Of particular importance to both IFAC and the IAASB are the global firm networks that hold the main responsibility for implementation of the standards developed as well as the moral guidance and leadership of the audit profession, especially in countries where the quality of audit practice has been regarded as sub-optimal.’’ Second, due to the lack of proprietary global network data, we use financial reporting comparability as our setting We believe that the consistent enforcement of a high-quality audit methodology is a necessary condition for network-wide highquality auditing, which should result in greater financial reporting comparability However, we not directly examine audit quality except for an exploratory analysis using Deloitte client-pairs Third, we cannot rule out self-selection or other forms of endogeneity, but we believe the Andersen tests, changes tests, and other analyses help mitigate these concerns Last, some of The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 173 the regressions use very large sample sizes, which may lead to large t-statistics However, our primary result is economically significant Also, the Andersen and changes tests use much smaller sample sizes, and the 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The Accounting Review 87 (5): 1767– 1789 https://doi.org/10.2308/accr-50192 The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 176 APPENDIX A Variable Definitions Shared_Auditor TACC Diff_TACC DACC ¼ if two clients, i and j, that are from different countries, are in the same industry, have the same quintile rank of size, and have the same fiscal year-ends are audited by auditors from the same global audit firm network at year t, and otherwise Total accruals, calculated as the difference between income before extraordinary items and cash flows from operations adjusted for cash flows from extraordinary items (IB À OANCF À XIDOC), scaled by beginning-of-year total assets Absolute value of the difference between total accruals of client i and total accruals of client j in year t Abnormal accruals, calculated as the difference between actual accruals and estimated accruals To address cross-country differences, we follow DeFond and Park (2001) and Francis and Wang (2008) and use a linear expectation model to capture normal accruals Specifically, abnormal accruals is calculated as follows: h i DepritÀ1 CACCitÀ1 d TACCit ¼ Salesit =ATtÀ1 À PPEit SalesitÀ1 Diff_DACC CACC Diff_CACC PPEitÀ1 d it DACCit ¼ TACCit À TACC Absolute value of the difference between abnormal accruals (DACC) of client i and client j in year t Current accruals, calculated as change in non-cash current assets less change in current liabilities excluding short-term debts ððDACT À DCHE   Þ À ðDLCT À DDLCÞÞ, scaled by beginning-of-year total assets   d CFAi CFAj   d CFAj d d CFAi  ¼ avg CACC À CACC À CACC ; CACC it it jt jt Average of the absolute difference in predicted current accruals of client i and the absolute difference in predicted current accruals of client j Adapting from Dechow and Dichev (2002) and Barth et al (2012), we estimate current accruals at the country-industry-auditor level as follows CFA CFA CFA þ bCFA CACCit ¼ bCFA CFOi;tÀ1 þ b2 CFOit ỵ b3 CFOi;tỵ1 ỵ eit After creating client-pairs, we calculate predicted current accruals of client i using the coefficients from its   CFAi d own country-industry-auditor level and using the coefficients from client j’s country estimation CACCit d CFAj The absolute value of the difference captures how much client industry-auditor level estimation CACC it ACC_min TACC_Cov Ret_Cov Size_diff Size_min Lev_diff Lev_min MB_diff MB_min Loss_prob_diff Loss_prob_min STD_sales_diff STD_sales_min Diff_CFO CFO_min i’s financial statements are comparable to client j’s financial statements In the same way, we calculate client j’s comparability measure, and take the average of the differences to calculate the comparability measure of client-pair i-j-t Minimum value of accruals of client i and accruals of client j in year t For the tests of Diff_TACC, we use the minimum value of total accruals For the tests of Diff_DACC, we use the minimum value of abnormal accruals, and for the tests of Diff_CACC, we use the minimum value of current accruals Co-movement of total accruals of client i and total accruals of client j in year t Co-movement is calculated as the adjusted R2 from the regression of client i’s total accruals on client j’s total accruals over the past 16 quarters, multiplied by À1 Co-movement of stock return of client i and stock return of client j in year t Co-movement is calculated as the adjusted R2 from the regression of client i’s quarterly returns on client j’s quarterly returns over the past 16 quarters Absolute value of difference between size of client i and size of client j in year t Size equals the natural logarithm of total assets in million US$ Minimum value of size of client i and size of client j in year t Absolute value of difference between leverage of client i and leverage of client j in year t Leverage equals the debt-to-asset ratio Minimum value of leverage of client i and leverage of client j in year t Absolute value of difference between market-to-book ratio of client i and client j in year t Minimum value of market-to-book ratio of client i and client j in year t Absolute value of difference between loss probability of client i and loss probability of client j in year t Loss probability is the proportion of quarters for which the client reports a negative income before extraordinary items in the past 16 quarters Minimum value of loss probability of client i and client j in year t Absolute value of the difference between the standard deviation of quarterly sales of client i and client j in year t Standard deviation of sales is calculated over the past 16 quarters Minimum value of the standard deviation of quarterly sales of client i and client j in year t Absolute value of difference between operating cash flows (scaled by beginning-of-year total assets) of client i and client j in year t Minimum value of operating cash flows of client i and client j in year t (continued on next page) The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 177 APPENDIX A (continued) STD_CFO_diff Absolute value of the difference between the standard deviation of quarterly operating cash flows (scaled by beginning-of-year total assets) of client i and client j in year t The standard deviation is calculated over the past 16 quarters STD_CFO_min Minimum value of the standard deviation of quarterly cash from operations of client i and client j in year t STD_sales_gr_diff Absolute value of the difference between the standard deviation of quarterly sales growth of client i and client j in year t The standard deviation is calculated over the past 16 quarters STD_sales_gr_min Minimum value of the standard deviation of quarterly sales growth rate of client i and client j in year t Same_Standard ¼ if client i and client j report their financial statements under the same accounting standard, and otherwise Same_Region ¼ if the headquarters of client i and client j are located in the same continent, and otherwise GDP_diff Absolute value of difference between the natural log of Gross Domestic Product (GDP) of client i’s country and client j’s country in year t GDP_min Minimum value of the natural log of GDP of client i’s country and client j’s country in year t GDP_capita_diff Absolute value of difference between natural log of GDP per capita of client i’s country and client j’s country in year t GDP_capita_min Minimum value of natural log of GDP per capita of client i’s country and client j’s country in year t Sec_reg An index capturing the effectiveness of a country’s securities regulation It is calculated as the mean of the disclosure requirement index and liability standard index, created by La Porta et al (2006) We define a pair of client i and client j as a High-High IP pair (Low-Low IP pair) when Sec_reg of countries of client i and client j are greater than (less than or equal to) 0.75 Anti_SD Anti-self-dealing index based on Djankov et al (2008), measuring how private enforcement mechanisms such as disclosure, approval, and litigation protect minority shareholders We define a pair of client i and client j as a High-High IP pair (Low-Low IP pair) when Anti_SD of countries of client i and client j are greater than (less than or equal to) 0.65 Pub_enf Public enforcement index created by La Porta et al (2006), measuring the degree of investigative authority that the regulatory supervisor has We define a pair of client i and client j as a High-High IP pair (LowLow IP pair) when Pub_enf of countries of client i and client j are greater than (less than or equal to) 0.72 Disc_req Disclosure requirement index created by La Porta et al (2006), measuring the extent to which there is required disclosure for firms issuing securities through a prospectus We define a pair of client i and client j as a High-High IP pair (Low-Low IP pair) when Disc_req of countries of client i and client j are greater than (less than or equal to) 0.88 Reg_pwr Regulatory power over the auditor profession by Bronson et al (2017) We define a pair of client i and client j as a High-High IP pair (Low-Low IP pair) when Reg_pwr of countries of client i and client j are greater than (less than or equal to) 0.7 Common_law We define a pair of client i and client j as a High-High IP pair (Low-Low IP pair) when both countries of client i and client j have common law (code law) systems Sanction ¼ if client i or client j is audited by Deloitte affiliates that have been sanctioned by the PCAOB for violations of quality control standards (i.e., Deloitte Mexico, Deloitte Brazil, and Deloitte Netherlands), and otherwise Below are alternative comparability measures that are based on returns      d CFAi d itCFAj ; RET d jtCFAi  d jtCFAj À RET Diff_RET ¼ avg RET À RET it Average of the absolute difference in predicted returns of client i and the absolute difference in predicted returns of client j Adapting from De Franco et al (2011), we estimate returns at the country-industryauditor level as follows CFA CFA ỵ bCFA RETit ẳ bCFA CFOit ỵ b2 TACCit ỵ 2it RETit is the cumulative percentage change in stock price beginning nine months before fiscal year-end and ending three months after fiscal year-end, adjusted for dividends and stock splits After creating client-pairs, we calculate return of client i using the coefficients from its own country-industry-auditor level  the predicted  d itCFAi and using the coefficients from client j’s country-industry-auditor level estimation estimation RET   d itCFAj The absolute value of the difference captures how much client i’s mapping of accruals and cash RET Diff_CACC2 flows to returns is comparable to client j’s mapping In the same way, we calculate client j’s comparability measure, and take the average of the differences to calculate the comparability measure of client-pair i-j-t Average of the absolute difference in predicted current accruals of client i and the absolute difference in predicted current accruals of client j We calculate this measure in the same way we create Diff_CACC, but we estimate current accruals based on stock returns We estimate current accruals at the country-industryauditor level as follows CFA CACCit ¼ aCFA ỵ aCFA RETit ỵ 2it (continued on next page) The Accounting Review Volume 95, Number 6, 2020 Ege, Kim, and Wang 178 APPENDIX A (continued) Diff_TACC2 Average of the absolute difference in predicted total accruals of client i and the absolute difference in predicted total accruals of client j We calculate this measure in the same way we create Diff_TACC2, but we estimate the mapping of returns to total accruals APPENDIX B Example Comparability Calculations Appendix B provides a detailed example of how our four primary financial reporting comparability measures are calculated For this example, we consider the client-pair-year consisting of two retail companies in 2007: Haverty Furniture Companies, Inc (hereafter, Company A), audited by Ernst & Young (EY) U.S., and Ideal Shopping Direct PLC (hereafter, Company B), audited by Grant Thornton (GT) U.K For Diff_TACC, we first calculate each company’s total accruals (TACC) TACC is defined as the difference between income before extraordinary items and cash flows from operations adjusted for cash flows from extraordinary items, scaled by beginning-ofyear total assets Company A and Company B’s TACC are À0.079 and 0.051 in 2007, respectively Then, Diff_TACC for this clientpair-year is calculated as the absolute value of the difference between the two companies’ TACC as follows: Diff TACCAB ¼ jÀ0:079 À 0:051j ¼ 0:130 For Diff_DACC, we first calculate each company’s abnormal accruals (DACC) DACC is defined as the difference between d that is estimated based on a linear expectation model (Francis and Wang 2008) Specifically: actual TACC and predicted TACC ! CACCitÀ1 DepritÀ1 d À PPEit =ATtÀ1 : TACCit ¼ Salesit SalesitÀ1 PPEitÀ1 Therefore: ! 21 d À 375 TACCA2007 ¼ 787 =469 ¼ À0:028 862 373 ! d B2007 ¼ 96:9 1:6 À 15:3 0:8 =37:1 ¼ 0:026 TACC 85:6 14:5 Company A and Company B’s DACC are À0.051 (À0.079 À (À0.028)) and 0.025 (0.051 À 0.026) in 2007, respectively Then, Diff_ DACC for this client-pair-year is calculated as the absolute value of the difference between the two companies’ DACC as follows: Diff DACCAB ¼ jÀ0:051 À 0:025j ¼ 0:076 For Diff_CACC, we first estimate the mapping of operating cash flows to current accruals for each company’s countryindustry-auditor grouping For this example, we estimate the model for U.S.-Retail-EY clients and U.K.-Retail-GT clients, which results in the following coefficients: (U.S.-Retail-EY) d ẳ 0:021 ỵ 0:072 CFOt1 0:382 CFOt ỵ 0:153 CFOtỵ1 CACC (U.K.-Retail-GT) d ẳ 0:003 ỵ 0:308 CFOt1 0:547 CFOt ỵ 0:084 CFOtỵ1 CACC   US;Retail;EY d Then, we calculate Company A’s predicted current accruals in 2007 based on its own auditor’s mapping CACC   A d UK;Retail;GT and predicted accruals based on Company B’s auditor’s mapping CACC A   d US;Retail;EY ẳ 0:021 ỵ 0:072 0:060 0:382 0:083 ỵ 0:153 0:087 ¼ 0:007 CACC A   d UK;Retail;GT ¼ 0:003 þ 0:308 0:060 À 0:547 0:083 þ 0:084 0:087 ¼ À0:017 CACC A The absolute value of the difference between the two predicted current accruals reveals the difference in audit methodologies of The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 179 the two auditors given Company As underlying economics CACC diff AB ẳ j0:007 0:017ịj ¼ 0:024 Similarly, we calculate Company B’s predicted current accruals in 2007 based on its own auditor’s mapping     UK;Retail;GT US;Retail;EY d d CACCA and based on Company A’s auditor’s mapping CACCB d UK;Retail;GT ¼ 0:003 þ 0:308 0:171 À 0:547 0:061 þ 0:084 30:117ị ẳ 0:012 CACC B d US;Retail;EY ẳ 0:021 ỵ 0:072 0:171 0:382 0:061 ỵ 0:153 30:117ị ¼ À0:008 CACC B CACC diff BA ¼ j0:012 À 0:008ịj ẳ 0:020 Last, we take the average of the differences to calculate Diff_CACC for this client-pair-year as follows: Diff CACCAB ẳ 0:5 30:024 ỵ 0:020ị ẳ 0:022 For TACC_Cov, we first calculate Company A’s and B’s total accruals for 16 quarters Then, we calculate the degree to which total accruals for the two companies covary over time as the adjusted R2 from the following regression A higher adjusted R2 indicates higher comparability TACCAq ẳ b0AB ỵ b1AB TACCBq ỵ eABq For example, using data from 2004 to 2007, the adjusted R2 from estimating the above regression for Company A and Company B is 0.063 We then multiply the adjusted R2 by À1 so that the measure is decreasing in comparability, consistent with the other three comparability measures Therefore, Company A and B’s accruals co-movement (TACC_Cov) is calculated as À0.063 The Accounting Review Volume 95, Number 6, 2020 Copyright of Accounting Review is the property of American Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission However, users may print, download, or email articles for individual use ... the effect of global audit methodologies on financial reporting comparability We find evidence consistent with the role of global network methodologies in global financial reporting comparability. .. difference in audit methodologies of The Accounting Review Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 179 the two auditors given... Volume 95, Number 6, 2020 Do Global Audit Firm Networks Apply Consistent Audit Methodologies across Jurisdictions? 163 TABLE Comparability and Shared Auditor Shared_Auditor ACC_min Size_diff