Foreign institutional ownership and auditor choice : Evidence from worldwide institutional ownership

We investigate the influence of foreign institutional investors on firms’ auditor
choices in an international setting. Foreign institutional investors are likely to
demand high-quality audits to mitigate the information asymmetry they face
and facilitate their external monitoring when they invest overseas. On the other
hand, foreign institutional investors not only face difficulties in monitoring
overseas firms in general but also have the limited ability to influence their
auditor choices in particular. Using a large sample of 111,078 firm-year
observations from 40 non-US countries for the period of 2001–2011, we find
that firms with higher foreign institutional ownership are more likely to hire Big
4 auditors. To address the endogeneity concern, we show that our findings are
robust to the use of identification strategies exploiting the exogenous variation
in foreign institutional ownership following MSCI index additions, two-stage
least squares regressions, and change-on-change regressions. More
importantly, we further explore cross-sectional/cross-country variations in the
relation between foreign institutional investors and auditor choice and find that
this relation is stronger (a) when foreign institutional investors are from
countries with stronger governance institutions and (b) when the investee firms
are located in countries with higher information asymmetries. Overall, our
findings suggest that cross-border institutional investment plays an important
role in influencing firms’ auditor choices and improving the information
environment of firms across different countries around the world.