Sangmi Kim

Type of the article: Research Article

Foreign subsidiaries operate in legal and institutional environments different from those of the parent company, which raises the complexity and risk of group audits. This study examines the effect of the complexity arising from foreign subsidiaries on the audit effort of group auditors and the moderating role of the institutional reliability of the subsidiaries’ host countries, proxied by the World Bank Rule of Law indicator. Regressions of audit hours and audit fees are estimated on 1,667 firm-year observations of non-financial firms listed on the Korea Composite Stock Price Index in 2014–2017, the last years before Korea’s standard audit hours regime took effect, where engagement-level audit hours are publicly disclosed. Complexity is positively associated with audit effort (coefficient 0.127, t = 4.48 for audit hours; 0.138, t = 4.21 for audit fees), and the result is robust to firm-clustered standard errors. The interaction between complexity and host-country institutional reliability is negative for audit hours (–0.136, t = –2.21): the simple slope of complexity declines from 0.168 when no subsidiary is located in a country with a stronger rule of law than Korea to an insignificant 0.032 when all subsidiaries are. This attenuation is concentrated among groups whose foreign subsidiaries are financially significant (interaction –0.415, t = –3.13), where it is robust to firm clustering and differs significantly from the low-significance group. Because subsidiary structures vary little within firms over the sample window, the evidence is cross-sectional in nature. Overall, group auditors calibrate their effort to both the complexity of foreign subsidiaries and the institutional quality of their host countries.