Auditor Choice in Politically Connected Firms: Printed in U.S.A

DOI: 10.1111/1475-679X.
12032
Journal of Accounting Research
Vol. 52 No. 1 March 2014
Printed in U.S.A.
Auditor Choice in Politically

Connected Firms
O M R A N E G U E D H A M I , , J E F F R E Y A . P I T T M A N ,
A N D W A L I D S A F F A R
Received 26 April 2011; accepted 15 September 2013
ABSTRACT
We extend recent research on the links between political connections and

financial reporting by examining the role of auditor choice. Our evidence
that public firms with political connections are more likely to appoint a Big
4 auditor supports the intuition that insiders in these firms are eager to im-
prove accounting transparency to convince outside investors that they refrain
from exploiting their connections to divert corporate resources. In evidence
consistent with another prediction, we find that this link is stronger for con-
nected firms with ownership structures conducive to insiders seizing private
benefits at the expense of minority investors. We also find that the relation
between political connections and auditor choice is stronger for firms operat-
ing in countries with relatively poor institutional infrastructure, implying that
Moore School of Business, University of South Carolina; SKKU Business School,

Sungkyunkwan University (Seoul, Republic of Korea); Memorial University of Newfound-
land; School of Accounting and Finance, The Hong Kong Polytechnic University.
Accepted by Philip Berger. We thank Najah Attig, Narjess Boubakri, Jean-Claude Cosset,
Sadok El Ghoul, Mara Faccio, Clive Lennox, Pete Lisowsky, Stefan Sundgren, and especially
an anonymous referee for their insights on an earlier version of this paper. Our paper has also
benefited from comments from participants at the 2012 European Accounting Association
Conference, the 2011 Global Finance Conference, and seminars at various universities. We
appreciate financial support from Canadas Social Sciences and Humanities Research Council
as well as excellent research assistance from Nabhomani Aggarwal, David Godsell, and Zeina
Mehdi. Omrane Guedhami and Jeffrey Pittman gratefully acknowledge funding from the Cen-
ter for International Business Education and Research at the University of South Carolina and
the CMA Professorship/Chair in Corporate Governance and Transparency at Memorial Uni-
versity, respectively.
107
Copyright
C , University of Chicago on behalf of the Accounting Research Center, 2013
108 O. GUEDHAMI, J. A. PITTMAN, AND W. SAFFAR
tough external monitoring by Big 4 auditors becomes more valuable for pre-
venting diversion in these situations. Finally, we report that connected firms
with Big 4 auditors exhibit less earnings management and enjoy greater trans-
parency, higher valuations, and cheaper equity financing.
1. Introduction
In response to calls for research on this issue (e.g., Wang, Wong, and Xia
[2008]), we estimate the importance of corporate insiders political con-
nections to auditor choice.1 Our analysis contributes to extant research
by isolating whether political connections affect the likelihood that public
firms rely on Big 4 auditors that tightly constrain insiders discretion over
financial reporting.2 Moreover, we examine three other research questions:
(1) Are connected firms with ownership structures that leave minority in-
vestors more vulnerable to expropriation by insiders more likely to appoint
Big 4 auditors?, (2) Are connected firms in countries with relatively weak
governance institutions more eager to engage a Big 4 auditor?, and (3) Do
connected firms benefit from hiring a Big 4 auditor?
Political connections heighten the tension that insiders in public firms
experience in their financial reporting incentives. These insiders could ex-
ploit their position to deny outside investors by siphoning corporate re-
sources that they later conceal by distorting the financial statements (e.g.,
Shleifer and Vishny [1994], La Porta et al. [1998]). In other words, they
may manipulate accounting numbers to suppress information on actual
economic performance in order to ensure that their diversionary practices,
largely stemming from political cronyism and corruption, are kept hidden.
In fact, Chaney, Faccio, and Parsley [2011] find that earnings quality is
lower in politically connected firms. Rendering the financial statements less
informative to provide cover for expropriation activities would be evident
in the absence of a Big 4 auditor.
However, there are countervailing incentives pushing politically con-
nected firms to improve disclosure. In particular, connected insiders who
refrain from self-dealing would prefer higher-quality financial reporting
to ensure that outside investors realize this. It follows that such politically
connected firms would be more likely to appoint Big 4 auditors since in-
vestors value accounting transparency for protecting their interests (e.g.,
Watts and Zimmerman [1983], Dyck and Zingales [2004]). This argument
reflects that more reliable financial reporting helps prevent expropriation
by dominant insiders and their political patrons.
1 Reinforcing the significance of our research, politically connected firms account for al-
most 8% of the worlds stock market capitalization (Faccio [2006]).

2 Although Arthur Andersen dissolved during our study period, we follow convention by
labeling the large brandname public accounting firms and their predecessors as the Big 4.
Choi and Wong [2007] review worldwide evidence implying that the Big 4 supply higher-
quality audits, reinforcing the U.S. evidence that Francis [2004] comprehensively surveys.
AUDITOR CHOICE IN POLITICALLY CONNECTED FIRMS 109
We evaluate which of these financial reporting incentives dominates by

examining whether auditor choice varies systematically with political ties.
Given that recent evidence implies that connected firms suffer unique
agency problems that may magnify the demand for external monitoring
for example, Qian, Hongbo Pan, and Yeung [2011] find that insiders ex-
propriation of minority investors in China is more severe in politically con-
nected firmswe extend research on political connectivity and financial
reporting outcomes to include the role of auditor choice.
Our analysis leads to four primary insights. First, we provide evidence that
the demand for Big 4 auditors is greater for politically connected public
firms relative to their nonconnected counterparts matched, using alterna-
tive techniques, on country, industry, size, ownership structure, and other
characteristics. In various specifications, our coefficient estimates translate
into political affiliations materially increasing the likelihood that firms will
appoint a Big 4 auditor by a range of 58%, with all other variables assigned
their mean values.3 Second, we report that connected firms with ownership
structures that intensify insiders incentives to divert corporate resources
are even more likely to appoint Big 4 auditors. Third, we find that the link
between auditor choice and political ties is stronger in firms operating in
countries with relatively poor governance institutions, implying that Big 4
audits become more valuable for disciplining connected insiders in these
countries. Finally, our results suggest that connected firms with Big 4 au-
ditors exhibit lower earnings management and enjoy greater transparency,
higher valuations, and cheaper equity financing.
Although our core results are robust to confronting this issue various
ways (e.g., alternative matching procedures, controlling for firm hetero-
geneity as well as an extensive set of country-level variables, and restricting
the sample to firms with long auditor tenure), the potential endogeneity
between auditor choice and political connections means that we cannot
infer causality from this analysis. We address another important issue by iso-
lating the incremental role that connections play in auditor choice beyond
ownership characteristics, including large ultimate shareholding (e.g., Fan
and Wong [2005]). In developing our predictions, we rely on prior re-
search to motivate that political connections exacerbate agency conflicts
between dominant large shareholders and outside investors (e.g., Morck,
Stangeland, and Yeung [2000], Faccio [2006], Berkman, Cole, and Fu
[2010], Qian, Hongbo Pan, and Yeung [2011]). Empirically, we employ
several strategies to better identify the link between connections and au-
ditor choice. First, we separately control in all regressions for the equity
stakes held by the ultimate shareholder and the state, which have been
shown to influence auditor choice (e.g., Fan and Wong [2005], Guedhami
3 To provide some perspective on the economic magnitude of our evidence, Fan and Wong
[2005] estimate that raising the fraction of voting (cash flow) rights belonging to the ultimate
owner one standard deviation from its mean value leads to hiring a Big 4 auditor becoming
5% (2%) more likely.
Pittman, and Saffar [2009]). Second, we apply several matching techniques

to assemble a benchmark group of nonconnected firms against which we
evaluate auditor choice in politically connected firms. Third, we conduct
cross-sectional analysis to examine whether the link between political con-
nections and auditor choice varies with corporate ownership characteris-
tics. In all of these estimations, we find that connections affect auditor
choice beyond the ownership effects.
The rest of this paper is organized as follows. Section 2 reviews prior
research to develop the testable hypotheses. Section 3 outlines our data and
reports descriptive statistics on the regression variables. Section 4 covers the
empirical evidence and section 5 concludes.
2. Motivation
2.1 THE IMPACT OF POLITICAL CONNECTIONS ON AUDITOR CHOICE
Political connections can benefit firms in many ways.4 However, another
perspective holds that they can also lead to value-destroying tunneling by
dominant insiders eager to at least recover the costs incurred in develop-
ing these ties (e.g., Morck, Stangeland, and Yeung [2000]). In fact, Qian,
Hongbo Pan, and Yeung [2011] report that the share of earnings that in-
siders expropriate from outside investors in China exceeds the collective
value that political connections generate for the firm. Controlling share-
holders in connected firms may have more opportunity to divert corpo-
rate resources since they tend to be subject to fewer disciplinary constraints
from regulators. For example, Berkman, Cole, and Fu [2010] find evidence
from stock market returns in China implying that minority investors per-
ceive that regulators will fail to protect their interests by strictly enforc-
ing new governance standards when the firm has a controlling owner with
political connections.5 Similarly, recent U.S. research suggests that politi-
cally connected firms that fraudulently exaggerate their earnings experi-
ence more lenient monitoring from regulators relative to fraudulent firms
without political connections (e.g., Correia [2010], Yu and Yu [2011]).
Our research is grounded in prior research implying that Big 4 audi-
tors supply better monitoring than nonBig 4 auditors. However, a natural
4 These political benefits include preferential treatment in the form of access to credit from
state-owned banks (e.g., Dinc [2005]); the receipt of government contracts (e.g., Agrawal and
Knoeber [2001]); corporate bailouts in the event of financial distress (e.g., Faccio, Masulis,
and McConnell [2006]); lower tax burdens (e.g., Adhikari, Derashid, and Zhang [2006]);
lax regulatory enforcement (e.g., Berkman, Cole, and Fu [2010]); and greater allocation of
government investment during financial crises (e.g., Duchin and Sosyura [2012]).
5 However, evidence from a single country may not generalize elsewhere. For example, al-
though there is extensive research on political connections in Indonesia, Faccio, Lang, and
Young [2001] caution against extrapolating inferences from there given its weak capital mar-
ket institutions and poor corporate transparency. Rather than the unique conditions in play
when focusing on a single country, we analyze the importance of connections worldwide to
auditor choice to justify more general insights.
question is whether the Big 4 outperform other auditors outside the United
States where legal institutions governing investor protection are more be-
nign. Some equity pricing evidence suggests that the severe exposure to
civil lawsuits confronting auditors in the United States is responsible for
a major fault line that separates this country from the rest of the world
on differential audit quality (e.g., Khurana and Raman [2004], El Ghoul,
Guedhami, and Pittman [2012]). Although both reputation incentives and
litigation shape Big 4 audit quality in the United States (e.g., Baber, Kumar,
and Verghese [1995], Mansi, Maxwell, and Miller [2004]), the Big 4s inter-
est in protecting their reputations is largely behind their audits becoming
economically distinct in other countries where it is harder for investors to
recover damages when audit failure occurs.
In short, prior research suggests that reputation incentives are sufficient
to generate an audit quality differential in countries with mild private en-
forcement against auditors. Consistent with theory (e.g., DeAngelo [1981],
Rogerson [1983]), this evidence implies that large auditors with valuable
reputations at stake provide stricter monitoring. For example, recent re-
search on German (Weber, Willenborg, and Zhang [2008]) and Japanese
(e.g., Skinner and Srinivasan [2012]) firms supports the reputation expla-
nation for audit quality in countries that impose minimal discipline on
auditors in the form of holding them liable for violating securities laws.6
Moreover, Big 4 auditors with global practices may provide uniformly high-
quality assurance services worldwide to avoid undermining their reputa-
tions (e.g., Humphrey, Loft, and Woods [2009]). Altogether, this research
helps justify our focus on the importance of Big 4 auditors to constrain-
ing insiders in politically connected firms against distorting their financial
statements.
Politically connected firms may be reluctant to appoint Big 4 auditors
to improve accounting transparency since prior research suggests that
they have access to cheap loans from state-owned banks anyway (e.g.,
Dinc [2005], Claessens, Feijen, and Laeven [2008]). Moreover, Leuz and
Oberholzer-Gee [2006] find that Indonesian firms with close connections
to the state avoid raising capital from arms length sources that insist on
more transparency since they are eager to conceal transactions benefit-
ing controlling insiders and their political backers. In motivating their re-
search on the impact of politically charged events on the release of negative
financial news by Chinese state-owned enterprises, Piotroski, Wong, and
Zhang [2008, p. 3] explain that: transparency will limit the ability of politi-
cians and managers to consume their private benefits of control by expos-
ing poor governance . . . They find that connected firms heavily suppress
6 Additionally, Fan and Wong (2005) find that Big 4 auditors improve corporate gover-
nance in East Asia, a region where there is hardly any implicit insurance coverage available
to investors in the event of audit failure. In another study on this low-litigation region, Mit-
ton [2002] finds evidence corroborating that investors perceive that Big 4 auditors improve
accounting transparency in East Asian firms.
information, which Piotroski, Wong, and Zhang [2008] partly attribute to

these firms incentives to hide from minority shareholders expropriation-
related activities stemming from political cronyism and corruption.
Similarly, Stulz [2005] concludes that the threat of public exposure has a
sobering impact on whether politicians and insiders collude to extract pri-
vate benefits. In evidence implying that smaller investors are marginalized
in these situations, Fan, Wong, and Zhang [2007] find that Chinese firms
with politically connected CEOs seldom appoint directors representing mi-
nority shareholders, which stands in sharp contrast to the large fraction
of their directors who are affiliated with the largest shareholder or gov-
ernments. Faccio [2006] reports some cross-country evidence from stock
price reactions to announcements that politicians were joining the boards
of firms in which outside investors perceived that controlling sharehold-
ers and their political allies would exploit these connections to expropriate
them. Her evidence reconciles with prior research implying that politicians
extract rents from the firms that they manage (e.g., Shleifer and Vishny
[1994]). Politically connected firms in Canada tend to have concentrated
ownership (e.g., Morck, Stangeland, and Yeung [2000]), reinforcing that
outside investors have valid concerns that insiders in these firms may con-
sume private benefits to their detriment. Accordingly, although prior re-
search supports that political connections can add value to all sharehold-
ers, they can also engender agency conflicts between dominant insiders and
outside investors.
Given their diverging accounting transparency incentives, it remains un-
clear whether insiders in politically connected firms turn to Big 4 auditors
to lower information asymmetry. In one direction, the stricter monitoring
imposed by a higher-quality auditor would reduce insiders discretion to
distort financial reporting. Consequently, financing costs (valuations) for
connected firms with Big 4 auditors will fall (rise) under this argument
since accounting transparency helps outside investors identify any expro-
priation. In the other direction, connected insiders extracting private ben-
efits may choose a nonBig 4 auditor to hide that they are depriving out-
side investors. Accompanying political ties according to this argument are
strong incentives for insiders to deliberately render the financial statements
less informative by hiring a lower-quality auditor to help cover their tracks.
This underlying tension in insiders financial reporting incentives moti-
vates our analysis (Fan and Wong [2005]). We focus on how firms with polit-
ical connections weigh the marginal benefits of appointing a Big 4 auditor
(e.g., cheaper equity pricing and higher firm value) against its marginal
costs (e.g., narrower scope to expropriate). Big 4 audits are a two-edged
sword from the standpoint of insiders: negative when they are extracting
private benefits and positive when they internalize outside investors best
interests. The importance of political connections to the demand for Big 4
audits remains an empirical question that hinges on which financial report-
ing incentive dominates. We, largely for expositional convenience, predict
that firms with political ties tend to hire higher-quality auditors to credibly
commit to refrain from diverting corporate resources (all hypotheses are

stated in the alternative):
H1: In comparison to other public firms, politically connected firms are

more likely to appoint Big 4 auditors.
2.2 THE MEDIATING ROLE OF FIRMS OWNERSHIP STRUCTURES

Ownership characteristics may shape the role that political connections
play in auditor choice. La Porta et al. [2002] report that ownership struc-
tures in which dominant shareholders exercise control despite owning only
a small fraction of the firms cash flow are widespread around the world.7
Mapping into our research questions, Fan and Wong [2005] find that the
demand for external monitoring by a high-quality auditor in East Asian
firms rises when the controlling shareholders voting rights exceed her cash
flow rights. Given that minority investors become more susceptible to ex-
propriation as the ownership-control gap widens (e.g., Shleifer and Vishny
[1997], Joh [2003], Faccio [2006]), we expect to observe that such con-
nected firms are even more likely to appoint Big 4 auditors to reduce infor-
mation asymmetry.
Similarly, firms with a single large shareholder suffer worse agency con-
flicts with outside investors. Pagano and Roell [1998] model that firms with
multiple large shareholderswith both the ability (via their voting rights)
and the incentive (via their cash flow rights) to actively cross-monitor each
otherprevent insiders from accruing private benefits. In contrast, rather
than requiring the consent of a coalition of large shareholders, a single
dominant shareholder can unilaterally dictate corporate policy, including
diversionary activities (Bennedsen and Wolfenzon [2000]). It follows that
strict external monitoring by Big 4 auditors is more valuable to outside in-
vestors in connected firms when they cannot rely on committed internal
monitoring by multiple major shareholders to protect their interests.
Finally, large shareholders in business groups can exploit, for example,
pyramidal ownership to secure control rights that far exceed their equity
7 The collapse of Parmalat, the Italian dairy-and-food conglomerate, in 2003 illustrates the
interplay between ownership structure, political connections, and insiders disguising their di-
version of corporate resources by manipulating financial reporting. The company, which re-
mained closely controlled by the Tanzi family through a pyramidal ownership structure after
it went public in 1990, was accused of deliberately exaggerating its earnings. The companys
founder and CEO, Calisto Tanzi, who admitted to diverting about $640 million from Parmalat
to his familys companies (Sylvers [2004]), was eventually convicted and sentenced. Other in-
siders later confessed to depriving outside investors by tunneling commissions to offshore
companies that they controlled (e.g., Gumbel [2004]). After recounting how Mr Tanzi devel-
oped connections with politicians, Ferrarini and Giudici [2005, p. 12] argue that, Parmalat
reveals some features common to firms that have faced catastrophic financial failures: mas-
sive growth, questionable accounting and accountants, poor underlying performance, polit-
ical connections, a dominating shareholder, complex corporate structures and operational
mystery.
stakes, providing them with greater incentives and means to siphon corpo-
rate resources than their counterparts in independent firms (e.g., La Porta,
Lopez-de-Silanes, and Shleifer [1999], Claessens et al. [2000], Bae, Kang,
and Kim [2002]). Firms belonging to business groups may be more likely
to appoint a Big 4 auditor to provide outside investors with more assurance
that they abstain from extracting private benefits. Since the separation of
cash flow rights from voting rights in firms affiliated with a business group
magnifies agency costs, minority investors will particularly value the pres-
ence of a Big 4 auditor in this situation. In our second prediction, we ex-
amine whether the importance of political connections to auditor choice
varies with firms ownership structures:
H2: In comparison to other connected firms, politically connected firms
with ownership characteristics that worsen agency conflicts with out-
side investors are even more likely to appoint Big 4 auditors.
2.3 THE MEDIATING ROLE OF COUNTRY-LEVEL INSTITUTIONS
Next, we evaluate whether country-level governance institutions mediate
the relation between auditor choice and political connections. Recent ev-
idence implies that political connections are prevalent in countries with
underdeveloped legal institutions and pervasive corruption (e.g., Faccio
[2006, 2010]). Reflecting the importance of transparency, Djankov et al.
[2010] report that public disclosure of politicians finances and business
activities correlates with lower perceived corruption. Similarly, Johnson
et al. [2000] document that the risk of insider diversion is increasing in
countries corruption. More recently, Boubakri et al. [2012] find that po-
litical connections are more valuable in countries with weak institutional
environments. Consequently, we expect that operating in countries with
worse institutional infrastructure intensifies connected firms incentives to
engage a Big 4 auditor to lend more credibility to their financial statements.
In our third prediction, we isolate whether the role that political ties play
in auditor choice hinges on the quality of countries governance institu-
tions:
H3: In comparison to other public firms, politically connected firms in
countries with relatively poor governance institutions are even more
likely to appoint Big 4 auditors.
2.4ECONOMIC IMPLICATIONS OF AUDITOR CHOICE IN POLITICALLY
CONNECTED FIRMS
Finally, we examine several economic outcomes to help empirically clar-
ify what is behind any evidence that political connections elicit greater de-
mand for Big 4 auditors. Since exploiting connections to orchestrate the
diversion of corporate resources requires hiding, credible financial report-
ing plays a natural role in protecting outside investors by lowering infor-
mation asymmetry. Accordingly, we predict that connected firms intent on
reducing agency costs by appointing a Big 4 auditor exhibit less earnings
TABLE 1
Politically Connected Firms Distribution by Country
Country N % Country N %
Austria 5 0.36 Italy 37 2.70
Belgium 20 1.46 Japan 100 7.29
Canada 5 0.36 Korea, South 25 1.82
Chile 10 0.73 Malaysia 268 19.55
Denmark 10 0.73 Mexico 20 1.46
Finland 10 0.73 Philippines 18 1.31
France 51 3.72 Singapore 54 3.94
Germany 28 2.04 Spain 10 0.73
Greece 5 0.36 Sweden 10 0.73
Hong Kong 22 1.60 Switzerland 15 1.09
India 5 0.36 Taiwan 5 0.36
Indonesia 105 7.66 Thailand 93 6.78
Ireland 10 0.73 United Kingdom 395 28.81
Israel 10 0.73 United States 25 1.82
Total 1,371 100
This table reports the country and industry distribution for the sample of 1,371 politically connected
firms from 28 countries.
management, enabling them to enjoy greater transparency, lower equity

financing costs, and higher valuations:
H4: In comparison to other politically connected firms, politically con-
nected firms with Big 4 auditors benefit from lesser earnings man-
agement, greater transparency, higher valuations, and cheaper equity
financing.
3. Data Description
3.1 THE SAMPLE
To analyze the impact of political connections on auditor choice, we
hand-match data from two sources: political connections data from Faccio
[2006] and auditor identity, financial statement, and ownership data from
Worldscope. We confine the analysis to countries with connected firms ac-
cording to Faccio [2006], which yields a sample of 1,371 (30,181) firm-year
observations with (without) political connections from 28 countries cover-
ing the period from 2001 to 2005.8 Table 1 presents sample characteristics
for the politically connected firms by country. It is evident from the country
distribution that the sample exhibits good diversification across geograph-
ical regions, including Asia, Europe, Latin America, and North America,
8 However, all of our inferences hold when we extend our analysis to cover the entire set
of 47 countries studied in Faccio [2006]. In this expanded sample, politically connected firms
represent almost 2% of the total firm-year observations, which is comparable to the 2.7%
reported in Faccios [2006] full data set.
which is important when examining the interplay between political connec-

tivity and country-level governance institutions. The United Kingdom and
Malaysia contribute the largest share of the sample at 28.8% and 19.6%,
respectively, followed by Indonesia (7.7%), Japan (7.3%), and Thailand
(6.8%). All other countries comprise less than 4% of the sample.
3.2 VARIABLES AND DESCRIPTIVE STATISTICS

3.2.1. Measuring Auditor Quality. We follow extensive prior research by
gauging auditor quality with a dummy variable labeled BIG 4 that takes the
value of one for firms with Big 4 auditors (and their predecessors), and
zero otherwise.9 Given that the Worldscope database does not provide au-
ditor history details, we ensure accuracy in coding BIG 4 by identifying audi-
tors with five (20012005) of its compact discs. The descriptive statistics in
table 2 reveal that connected firms rely more on Big 4 auditors compared to
nonconnected firms; the 8277% difference in market share is statistically
significant at the 1% level. The Big 4 market share in our sample is slightly
higher than the 71% reported in Choi and Wong [2007] for a sample of
public firms from 39 countries for the period 19931998 and the 74% re-
ported in Francis and Wang [2008] for a sample of firms from 42 countries
for the period 19942004. Table A1 summarizes all variables used in the
analysis, including the data sources.
3.2.2. Measuring Political Connections. We rely on Faccios [2006] data-

base to measure political connections. Faccio [2006, p. 369] explains that
a firm is considered politically connected if at least one of its large share-
holders (anyone controlling at least 10% of voting shares) or one of its
top officers (CEO, president, vice-president, chairman, or secretary) is a
member of parliament, a minister, or is closely related to a top politician or
party. Apart from its extensive country coverage, an important upside of
this database is its considerable detail on the type of connection (i.e., con-
nection with members of parliament, a minister or the head of state, and
9 After prior cross-country research analyzing years surrounding its collapse (e.g., Francis
and Wang [2008]), we include Arthur Andersen in our main specification of the Big 4 audi-
tors. However, our core results remain when we remove all Andersen clients from the estima-
tions. Similarly, none of our inferences are sensitive to also excluding the successor auditors
(whether Big 4 or nonBig 4) to Andersen after its dissolution in 2002. Another issue is the im-
pact on our evidence of potential Worldscope auditor coding errors, which might be evident
in low Big 4 audit market shares in some of the countries represented in our sample. We help
mitigate this concern by removing in successive regressions firms from countries in which the
Big 4 market share is below 25% (this involves excluding firms from India and Greece) and
50% (this involves excluding firms from India, Greece, France, and Mexico). Our evidence
supporting the prediction in H1 holds at the 5% level or better in these smaller samples. Also,
we perform spot checks on 10% of the Indian, Greek, French, and Mexican firms in our sam-
ple, which confirms without exception that auditor identity in Worldscope matches that in
firms annual reports. In any event, auditor coding errors, which inject noise into the analysis,
would likely work against our tests rejecting the null hypotheses.
TABLE 2
Descriptive Statistics for the Politically Connected Firms
Means Medians
Connected Nonconnected Connected Nonconnected
Firms Firms t-statistics Firms Firms z-statistics
BIG 4 0.82 0.77 3.39
LARGEOWN 0.27 0.26 0.57 0.20 0.17 0.89
COMPLEXITY 2.74 2.60 3.08 3.00 2.00 2.68
FOREIGNSALES 20.46 18.06 2.22 0.00 0.00 2.05
FINANCING 0.07 0.08 0.99
CROSS-LISTING 0.10 0.05 5.48
SIZE 15.68 15.42 2.18 15.15 15.50 2.25
STATEOWN 0.26 0.06 2.06 0.00 0.00 1.94
ROA 0.03 0.03 1.21 0.04 0.03 0.89
LEVERAGE 0.59 0.44 6.59 0.34 0.18 7.31
GROWTH 4.85 6.30 2.36 3.25 2.88 1.34
INV 0.09 0.10 4.91 0.06 0.08 5.36
MTB 1.70 1.61 1.93 1.27 1.20 1.53
ACCURACY 0.01 0.01 0.52 0.00 0.00 0.70
IAS 0.18 0.16 1.67
ANALYSTS 10.91 8.33 5.63 10.00 6.00 6.62
EM 0.04 0.08 4.20 0.04 0.05 3.84
KMED 11.15 11.76 0.76 10.34 10.83 0.38
This table reports measures of central tendency for all explanatory variables according to political con-
nection. The full sample includes 1,371 politically connected firms and 1,911 nonconnected firms. , ,
and denote statistical significance at the 1%, 5%, and 10% levels, respectively. Definitions and data sources
for the variables are provided in table A1.
close relationship to a top official). Faccio [2006] classifies a firm as con-

nected through a minister or head of state when the politician or a close rel-
ative (son or daughter) holds this office and is a large shareholder or top of-
ficer. In her analysis, a firm is connected with a member of parliament when
the large shareholder or the top director is a member of parliament. Rela-
tives are not included in this classification. Close connections in the form
of well-known friendships and connections are identified by several sources
(The Economist, Forbes, or Fortune) and prior studies (e.g., Backman [1999],
Agrawal and Knoeber [2001], Fisman [2001]). The names of top officers
and shareholders are drawn from Worldscope, Extel, Lexis-Nexis, and com-
pany Web sites. Shareholder information is also collected from Claessens et
al. [2000], Faccio and Lang [2002], and various stock exchanges Web sites.
Applying these definitions, Faccio [2006] identifies 541 firms with political
connections. We follow recent research by specifying our main test variable
as a dummy variable (CONNECTED) that takes the value of one if a company
is identified as politically connected in Faccios [2006] database, and zero
otherwise (e.g., Faccio, Masulis, and McConnell [2001], Boubakri, Cosset,
and Saffar [2008], Boubakri et al. [2012], Faccio [2010], Chaney, Faccio,
and Parsley [2011]).
3.2.3. Measuring Country-Level Governance Institutions. We rely on four

widely used proxies to calibrate the quality of countries governance
institutions. The first variable is Faccios [2006, p. 373] regulatory score

(RESTRICTIONS), which is an assessment of the stringency of regulations
that prohibit or set limits on the business activities of public officials. This
regulatory score varies from zero to six with high values indicating major
restrictions on public officials. The second variable is La Porta et al.s [1998,
p. 1125] measure of the risk of expropriation (EXPROPRIATION), which is
an assessment of the risk of a modification in a contract taking the form
of a repudiation, postponement, or scaling down due to budget cutbacks,
indigenization pressure, a change in government, or a change in govern-
ment economic and social priorities. We recode the index from 0 to 10
with higher values reflecting greater risk of expropriation. The third vari-
able is Djankov et al.s [2008] anti-self-dealing index (ANTISELF), which
focuses on the regulation of corporate self-dealing transactions in 72 coun-
tries along three dimensions: disclosure, approval procedures for transac-
tions, and facilitation of private litigation when self-dealing is suspected.
The fourth proxy is La Porta, Lopez-de-Silanes, and Shleifers [2006] mea-
sure of investor protection (PROTECTION), which is equal to the princi-
pal component of the anti-director rights, disclosure requirements, and li-
ability standards indices described in their database. Table A2 reports the
means of these variables by country.
3.2.4. Control Variables. In our multivariate regression analysis, we at-
tempt to isolate the role that political connections play by comprehen-
sively controlling for two sets of variables known to affect auditor choice
according to prior research (e.g., Mansi, Maxwell, and Miller [2004], Fan
and Wong [2005], Lennox [2005], Choi and Wong [2007], Fortin and
Pittman [2007], Wang, Wong, and Xia [2008], Guedhami, Pittman, and
Saffar [2009]). The first set includes the following firm-level characteristics:
firm size (SIZE), which we measure with the natural logarithm of total as-
sets expressed in U.S. dollars;10 asset structure (INV), which we capture with
the ratio of inventory to total assets; leverage (LEVERAGE), which we code
as the ratio of long-term debt to total equity; growth (GROWTH), which
amounts to the asset growth ratio in the past year; ownership structure vari-
ables: the equity stakes held by the largest shareholder (LARGEOWN) and
the government (STATEOWN), and the percentage of voting rights belong-
ing to the ultimate owner (CONTROLRIGHTS) obtained from Claessens,
Djankov, and Lang [2000] and Faccio and Lang [2002]; complexity
10 None of our core results are materially sensitive to replacing SIZE with the natural loga-
rithm of sales or market capitalization. Given that both BIG 4 and POLITICAL are positively
correlated with SIZE according to table A3, we help reduce the concern that firm size is spu-
riously responsible for our evidence as follows. After Feltham, Hughes, and Simunic [1991]
and Pittman and Fortin [2004], we re-estimate our regressions after isolating a size-truncated
sample comprised of all firms ranging between the smallest Big 4 client according to assets
and the largest nonBig 4 client. In this restricted sample, which helps address whether our
results reflect pervasive economic phenomena rather than very large firms dominating the
analysis, the evidence on our predictions persists at the 5% level or better.
(COMPLEXITY), which we measure with the number of business segments

based on two-digit SIC codes; foreign sales (FOREIGNSALES), which is the
portion of sales from foreign operations; level of financing activities, which
we capture with two variables: a dummy variable that takes the value of one
if the sum of new long-term debt plus new equity exceeds 20% of total as-
sets (FINANCING) and cross-listing in foreign markets (CROSS-LISTING);
and profitability (ROA), which is the return on assets ratio. The second set
of controls includes two macroeconomic variables, namely the logarithm
of GDP per capita (LGDPC) and a countrys foreign direct investment as a
fraction of GDP (FDI), and a proxy for a countrys auditor discipline infras-
tructure, which reflects the intensity of civil litigation against auditors (SUE
AUDITOR) according to La Porta, Lopez-de-Silanes, and Shleifer [2006].
Prior evidence suggests a high correlation between the level of economic
development and the demand for transparency, including auditor choice
(e.g., Leuz, Nanda, and Wysocki [2003], Guedhami, Pittman, and Saffar
[2009]).
Table 2 presents descriptive statistics for the regression variables. The
average politically connected firm in our sample is relatively large accord-
ing to its assets (SIZE = 15.7; $553 million before logarithmic transforma-
tion) and valuable (MTB = 1.7), with considerable long-term debt to equity
(LEVERAGE = 59%) and moderate asset growth (GROWTH = 5%) and for-
eign operations (FOREIGNSALES = 20%). In comparison to nonconnected
firms, we find that connected firms, on average, are larger, more leveraged,
more complex, and more likely to cross-list in foreign markets. Although
connected firms have a higher fraction of state ownership and foreign sales
than nonconnected firms, their growth rates and inventory levels tend to be
lower. These differences are consistent with prior research (e.g., Boubakri,
Cosset, and Saffar [2008], Boubakri et al. [2012], Faccio [2010]).
Table A3 reports correlation coefficients between the regression variables
while allowing for country and firm level clustering. Consistent with the
prediction in H1, we observe a positive correlation between CONNECTED
and BIG 4 that is significantly different from zero at the 1% level. In the
next section, we consider whether this preliminary evidence that politically
connected firms are more likely to appoint Big 4 auditors persists in a series
of multivariate regressions. Finally, we find that the correlations between
the controls are generally small, reducing concerns that multicollinearity is
spuriously responsible for our evidence on the predictions.
4. Empirical Results
In a multivariate regression framework, we estimate the impact of polit-
ical connections on the likelihood that firms will hire a Big 4 auditor to
examine the prediction in H1. Next, we analyze the prediction in H2 that
agency problems embedded in firms ownership structures strengthen the
link between political connections and auditor choice. For the prediction
in H3, we isolate whether the importance of political connections to auditor
choice hinges on the quality of a countrys governance institutions. Finally,

we examine whether politically connected firms with Big 4 auditors benefit
from lower earnings management, greater transparency, higher valuations,
and cheaper financing under the prediction in H4.
4.1 POLITICAL CONNECTIONS AND AUDITOR CHOICE
4.1.1. Main Evidence. To evaluate the link between political connections
and auditor choice, we focus on the sample of connected firms described
in section 3.1 and a set of peer firms without political connections. In or-
der to improve identification by confronting the threat that differences in
firm characteristics, such as their ownership structures and size, are spu-
riously responsible for any evidence supporting our predictions, we em-
ploy two separate matching techniques to specify the benchmark group of
nonconnected firms.11 The first peer group consists of nonconnected firms
matched to connected firms based on country, industry, year, and decile of
total assets. The second group comprises firms matched on various observ-
able characteristics according to a propensity score matching procedure
that we outline below.
Table 3 presents the results from estimating several pooled multivariate
logistic regressions to analyze the impact of political connections on au-
ditor choice worldwide. All standard errors are clustered at the firm and
country level, and adjusted for heteroskedasticity. We rely on two-sided
tests to gauge statistical significance in all estimations. To better assess the
economic impact of the key test variable (CONNECTED), we also report
marginal effects in square brackets. In these regressions, we control for
ownership structure in alternative ways. In models 1 and 2, we control for
the equity stake of the largest shareholder (LARGEOWN), rather than their
ultimate ownership (CONTROLRIGHTS), to reduce data attrition. For ex-
ample, narrowing our focus to firms with ultimate ownership data would
lower the countries under study from 28 to 19, preventing us from exam-
ining firms from countries such as the United States and Mexico that have
a considerable number of political connections according to table 1. How-
ever, we replace LARGEOWN with CONTROLRIGHTS in models 3 and 4
and with both CONTROLRIGHTS and CASHFLOWRIGHTS in models 5 and
6 to better isolate the incremental importance of political connections to
auditor choice beyond the ultimate ownership effects that Fan and Wong
[2005] document.
Model 1 reveals that the coefficient for the dummy variable identifying
politically connected firms (CONNECTED) loads positively at the 5% level,
implying that these firms are more likely to hire Big 4 auditors relative to
nonconnected peers in the same country, industry, year, and decile of total
11 In another strategy for isolating the importance of political connections to auditor
choice, we assemble a third peer group consisting of nonconnected peers matched to con-
nected firms based on country, industry, and year. In unreported estimations, we find evidence
at the 1% level supporting the prediction in H1 when we apply this matching technique.
TABLE 3
Political Connections and the Auditor Choice
Full Sample Ultimate Ownership Sample
Connected Firms Matched Propensity Connected Firms Matched Propensity Connected Firms Matched Propensity
on Country, Industry, Year, Score on Country, Industry, Year, Score on Country, Industry, Year, Score
and Decile of Total Assets Matching and Decile of Total Assets Matching and Decile of Total Assets Matching
Models 1 2 3 4 5 6
CONNECTED 0.41 0.32 0.54 0.36 0.53 0.36
(2.52) (1.78) (2.48) (2.06) (2.45) (2.05)
LARGEOWN 0.67 0.17
(1.78) (0.47)
CONTROLRIGHTS 1.30 0.24 1.22 0.31
(2.66) (0.62) (2.34) (0.49)
CASHFLOWRIGHTS 0.19 0.09
(0.42) (0.15)
COMPLEXITY 0.11 0.05 0.02 0.01 0.02 0.01
(1.76) (0.78) (0.23) (0.15) (0.23) (0.14)
FOREIGNSALES 0.01 0.00 0.01 0.00 0.01 0.00
(3.02) (0.82) (2.36) (0.23) (2.33) (0.22)
FINANCING 0.01 0.22 0.15 0.27 0.15 0.27
(0.07) (1.17) (0.55) (1.49) (0.54) (1.49)
CROSS-LISTING 0.62 0.44 0.83 0.49 0.82 0.48
(1.47) (0.95) (2.08) (1.05) (2.05) (1.05)
SIZE 0.15 0.21 0.10 0.20 0.10 0.20
(6.25) (6.87) (3.39) (6.44) (3.40) (6.34)
ROA 2.08 0.74 1.95 0.61 1.97 0.61
(4.09) (1.75) (2.71) (1.46) (2.75) (1.46)
STATEOWN 0.05 0.06 0.02 0.06 0.02 0.06
AUDITOR CHOICE IN POLITICALLY CONNECTED FIRMS
(3.60) (2.30) (0.40) (2.38) (0.41) (2.38)

LEVERAGE 0.05 0.10 0.01 0.08 0.01 0.08
(0.46) (0.87) (0.09) (0.70) (0.07) (0.70)
121
(Continued)
122
T A B L E 3Continued
Full Sample Ultimate Ownership Sample
Connected Firms Matched Propensity Connected Firms Matched Propensity Connected Firms Matched Propensity
on Country, Industry, Year, Score on Country, Industry, Year, Score on Country, Industry, Year, Score
and Decile of Total Assets Matching and Decile of Total Assets Matching and Decile of Total Assets Matching
GROWTH 0.01 0.00 0.00 0.00 0.00 0.00
(2.84) (0.16) (0.21) (0.55) (0.23) (0.56)
INV 1.19 0.96 1.93 0.75 1.92 0.75
(1.69) (1.37) (2.47) (1.07) (2.46) (1.07)
FDI 0.07 0.07 0.01 0.07 0.01 0.07
(3.41) (2.97) (0.27) (2.82) (0.30) (2.82)
LGDPC 0.33 0.42 0.17 0.45 0.17 0.45
(4.58) (5.41) (2.03) (5.61) (1.91) (5.62)
SUE AUDITOR 1.05 1.12 1.66 1.10 1.64 1.09
(2.73) (3.32) (3.43) (3.18) (3.40) (3.17)
Intercept 4.99 6.43 2.80 6.81 2.71 6.82
(5.91) (6.42) (2.43) (6.45) (2.31) (6.45)
[Marginal effect of [6.11] [5.37] [7.69] [6.28] [7.60] [6.25]
CONNECTED in
O. GUEDHAMI, J. A. PITTMAN, AND W. SAFFAR
%]
Pseudo R 2 0.10 0.11 0.09 0.11 0.09 0.10
2 153.8 132.1 90.37 119.3 90.57 119.4
N 3,282 2,742 2,690 2,266 2,690 2,266
This table reports pooled logit estimation results for auditor choice of politically connected firms and nonconnected firms. The sample consists of 1,371 politically connected
firms and the set of peer firms without political connections matched to connected firms based on country, industry, year, and decile of total assets (models 1, 3, and 5) and various
observable characteristics according to a propensity score matching procedure (models 2, 4, and 6). Beneath each estimate is reported the robust z-statistic clustered at both the
country and the firm level. The table also reports the marginal effect of the variable CONNECTED. , , and denote statistical significance at the 1%, 5%, and 10% levels,
respectively, based on two-sided tests. The definitions and data sources for the variables are outlined in table A1.
assets.12 Reflecting its material economic impact, the coefficient estimate

for CONNECTED translates into political affiliations increasing the likeli-
hood of appointing a Big 4 auditor by 6%, with all other variables assigned
their mean values. This result is consistent with the prediction in H1 that
politically connected firms are associated with greater demand for Big 4
auditors.13
Next, we examine the demand for a Big 4 auditor between connected
firms and nonconnected peers matched according to propensity scores de-
rived as follows (e.g., Boubakri et al. [2012]). First, we require that the
candidate firm for the matching share the same country, year, and indus-
try class as the connected firm. Second, among the potential control sample
firms, we select the optimal match based on the nearest neighbor technique
of the propensity score matching procedure. We follow Rosenbaum and
Rubin [1983] and Heckman, Ichimura, and Todd [1997, 1998] in relying
on this procedure in an attempt to control for differences in characteristics
between connected and nonconnected firms. To calculate the propensity
score, we analyze a comprehensive set of firm characteristics that should
capture the likelihood that a given firm will be politically connected ac-
cording to prior research. More specifically, we consider size, leverage, the
largest shareholders ownership stake, state ownership, and cross-listing as
connected firms are likely to be different from nonconnected peers along
these characteristics (see, e.g., Faccio [2006, 2010], Leuz and Oberholzer-
Gee [2006], Boubakri, Cosset, and Saffar [2008], and Bunkanwanicha and
Wiwattanakantang [2009]).
This matching procedure translates into a sample of 2,742 firm-year ob-
servations equally distributed by country, industry, and year between polit-
ically connected and nonconnected firms. Despite the major data attrition
that accompanies constructing a matched sample using propensity scores in
our setting, an upside of applying this technique here is the large number
of potential matches (30,181 nonconnected observations), ensuring that
the connected and nonconnected samples have extremely close propen-
sity scores. In model 2, we find that connected firms are significantly more
12 Reflecting the importance of political connections to auditor choice, the incremental R 2
for CONNECTED is 0.037 relative to 0.027 for SIZE.

13 Although we follow extensive prior research in primarily specifying auditor quality with
the presence or absence of a Big 4 auditor, we also examine whether our results are mate-
rially sensitive to replacing BIG 4 with firms audit fees. Extant research implies that audit
fees are higher when auditors expend more effort on an engagement, translating into bet-
ter audits (e.g., Dye [1993], Davis, Ricchiute, and Trompeter [1993], Whisenant, Sankaragu-
ruswamy, and Raghunandan [2003], Caramanis and Lennox [2008]). Consequently, politi-
cally connected firms will incur higher audit fees under the intuition for the prediction in
H1. However, given poor audit fee data availability in Worldscope, the sample shrinks to 1,756
firm-year observations compared to the 3,282 observations under study in model 1 in table 3.
Nevertheless, we find in unreported results that CONNECTED continues to load positively at
the 1% level despite the loss in power in this smaller sample, suggesting that connected firms
pay higher audit fees than their nonconnected peers matched by country, industry, year, and
size.
likely to appoint a Big 4 auditor than their propensity score matched peers.
The coefficient estimate for CONNECTED in model 2 implies that a 5%
increase in the probability of engaging a Big 4 auditor accompanies a polit-
ical connection. In unreported tests, we exploit the large number of close
matches available in our data set by implementing one-to-five and one-to-
ten matching, and find that CONNECTED loads positively at the 5% and 1%
levels, respectively, in these larger samples.
To better isolate the impact of political connections on auditor choice,
we replace in models 3 and 4 the variable LARGEOWN with the ultimate
ownership variable CONTROLRIGHTS after Fan and Wong [2005]. In both
regressions, we continue to estimate a positive and statistically significant
(at the 5% level) coefficient on CONNECTED. Corroborating our earlier
evidence, these results imply that connected firms are more likely to en-
gage a Big 4 auditor compared to their peer group of nonconnected firms.
Economically, the coefficient estimates for CONNECTED suggest that firms
become 8% (model 3) and 6% (model 4) more likely to hire a Big 4 audi-
tor in the presence of a political connection, with all other variables set to
their mean values. We complement the propensity score matching evidence
in model 4 by conducting one-to-five and one-to-ten matching to take ad-
vantage of the deep pool of control observations available in our data set.
In these unreported estimations, we find that CONNECTED is positive and
statistically significant at the 1% level in both cases. In models 5 and 6, we
continue to find that CONNECTED loads positively at the 5% level when we
add the cash flow rights of the ultimate owner to models 3 and 4. Consistent
with Fan and Wong [2005], CASHFLOWRIGHTS is statistically insignificant
in these regression models, while CONTROLRIGHTS only enters negatively
in model 5. It is important to note that these ownership variables are highly
correlated in our data ( = 0.77, p < 0.001).
In other unreported analysis, we follow Fan and Wong [2005] by speci-
fying control concentration with a dummy variable (CONTROLRIGHTS
30%) assigned the value one if CONTROLRIGHTS is at least 30%, and zero
otherwise. Additionally, in successive regressions, we replace CONTROL-
RIGHTS with the separation between the voting and cash-flow rights be-
longing to the ultimate owner (WEDGE), and a dummy variable set equal
to one if WEDGE is at least 20%, and zero otherwise. We find that our
core evidence on CONNECTED holds at the 5% level or better in these
re-estimations, reinforcing that the importance of political connections to
auditor choice is incremental to the impact of the ultimate ownership char-
acteristics that Fan and Wong [2005] examine.14
14 Our empirical design primarily diverges from Fan and Wongs [2005] in two ways. First,
we control for a larger set of firm-level determinants of auditor choice. In fact, the 14 controls
for firm characteristics in our models include the four in their main specifications. Second, we
apply various matching techniques to improve identification in our setting. After restricting
our sample to the eight Asian countries analyzed in Fan and Wong [2005] and no longer
examining matched samples, we find a positive and statistically significant coefficient on
Collectively, the results in table 3 using different matching techniques

suggest that the demand for a Big 4 auditor is higher in politically con-
nected firms relative to their nonconnected peers. Importantly, our ev-
idence persists after controlling for a comprehensive set of firm-level
determinants of auditor choice. In particular, we find that the role that
political connections play in auditor choice extends beyond the impact of
the ownership variables capturing the equity stakes held by the ultimate
shareholder and the state. Interestingly, the coefficient for state ownership
(STATEOWN) is generally negative and statistically significant in table 3.
This result suggests that the demand for Big 4 auditors is decreasing in
state ownership, supporting that the evidence in Guedhami, Pittman, and
Saffar [2009] for the specific case of newly privatized firms generalizes to
public firms worldwide. More generally, this evidence squares with prior re-
search on the political economy and financial reporting transparency (e.g.,
Bushman, Piotroski, and Smith [2004], Bushman and Piotroski [2006]).
Among the other firm-level determinants, we find that firm size, profitabil-
ity, and foreign sales are positively related to auditor choice; only FINANC-
ING and LEVERAGE have no perceptible impact on this decision in any of
the table 3 regressions. Additionally, the three country-level controls (FDI,
LGDPC, and SUE AUDITOR) generally enter positively and significantly at
the 5% level or better, implying that the demand for high-quality auditors
is higher in countries with more foreign investor involvement, more devel-
oped economies, and more discipline imposed on auditors through civil
litigation institutions.
4.1.2. Sensitivity Analyses. In this section, we evaluate whether our ear-

lier evidence on the importance of political connections to auditor choice
persists when we tackle potential omitted variables bias and endogeneity,
re-estimate our regressions on alternative matched samples, and respecify
auditor quality. To preview, the results that we report in table 4 lend ad-
ditional support to the prediction in H1 that public firms with political
connections are more likely to appoint high-quality auditors. Except when
examining whether our evidence holds when we apply alternative matching
approaches, we rely on the sample of connected firms and nonconnected
peers matched based on country, industry, year, and decile of total assets
(model 3 in table 3) as our baseline in these sensitivity tests.
4.1.2.1. Omitted Variables Bias and Endogeneity. We begin the sensitivity
analysis by confronting whether endogeneity or omitted variables bias ex-
plains the evidence in table 3. Although our research design mitigates
these issues since we control for an extensive set of firm- and country-level
CONTROLRIGHTS, helping to reconcile our evidence to theirs. More generally, our results
are consistent with El Ghoul et al. [2013], who find that Fan and Wongs [2005] evidence
for East Asia does not extend to Western Europe where investor protection institutions are
typically better.
TABLE 4
Political Connections and the Auditor Choice: Sensitivity Tests
126
Connected Firms
Matched on Country, Connected Firms
Exclude Industry, Year, and Matched on Country,
Additional Short Decile of the Largest Industry, Year, and
Random Control Auditor Shareholders Voting Largest Owner
Effects Variables Tenure Rights Identity
Models 1 2 3 4 5
CONNECTED 1.74 0.59 1.00 0.56 0.54
(2.44) (2.13) (3.07) (2.36) (2.48)
CONTROLRIGHTS 4.92 0.50 1.02 1.21 1.30
(2.93) (0.87) (1.74) (2.08) (2.66)
COMPLEXITY 0.00 0.03 0.01 0.02 0.02
(0.00) (0.37) (0.16) (0.25) (0.23)
FOREIGNSALES 0.01 0.01 0.01 0.01 0.01
(1.24) (1.92) (2.32) (1.71) (2.36)
FINANCING 1.61 0.30 0.12 0.46 0.15
(1.99) (1.01) (0.34) (1.46) (0.55)
CROSS-LISTING 2.35 0.87 1.49 1.09 0.83
(1.83) (2.15) (2.19) (1.91) (2.08)
SIZE 0.27 0.23 0.10 0.12 0.10
(2.89) (4.44) (2.51) (3.45) (3.39)
STATEOWN 0.01 0.02 0.01 0.01 0.02
(0.04) (0.49) (0.14) (0.09) (0.40)

ROA 3.24 2.08 1.80 2.49 1.95
(1.66) (2.83) (2.06) (2.66) (2.71)
LEVERAGE 0.03 0.03 0.24 0.12 0.01
(0.10) (0.24) (1.46) (0.76) (0.09)
GROWTH 0.00 0.00 0.00 0.00 0.00
(0.33) (1.06) (0.62) (0.22) (0.21)
INV 7.96 0.65 2.40 1.86 1.93
(3.50) (0.76) (2.61) (1.92) (2.47)
FDI 0.10 0.04 0.01 0.02 0.01
(2.25) (1.95) (0.35) (0.61) (0.27)
(Continued)
Connected Firms
Matched on Country,
Exclude Industry, Year, and Connected Firms
Additional Short Decile of the Largest Matched on Country,
Random Control Auditor Shareholders Voting Industry, Year, and
Effects Variables Tenure Rights Largest Owner Identity
LGDPC 0.44 0.57 0.03 0.21 0.17
(1.62) (1.34) (0.26) (2.04) (2.03)
SUE AUDITOR 8.37 2.16 2.06 1.51 1.66
(4.80) (2.40) (3.39) (2.40) (3.43)
OPENNESS 0.01
(2.60)
NEWSPAPER 0.36
(1.08)
DISCLOSE 1.71
(1.57)
JUDICIAL 0.14
(0.95)
RULEOFLAW 0.14
(0.48)
PREDATION 0.95
(4.53)
BUSINESSGROUP 0.32
(1.10)
Intercept 4.78 0.51 1.47 3.31 2.80
(1.34) (0.27) (1.00) (2.43) (2.43)
[Marginal effect of CONNECTED in %] [8.16] [9.84] [7.98] [7.69]
Pseudo R 2 0.14 0.11 0.09 0.09
2 116.1 67.89 67.35 90.37
N 2,690 2,534 2,113 2,144 2,690
This table reports pooled logit estimation results for auditor choice of politically connected firms and nonconnected firms using the specification in model 3 in table 3 as
the baseline regression. Model 1 uses panel random effects to estimate our baseline specification. Model 2 includes OPENNESS, NEWSPAPER, DISCLOSE, JUDICIAL, RULEOFLAW,
PREDATION, and BUSINESSGROUP as additional control variables. Model 3 considers the sample of connected firms that neither upgrade from a nonBig 4 to a Big 4 auditor nor
downgrade from a Big 4 to a nonBig 4 auditor between 1998 and 2005 (i.e., the model excludes firms with short auditor tenure). Model 4 considers a sample of connected firms
matched on country, industry, year, and decile of the largest shareholders voting rights. Model 5 considers a sample of connected firms matched on country, industry, year, and the
127
largest shareholders identity. Beneath each estimate is reported the robust z-statistic clustered at both the country and the firm level. The table also reports the marginal effect of
the variable CONNECTED. , , and denote statistical significance at the 1%, 5%, and 10% levels, respectively, based on two-sided tests. The definitions and data sources for the
variables are outlined in table A1.
variables and implement various matching procedures, we address linger-

ing concerns with three techniques.
First, in unreported analysis, we estimate a treatment effects model since
it is plausible that some unobserved determinants of auditor choice may
also affect political connections, causing our reported results to be bi-
ased and inconsistent. After Chaney, Faccio, and Parsley [2011] and Chen,
Chen, and Wei [2011], we rely on CAPITALa dummy variable set equal
to one if the firm is located in the capital city, and zero otherwiseas an
instrument for political connectivity given prior evidence on its role in facil-
itating the formation of political connections (e.g., Roberts [1990], Agrawal
and Knoeber [2001], Bertrand et al. [2007]). Importantly, the correlation
between CAPITAL and BIG 4 is small in our data set ( = 0.05), helping to
justify the validity of this exclusion restriction (e.g., Larcker and Rusticus
[2010], Lennox, Francis, and Wang [2012]). In the first stage, we perform
a logit regression of political ties on the dummy variable CAPITAL and the
set of independent variables included in model 3 of table 3. The first stage
fitted values for political connections are then used in the second stage
logit regression explaining auditor choice. Similar to Boubakri, Cosset, and
Saffar [2008] and Chaney, Faccio, and Parsley [2011], the first stage regres-
sion results include that the firms location is a good predictor of political
connections: the coefficient for CAPITAL loads positively at the 1% level,
implying that the incidence of connections is higher for firms located in
the capital. Consistent with the prediction in H1, we find in the second
stage logit estimation that the coefficient of the (predicted) political con-
nection variable is positive and statistically significant at the 1% level.15
Second, we exploit the panel nature of our data by estimating a random
effects model. In the results reported in model 1 of table 4, we continue to
find that appointing a Big 4 auditor becomes more likely in the presence
of a political connection. This is constructive for mitigating the concern
that omitted variables are spuriously behind the evidence supporting the
prediction in H1. Third, we control for several additional country-level fac-
tors that capture: openness to international trade (OPENNESS); the level of
freedom of the press (NEWSPAPER), which measures the extent of public
opinion pressure according to Dyck and Zingales [2004]; the risk of state
15 Although the treatment effects model has the advantage of analyzing the entire sample
(e.g., Chaney, Faccio, and Parsley [2011]), an alternative approach to addressing endogeneity
in order to improve identification is to analyze political connection formation over time and
observe the ensuing effects on auditor choice. However, Chaney, Faccio, and Parsley [2011]
stress that a major limitation of this approach is the small sample of firms for which the date
of political connection formation can be determined, preventing researchers from using for-
mation dates to draw meaningful inferences. In our setting, we could only pinpoint the date
of formation of the political connection for 44% of our sample. Regrettably, the vast majority
of these connections were forged before 2001 when our sample period begins, precluding
us from reliably examining the link between changes in political connections and auditor
choice. Moreover, Faccios [2006] database does not disclose the connected member, which
complicates tracking shifts in political affiliations over our 20012005 sample period.
expropriation (PREDATION) using Durnev and Fauvers [2009] predation

index; and three proxies for the quality of legal institutions derived from La
Porta, Lopez-de-Silanes, and Shleifer [2006], namely, accounting standards
(DISCLOSE), the efficiency of the judicial system (JUDICIAL), and the rule
of law (RULEOFLAW). Prior research implies that these country-level vari-
ables matter to the demand for accounting transparency as well as the pres-
ence and value of political connections (e.g., Faccio [2006], Choi and Wong
[2007], Guedhami, Pittman, and Saffar [2009], Boubakri et al. [2012]).
Besides these country-level variables, we control for business group mem-
bership (BUSINESSGROUP), which may affect group-wide auditor choice.
Despite that adding these controls leads to some sample attrition, we find
in model 2 that the positive relation between CONNECTED and auditor
choice remains in this regression. Although these additional tests provide
some assurance that endogeneity is not responsible for the link that we ob-
serve between political connections and auditor choice, we stress that we
still cannot infer causality from the analysis.
It also would be premature to conclude that our evidence reflects that
politically connected firms are more likely to appoint a Big 4 auditor to
provide stricter monitoring of the financial reporting process unless we
consider two other competing explanations for our evidence. First, a Big 4
auditor can protect its valuable reputation and avoid litigation by refusing
to accept engagements from clients that are more apt to resort to manip-
ulating their financial statements to hide underlying performance, or re-
sign from engagements when the ensuing risk reaches an intolerable level
(e.g., DeFond, Ettredge, and Smith [1997], Shu [2000], Johnstone and Be-
dard [2004]). Second, insiders intending to materially distort their firms
financial statements by, for example, overstating earnings to conceal their
diversionary activities may prefer to hire a nonBig 4 auditor in order to fly
under the radar when they begin accumulating private benefits at the ex-
pense of outside investors (e.g., Fan and Wong [2005], Guedhami, Pittman,
and Saffar [2009]).
We follow Lennox and Pittman [2010] in considering the potential roles
that screening by auditors and selection by their clients play by evaluat-
ing whether our core results hold when we isolate firms with long auditor
tenure. The intuition for this analysis is that endogeneity is worse when the
duration between auditor choice and the decision to deliberately exagger-
ate earnings is shorter since a firm planning to misreport would require
less lead time to cover its tracks by switching to a nonBig 4 auditor, while
its Big 4 auditor may shed clients that have become riskier (e.g., Jones and
Raghunandan [1998], Johnstone and Bedard [2004]).16 Consequently, we
restrict the sample to firms that neither upgrade from a nonBig 4 to a Big 4
16 Consistent with Bockus and Giglers [1998] theory, Shu [2000] reports that riskier clients
are less likely to retain another large auditor when their incumbent auditor resigns from the
engagement. Although prior research implies that large audit firms in the United States are
more eager to avoid riskier clients since they have more to lose in the form of reputational and
auditor nor downgrade from a Big 4 to a nonBig 4 auditor between 1998

and 2005this timeframe covers the five years (20012005) under study
in the rest of our analysis and the three preceding yearssince we are on
more solid ground in treating BIG 4 as predetermined when auditor tenure
is longer (Myers, Myers, and Omer [2003], Caramanis and Lennox [2008],
Chang, Dasgupta, and Hilary [2009]). In this smaller sample, we find sup-
port at the 1% level in model 3 for the prediction in H1, reducing concern
that screening or selection phenomena are spuriously responsible for our
earlier evidence. Our results are almost identical when we apply the same
five-year tenure breakpoint as Lennox and Pittman [2010].
4.1.2.2. Alternative Samples. In recent cross-country research, Guedhami,
Pittman, and Saffar [2009] examine auditor choice in state-owned enter-
prises and during their transition to private ownership. In particular, they
report a negative relation between the extent of government ownership and
the likelihood of selecting a Big 4 auditor. They also find that privatization
corrects the distortions in auditor choice that Wang, Wong, and Xia [2008]
stress, although continued government ownership lowers the probability of
appointing a Big 4 auditor after privatization. To alleviate the concern that
our evidence on the role that political connections play in auditor choice
reflects the governments ownership, we control for its equity stake in all
regressions. In unreported analysis, we better isolate the importance of po-
litical connections to this decision by excluding privatized firms. The pos-
itive and statistically significant relation at the 1% level between political
connections and auditor choice persists in this regression.
Our empirical strategy in table 3 involves applying two forms of match-
ing to improve identification. Next, we expand this analysis to consider
whether our core evidence is robust to implementing alternative match-
ing techniques. First, in model 4, we compare connected firms to their
nonconnected peers matched based on country, industry, year, and decile
of the largest shareholders voting rights. Second, in model 5, we select
nonconnected firms based on country, industry, year, and the largest share-
holders identitythe specific types reflect ownership by widely held non-
financial institutions, widely held financial institutions, families, the state,
and dispersed shareholders according to data available from Claessens et al.
[2000] and Faccio and Lang [2002]. Most relevant to our purposes, CON-
NECTED remains positive and statistically significant at the 5% level in both
regressions, reinforcing our earlier evidence on the link between political
connection and auditor choice.
4.1.2.3. Alternative Dependent Variables. There are reasons to doubt that
BIG 4 is the relevant construct for all of the countries represented in our
litigation costs in the event of audit failure, this evidence is sensitive to shifts in the auditor
litigation liability landscape there (e.g., Jones and Raghunandan [1998], Francis and Reynolds
[2003], Choi, Doogar, and Ganguly [2004]).
sample. For example, although table 2 reports that the Big 4 audit nearly
82% of the politically connected firms in our sample, data inspection re-
veals wide variation in their market shares across countries. Consequently,
we respecify auditor choice by coding a dummy variable, LARGEST FIVE,
one when the auditor is among the five largest in the country according
to client assets, and zero otherwise. In unreported analysis, we find that
CONNECTED remains positive and statistically significant at the 5% level
when we replace BIG 4 with this alternate dependent variable. We find al-
most identical evidence when we calibrate market share with the number
of clients rather than their assets (e.g., Wang, Wong, and Xia [2008]), or
identify large auditors as those that hold at least a 5% market share in the
country (e.g., DeFond, Wong, and Li [2000]).17
4.2POLITICAL CONNECTIONS AND AUDITOR CHOICE: THE MEDIATING

ROLE OF FIRMS OWNERSHIP STRUCTURES
In table 5, we examine in panel A whether the importance of politi-
cal connections to auditor choice varies systematically with the extent of
agency costs embedded in firms ownership structures. Initially, we estimate
whether the relation between auditor choice and political ties is sensitive
to the presence of any wedge between the controlling shareholders vot-
ing rights and cash flow rights. To ensure that we draw valid inferences
concerning the interaction, we also report the corrected mean interac-
tive effect of the interaction terms using the methodology proposed by
Ai and Norton [2003] for nonlinear models. In model 1, we find that the
OWNERSHIPWEDGECONNECTED interaction has no perceptible impact
on auditor choice, inconsistent with the prediction in H2 that control di-
verging from ownership explains demand for high-quality auditors in con-
nected firms. Next, we analyze in model 2 whether connected firms are
more likely to hire a Big 4 auditor when the control rights of the ultimate
owner exceed 50% and find supportive results.
Consistent with the prediction in H2, we find evidence in model 3 that
connected firms with a single large shareholder are more likely to appoint a
Big 4 auditor, implying that they rely more heavily on external monitoring
by high-quality auditors in the absence of internal monitoring by multi-
ple large shareholders. This evidence persists in model 4 when we replace
the dummy variable representing the absence of multiple major sharehold-
ers with a continuous version of this conditioning variable, NUMBER OF
17 Another issue is that the Big 4 are prohibited from operating in some countries unless
they form affiliations with local auditors. It follows that audit quality falls when the country re-
quires the Big 4 to arrange these local affiliations to access the market. After identifying these
cases using Worldscope data, we narrow our BIG 4 specification to strictly firms from coun-
tries that do not require local affiliations; that is, we treat Big 4 auditors with local affiliations
as equivalent to nonBig 4 auditors. In this re-specification, we continue to find evidence at
the 5% level supporting the prediction in H1 that connected firms are more likely to prefer
higher-quality auditors.
132
TABLE 5
Political Connections and Auditor Choice
Panel A: The mediating role of the ownership structure
OWNERSHIP CONTROL SINGLE NUMBER OF BUSINESS
WEDGE RIGHTS > 50 LARGEOWN LARGE OWNERS GROUP
Models 1 2 3 4 5
OWNERSHIPWEDGE CONNECTED 0.13
(0.29)
CONTROLRIGHTS > 50 CONNECTED 1.12
(1.88)
SINGLELARGEOWN CONNECTED 1.25
(2.25)
NUMBER OF LARGE OWNERS CONNECTED 0.84
(2.02)
BUSINESSGROUP CONNECTED 1.76
(2.88)
Intercept 2.92 2.60 2.37 3.07 2.46
(2.54) (2.07) (1.96) (2.44) (1.92)
[Marginal effect of [1.88] [12.09] [14.59] [12.83] [14.86]
#VARIABLES CONNECTED in %]
Mean interactive effect of 0.02 0.13 0.17 0.12 0.14
#VARIABLES CONNECTED
(0.42) (1.58) (1.96) (1.87) (1.74)
Pseudo R 2 0.09 0.09 0.11 0.11 0.13
2 91.84 94.19 106.8 106.8 102.0
N 2,690 2,690 2,443 2,443 2,625
(Continued)
Panel B: The mediating role of the firm characteristics
NEG- BANKRUPTCY CURRENT CROSS-
SIZE EARNINGS CAPEX XDOPS PROBABILITY ASSETS LISTING LEVERAGE FINANCING
Models 1 2 3 4 5 6 7 8 9
SIZE CONNECTED 0.14
(2.03)
NEG EARNINGS CONNECTED 0.76
(2.28)
CAPEX CONNECTED 0.09
(2.06)
XDOPS CONNECTED 0.73
(2.16)
BANKRUPTCY PROBABILITY CONNECTED 0.02
(1.86)
CURRENT ASSETS CONNECTED 0.35
(2.59)
CROSS-LISTING CONNECTED 0.62
(0.60)
LEVERAGE CONNECTED 0.01
(1.48)
FINANCING CONNECTED 0.17
(0.31)
Intercept 2.72 2.76 2.56 2.71 3.15 2.73 2.78 2.88 2.81
(2.31) (2.38) (2.22) (2.35) (2.54) (2.35) (2.41) (2.49) (2.44)
[Marginal effect of [2.07] [13.99] [1.33] [9.81] [0.33] [5.26] [7.73] [0.18] [2.71]
#VARIABLES CONNECTED in %]
Mean interactive effect of 0.01 0.11 0.01 0.10 0.00 0.05 0.01 0.001 0.03
#VARIABLES CONNECTED
(0.96) (1.90) (1.85) (1.80) (1.62) (2.22) (0.06) (1.20) (0.39)
Pseudo R 2 0.09 0.09 0.09 0.09 0.10 0.09 0.09 0.09 0.09
2 93.06 93.06 96.66 92.42 89.64 93.57 90.94 91.88 90.36
N 2,690 2,690 2,690 2,690 2,395 2,690 2,690 2,690 2,690
133
(Continued)
Panel C: The mediating role of the country-level variables
NEWSPAPER POLITICALOPP ELECTION BANKDEP FINSYSDEP
134
Models 1 2 3 4 5
NEWSPAPER CONNECTED 0.02
(0.07)
POLITICALOPP CONNECTED 2.27
(1.82)
ELECTION CONNECTED 0.53
(1.93)
BANKDEP CONNECTED 0.01
(1.82)
FINSYSDEP CONNECTED 0.01
(1.86)
Intercept 1.71 2.39 2.78 1.01 0.99
(1.46) (2.05) (2.41) (0.78) (0.76)
[Marginal effect of #VARIABLES CONNECTED in %] [0.25] [35.20] [6.86] [0.13] [0.13]

Mean interactive effect of #VARIABLES CONNECTED 0.05 0.23 0.06 0.001 0.001
(1.58) (1.05) (1.77) (1.75) (1.78)
Pseudo R 2 0.11 0.09 0.09 0.10 0.10

2 109.7 97.22 94.48 83.35 83.86
N 2,544 2,544 2,690 1,988 1,988
This table reports results on the role of ownership characteristics (panel A), other firm characteristics (panel B), and country-level variables (panel C) in conditioning the impact
of political connections on auditor choice. In all specifications, we use model 3 in table 3 as the baseline regression. In panel A, the ownership variables interacted with CONNECTED
are the wedge between the controlling shareholders voting rights and cash flow rights (OWNERSHIPWEDGE) in model 1, a dummy variable for whether control rights of the ultimate
owner exceed 50% (CONTROLRIGHTS>50) in model 2, the presence of a single large shareholder (SINGLELARGEOWN) in model 3, the number of multiple major shareholders
(NUMBER OF LARGE OWNERS) in model 4, and a dummy variable indicating business group affiliation (BUSINESSGROUP) in model 5. In panel B, the firm characteristics interacted
with CONNECTED are firm size (SIZE) in model 1, a dummy variable for loss firms (NEG EARNINGS) in model 2, capital expenditures (CAPEX) in model 3, a dummy variable
for firms reporting extraordinary items or discontinued operations (XDOPS) in model 4, the change in bankruptcy probability (BANKRUPTCY PROBABILITY) in model 5, current
assets ratio (CURRENT ASSETS) in model 6, cross-listing status (CROSS-LISTING) in model 7, leverage (LEVERAGE) in model 8, and financing demand (FINANCING) in model 9. In
panel C, the country-level variables interacted with CONNECTED are the circulation of daily newspapers divided by population (NEWSPAPER) in model 1, the strength of political
opposition (POLITICALOPP) in model 2, a dummy variable indicating whether it is a national election year (ELECTION) in model 3, and the total value of bank (financial system)
deposits to GDP in model 4 (model 5). Beneath each estimate is reported the robust z-statistic clustered at both the country and the firm level. The table also reports the marginal
effect of each interaction term and the mean interactive effect using the methodology proposed by Ai and Norton [2003]. , , and denote statistical significance at the 1%, 5%,
and 10% levels, respectively, based on two-sided tests. The definitions and data sources for the variables are outlined in table A1. Results for the control variables are not reported
for the sake of brevity.
LARGE OWNERS, which is the natural logarithm of one plus the number
of shareholders holding at least a 10% equity stake. These results reinforce
that committed monitoring by several large shareholders obviates the disci-
plinary role that Big 4 audits play in connected firms.
Similarly, the interaction between BUSINESSGROUP and CONNECTED
loads positively in model 5, implying that Big 4 appointments become more
likely when connected firms belong to a business group. We also estimate
a positive and significant mean interactive effect (reported at the bottom
of model 5). Our results square with Faccios [2006] evidence that cumu-
lative abnormal returns surrounding politicians joining firms boards are
negative when the connected firm has a pyramidal ownership structure
that increases agency costs since expropriation becomes more lucrative for
the controlling shareholder as the gap between their voting and cash flow
rights widens (e.g., Johnson et al. [2000], La Porta et al. [2002], Fan and
Wong [2005]).
Collectively, the evidence in panel A of table 5 generally supports the in-
tuition that connected firms are even more eager to engage high-quality
auditors when their ownership structures leave minority investors more
vulnerable to expropriation by dominant shareholders. Economically, our
coefficient estimates translate into connected firms (i) with the ultimate
owners control rights exceeding 50%; (ii) with a single large shareholder;
and (iii) affiliated with a business group becoming 12%, 15%, and 15%
more likely to appoint a Big 4 auditor, respectively, with the rest of the re-
gression variables set to their mean values.
In panel B of table 5, we complement the cross-sectional results involv-
ing ownership structure by analyzing whether the link between political
connections and auditor choice hinges on other firm-level characteristics.
More specifically, we follow prior research by examining the role that client
size, profitability, complexity, financial constraints, and risk play in shaping
connected firms demand for Big 4 auditors (e.g., Fan and Wong [2005],
Hay, Knechel, and Wong [2006], Chang, Dasgupta, and Hilary [2009],
Sankaraguruswamy, Whisenant, and Willenborg [2013]). Consistent with
expectations, we report in models 16 evidence that connected firms that
are larger have positive earnings in the past year, have larger capital ex-
penditures, are more complex according to the presence of extraordinary
items or discontinued operations, exhibit a greater change in bankruptcy
probability, and have more current assetsfirms with higher levels of inven-
tory and receivables are harder to auditare more likely to rely on a Big 4
auditor.18 Except for models 1 and 5, the mean interactive effects reported
18 We continue to find supportive evidence when we replace the dummy variable for
whether the firm has incurred a loss in a prior year with its return on equity to capture prof-
itability. Similarly, our results in table 5 are robust to measuring client size with revenues rather
than assets. We resort to alternative proxies for some constructs when poor data availability
means that we cannot examine more standard measures. For example, we follow Whisenant,
Sankaraguruswamy, and Raghunandan [2003] and Sankaraguruswamy, Whisenant, and
at the bottom of panel B are statistically significant. In contrast, we find no

evidence in model 7 supporting that connected firms that are cross-listed
tend to prefer higher-quality auditors. Similarly, in untabulated results that
shift the focus from foreign financing to foreign operations, this interac-
tion remains statistically insignificant when we replace cross-listing with the
amount of foreign sales to gauge firms international orientation. In mod-
els 8 and 9, we also fail to find that connected firms with more debt in their
capital structures or requiring more external financing exhibit greater de-
mand for Big 4 auditors; both LEVERAGE and FINANCING are irrelevant to
auditor choice according to table 3.
In the first three regressions in panel C of table 5, we examine the
role of public scrutiny in shaping auditor choice in politically connected
firms. This analysis is rooted in the intuition that connections increase
the exposure of insiders to public scrutiny from the press and political
opponents, reducing their ability and incentives to extract private bene-
fits (Stulz [2005]). In short, subjecting connected firms to tough public
scrutiny constrains their diversionary instincts. Consequently, these firms
will prefer to appoint Big 4 auditors since they have nothing to hide when
they refrain from self-dealing. In successive regressions, we interact CON-
NECTED with three variables reflecting the extent of media and political
oversight, namely the circulation of daily newspapers divided by popula-
tion (NEWSPAPER) from Dyck and Zingales [2004], the strength of polit-
ical opposition (POLITICALOPP) obtained from the Database of Political
Institutions (Beck et al. [2001]), and a dummy variable indicating whether
it is a national election year (ELECTION) from the Database of Political
Institutions. The results generally indicate that these variables condition
the link between political connections and auditor choice in the predicted
directions. More specifically, the interaction terms between CONNECTED
and the variables measuring the strength of political opposition (model 2)
and the presence of an election year (model 3) load positively, although
we fail to find supportive results when we focus on the role of the press in
model 1. The positive mean interactive effects reported in models 2 and 3
reinforce our conclusions. Next, we evaluate whether the countries debt
market development mediates the link between political ties and auditor
choice given Chaney, Faccio, and Parsleys [2011] evidence on the impor-
tance of political connections to firms borrowing costs. We measure debt
market development with the total value of bank (financial system) deposits
to GDP in model 4 (model 5). In both regressions, we find evidence imply-
ing that connected firms in countries with more developed debt markets
Willenborg [2013] in gauging firm complexity with the presence of extraordinary items or
discontinued operations, rather than the number of subsidiaries, the audit report lag, or
the presence of pension or other postretirement plans. However, the interaction with CON-
NECTED becomes statistically insignificant when we measure client complexity with the num-
ber of business segments.
are less likely to hire Big 4 auditors; the mean interactive effects are also
negative and statistically significant.
4.3 DOES COUNTRY-LEVEL GOVERNANCE AFFECT THE LINK BETWEEN
POLITICAL CONNECTION AND AUDITOR CHOICE?
Given prior research that the value of political connections is higher
in weaker institutional environments, it follows that insiders resisting the
temptation to expropriate outside investors will have even more incentive
to improve external monitoring by hiring a Big 4 auditor in these countries.
Consequently, we examine the prediction in H3 that the relation between
political connections and auditor choice is stronger in countries with rela-
tively lax governance institutions by re-estimating the regression in model 3
in table 3 after bisecting the sample into countries with weak versus strong
governance according to the median rating of the various proxies described
in section 3.2.19
Table 6 presents the results after dividing the sample using the four prox-
ies for country-level governance, RESTRICTIONS, EXPROPRIATION, ANTI-
SELF, and PROTECTION. We find across all proxies that the coefficient
on CONNECTED is positive and statistically significant in the subsample of
firms located in countries with weak governance institutions (models 1, 3, 5,
and 7), suggesting that political connections magnify the demand for high-
quality audits in these situations.20 However, in stark contrast, we find that
the coefficient on CONNECTED is statistically indistinguishable from zero
in the subsample of countries with strong governance institutions (models
2, 4, 6, and 8). The difference in the CONNECTED coefficients between the
samples of weak and strong institutional environments is statistically signif-
icant for two out of the four country-level governance variables; the excep-
tions are the comparisons involving RESTRICTIONS and EXPROPRIATION.
In unreported regressions, we control for the largest shareholders equity
stake (LARGEOWN) rather than their control rights (CONTROLRIGHTS) in
order to recover observations by improving the country coverage in table 6
to 28 from 19, and find that the CONNECTED coefficients are significantly
different between the countries with weak and strong governance institu-
tions in all four comparisons. These results lend support to the intuition
19 This split sample design with respect to country-level variables follows extensive prior re-
search (e.g., Lang, Lins, and Miller [2004], Pinkowitz, Stulz, and Williamson [2006], Wang
[2010]). In an important advantage, this approach avoids multicollinearity complications aris-
ing from the high correlations between the test variables and their interaction terms, especially
when the interaction involves a dummy variable and country-level time invariant variables. In-
deed, in our analysis, the Belsley collinearity test indicates a score above the threshold of 30
when we include the interaction terms.
20 Economically, our evidence in this section implies that the importance of political con-
nections to auditor choice is generally larger when we isolate firms from countries with rela-
tively poor governance institutions. For the full sample, the regression in model 3 in table 3
suggests that the probability of hiring a Big 4 auditor rises 8% in the presence of a political
connection. In comparison, the coefficient estimates for CONNECTED translate into an 8%
impact in model 1 in table 6, 9% in model 3, 13% in model 5, and 14% in model 7.
TABLE 6
Political Connections and Auditor Choice: The Mediating Role of Country-Level Institutions
138
RESTRICTIONS RESTRICTIONS EXPROPRIATION EXPROPRIATION ANTISELF ANTISELF PROTECTION PROTECTION

Variable Low High High Low Low High Low High
Models 1 2 3 4 5 6 7 8
CONNECTED 0.60 0.42 0.71 0.18 0.87 0.11 0.97 0.23
(1.80) (1.35) (2.08) (0.63) (2.53) (0.37) (2.85) (0.71)
CONTROLRIGHTS 2.70 2.00 1.37 0.59 0.81 1.19 1.64 1.32
(1.73) (3.66) (2.32) (0.54) (0.95) (1.67) (2.05) (1.78)
COMPLEXITY 0.15 0.08 0.10 0.05 0.05 0.04 0.05 0.01
(1.28) (0.78) (1.01) (0.36) (0.50) (0.27) (0.47) (0.10)
FOREIGNSALES 0.01 0.01 0.01 0.01 0.01 0.01 0.00 0.01
(1.47) (1.99) (1.54) (2.11) (1.18) (1.64) (0.06) (1.63)
FINANCING 0.22 0.39 0.64 0.25 0.32 0.39 0.27 0.36
(0.48) (0.99) (1.47) (0.62) (0.70) (1.03) (0.63) (0.97)
CROSS-LISTING 1.09 0.39 0.81 1.11 0.68 0.56 0.55 0.69
(1.73) (0.84) (1.79) (1.26) (1.54) (0.49) (1.10) (0.59)
SIZE 0.08 0.22 0.14 0.05 0.10 0.44 0.16 0.48
(1.47) (3.32) (1.94) (1.13) (2.14) (5.22) (3.03) (5.47)
STATEOWN 0.01 0.03 0.03 0.06 0.13 0.01 0.16 0.00
(0.12) (0.49) (0.55) (0.79) (1.90) (0.10) (2.66) (0.05)
ROA 3.20 1.76 2.20 2.36 1.20 2.63 1.13 2.41
(2.51) (2.07) (2.69) (1.82) (0.93) (2.83) (0.80) (2.70)

LEVERAGE 0.10 0.17 0.28 0.12 0.20 0.27 0.19 0.35
(0.50) (0.90) (1.67) (0.59) (1.24) (1.17) (1.23) (1.57)
GROWTH 0.00 0.00 0.01 0.00 0.00 0.01 0.00 0.01
(0.16) (0.66) (1.25) (0.46) (0.20) (1.14) (0.25) (1.35)
INV 0.36 2.10 1.88 0.67 1.32 0.27 1.10 0.43
(0.27) (1.94) (1.70) (0.52) (1.06) (0.21) (0.82) (0.34)
FDI 0.07 0.04 0.01 0.04 0.08 0.00 0.05 0.00
(2.28) (1.17) (0.28) (1.46) (2.52) (0.11) (1.81) (0.04)
(Continued)
RESTRICTIONS RESTRICTIONS EXPROPRIATION EXPROPRIATION ANTISELF ANTISELF PROTECTION PROTECTION
Variable Low High High Low Low High Low High
LGDPC 0.52 0.09 0.39 0.29 0.29 0.73 0.22 0.73
(3.51) (0.40) (0.31) (2.01) (2.56) (2.96) (1.84) (2.90)
SUE AUDITOR 0.22 2.12 3.76 0.45 2.82 1.06 0.04 1.57
(0.07) (3.23) (3.63) (0.74) (3.31) (0.87) (0.06) (0.51)
Intercept 6.30 1.36 1.36 2.13 5.23 10.15 3.82 12.28
(1.87) (0.53) (0.12) (1.23) (2.90) (3.72) (2.09) (2.86)
[Marginal effect of [8.02] [5.72] [8.93] [2.78] [12.93] [1.17] [14.33] [2.36]
CONNECTED in
%]
p-value for [0.69] [0.23] [0.03] [0.01]
difference in
CONNECTED
coefficient
Pseudo R 2 0.09 0.16 0.17 0.06 0.14 0.16 0.12 0.17
2 54.62 75.72 88.76 31.72 76.48 72.17 70.53 74.39
N 1,187 1,503 1,651 1,039 1,426 1,264 1,443 1,247
For subsamples of weak versus strong governance countries, this table reports pooled logit estimation results for auditor choice for politically connected firms and nonconnected
peers using model 3 in table 3 as the baseline regression. Models 1 and 2 report the results for subsamples of firms from countries with low and high regulatory scores (RESTRIC-
TIONS), respectively. Models 3 and 4 report the results for subsamples of firms from countries with high and low risk of expropriation (EXPROPRIATION), respectively. Models 5
and 6 report the results for subsamples of firms from countries with low and high scores on the anti-self-dealing index (ANTISELF), respectively. Models 7 and 8 report the results
for subsamples of firms from countries with low and high investor protection scores (PROTECTION), respectively. Beneath each estimate is reported the robust z-statistic clustered at
both the country and the firm level. The table also reports the marginal effect of the variable CONNECTED and the p-value for the difference in the CONNECTED coefficient between
the weak and strong institution subsamples. The standard errors for the differences between weak and strong institutions regressions are computed with a seemingly unrelated
regression (SUR) system that estimates both groups jointly. , , and denote statistical significance at the 1%, 5%, and 10% levels, respectively, based on two-sided tests. The
definitions and data sources for the variables are outlined in table A1.
139
that the incentives of politically connected firms to appoint a Big 4 auditor

are stronger in countries with relatively poor governance institutions.
4.4 ECONOMIC OUTCOMES STEMMING FROM AUDITOR CHOICE

IN POLITICALLY CONNECTED FIRMS
The analysis above suggests that politically connected firms are more
likely to engage a Big 4 auditor, especially when they suffer more severe
agency problems and operate in countries with relatively lax country-level
governance institutions. This evidence naturally raises another question:
why are these firms more eager to engage a Big 4 auditor? Extant research
detects that firms with better auditors enjoy higher-quality earnings (e.g.,
Becker et al. [1998]), higher valuations (e.g., Fan and Wong [2005]), and
lower cost of capital (e.g., Mansi, Maxwell, and Miller [2004]). However,
there is evidence that connected firms have preferential access to credit
(e.g., Khwaja and Mian [2005]) and are more likely to be bailed out by gov-
ernments (Faccio, Masulis, and McConnell [2006]). In other words, some
research implies that the upside of tough external monitoring by Big 4
auditors may be minimal for connected firms. In the other direction, the
presence of a Big 4 auditor protects outside investors by constraining in-
siders discretion over the financial reporting process, which may translate
into connected firms benefiting from lower information asymmetry. In this
section, we contribute to empirically settling this issue by testing the predic-
tion in H4 that politically connected firms appointing a Big 4 auditor prac-
tice less earnings management, enjoy greater transparency, exhibit higher
valuations, and attract cheaper financing.
In table 7, we report the results of this analysis, which involves interacting
auditor choice with the variable CONNECTED to isolate whether politically
connected firms benefit more from becoming better known by hiring a Big
4 auditor. In focusing on the interaction term between CONNECTED and
auditor choice, we examine an extensive set of firm-level outcome variables
motivated by prior research, namely earnings management (e.g., Becker
et al. [1998], Chaney, Faccio, and Parsley [2011]); analyst forecast coverage
and accuracy (e.g., Lang, Lins, and Miller [2004], Lang, Lins, and Maffett
[2012], Chen, Ding, Kim [2010]); accounting standard choice (e.g., Lang
and Maffett [2011], Lang, Lins, and Maffett [2012]); valuation (e.g., Fan
and Wong [2005]); and equity pricing (e.g., Khurana and Raman [2004]).
We initially examine the impact of auditor choice on earnings manage-
ment since providing evidence that the presence of a Big 4 auditor reduces
information asymmetry evident in accounting transparency is arguably a
necessary condition for proceeding to analyze, for example, whether Big 4
clients enjoy higher valuations and lower equity financing costs. After Fan
and Wong [2005], we implement a two-stage estimation procedure. In the
first stage, we predict, for each firm-year, the probability of choosing a Big
4 auditor using model 1 in table 3. In the second stage, we regress earnings
management (EM)specified after Leuz, Nanda, and Wysocki [2003] as
the absolute value of accruals over total assets where accruals are calculated
TABLE 7
Analysis of the Importance of Auditor Choice to Earnings Management, Transparency, Market Valuation, and Equity Pricing
(1) Earnings Management (EM) (2) Analyst Following (ANALYSTS) (3) Forecast Accuracy (ACCURACY)
Variable Variable Variable
PBIG4CONNECTED 0.12 PBIG4CONNECTED 1.62 PBIG4CONNECTED 0.13
(2.67) (2.44) (3.06)
PBIG4 0.05 PBIG4 1.04 PBIG4 0.01
(1.45) (1.45) (0.37)
CONNECTED 0.09 CONNECTED 1.42 CONNECTED 0.11
(2.74) (2.52) (2.98)
ROA 0.10 CROSS-LISTING 0.13 CROSS-LISTING 0.00
(4.14) (1.37) (0.85)
SIZE 0.00 SIZE 0.27 SIZE 0.00
(1.46) (10.20) (1.74)
GROWTH 0.00 LARGEOWN 0.04 ANALYSTS 0.00
(0.81) (0.20) (1.20)
LEVERAGE 0.01 STATEOWN 0.02 NEG EARNINGS 0.08
(1.34) (1.59) (2.34)
LARGEOWN 0.01 GROWTH 0.00 CHANGE EARNINGS 0.00
(0.57) (1.32) (0.66)
CROSS-LISTING 0.00 VARIANCE 0.23 CIFAR 0.00
(0.43) (1.36) (0.96)
STATEOWN 0.00 EARNINGS SURPRISE 1.69 ANTISELF 0.00
(0.36) (1.82) (0.17)
LAWORDER 0.00 Intercept 3.20 EARNINGS MGN 0.00
(0.17) (5.88) (0.64)
SECREG 0.00 LISTED FIRMS 0.00
(0.34) (0.31)
ANTISELF 0.05 IDV 0.00
(2.96) (0.41)
(Continued)
141
142
(1) Earnings Management (EM) (2) Analyst Following (ANALYSTS) (3) Forecast Accuracy (ACCURACY)
STOCKTRAD 0.00 UAI 0.00
(0.42) (1.05)
Intercept 0.14 Intercept 0.04
(5.10) (0.90)
Adjusted R 2 0.09 Adjusted R 2 0.53 Adjusted R 2 0.09
N 1,661 N 1,126 N 842
(4) Accounting Standard Choice (IAS) (5) Market Valuation (MTB) (6) Cost of Equity (KMED)
PBIG4 CONNECTED 5.10 PBIG4CONNECTED 1.38 PBIG4CONNECTED 5.97
(2.40) (2.23) (2.73)
PBIG4 0.39 PBIG4 0.72 PBIG4 3.15
(0.22) (2.26) (1.83)
CONNECTED 4.01 CONNECTED 1.01 CONNECTED 4.77
(2.25) (2.05) (2.59)
LARGEOWN 0.53 SIZE 0.03 SIZE 0.32
(1.20) (2.14) (6.41)
FOREIGNSALES 0.00 GROWTH 0.02 VARIANCE 7.33
(1.14) (9.00) (10.24)

CF 0.00 LARGEOWN 0.19 FBIAIS 9.32
(0.50) (1.16) (2.37)
FINANCING 0.05 CROSS-LISTING 0.13 MTB 0.39
(0.19) (0.87) (8.37)
CROSS-LISTING 0.15 FOREIGNSALES 0.00 DISCLOSE 1.49
(0.45) (2.22) (1.82)
SIZE 0.25 CAPEX 0.00 MACVAR 8.55
(4.01) (0.50) (4.40)
(Continued)
(4) Accounting Standard Choice (IAS) (5) Market Valuation (MTB) (6) Cost of Equity (KMED)
LEVERAGE 0.48 ANTISELF 0.12 LAWORDER 0.22
(3.98) (0.70) (1.69)
TURNOVER 0.26 Intercept 2.08 INFLATION 0.45
(1.82) (5.88) (2.97)
GROWTH 0.01 Intercept 11.54
(1.72) (4.77)
LGDPC 0.26
(1.81)
ANTISELF 4.50
(7.71)
STOCKTRAD 0.21
(0.82)
CIFAR 0.07
(3.47)
Intercept 16.46
(6.87)
[Marginal effect of PBIG4 [44.71]
CONNECTED in %]
Mean interactive effect of 0.53
PBIG4 CONNECTED (1.80)
Pseudo R 2 0.25 Adjusted R 2 0.13 Adjusted R 2 0.36
N 2,993 N 3,119 N 1,124
This table reports results from regressing earnings management (model 1), the natural logarithm of one plus the number of analysts following the firm (model 2), analyst
forecast accuracy (model 3), accounting standard choice (model 4), valuation (model 5), and equity pricing (model 6) on firm-level and country-level variables. The sample includes
connected and nonconnected firms analyzed in table 3. Except for model 2, which includes year, industry, and country effects, all other models include industry and year effects.
Beneath each estimate is reported the robust t/z-statistic clustered at both the country and the firm level. Model 4 reports the marginal effect of the interaction term and the mean
interactive effect using the methodology proposed by Ai and Norton [2003]. , , and denote statistical significance at the 1%, 5%, and 10% levels, respectively, based on
two-sided tests. The definitions and data sources for the variables are outlined in table A1.
143
as: (total current assets cash) (total current liabilities short-term debt
taxes payable) depreciation expense (see table A1 for more details)on the
predicted probability of Big 4 auditors (PBIG4). Importantly, relying on
Leuz, Nanda, and Wysocki [2003] specification minimizes data attrition
in our sample. In addition to our test variables, we include several firm-
and country-level controls in this regression: firm size (SIZE), cross-listing
(CROSS-LISTING), profitability (ROA), firm growth (GROWTH), firm lever-
age (LEVERAGE), the ownership stake of the largest shareholder (LARGE-
OWN), state ownership (STATEOWN), a composite securities regulation in-
dex (SECREG), law and order (LAWORDER), stock market development
(STOCKTRAD), and investor protection (ANTISELF). All variables are de-
fined in table A1. The results in model 1 include that the coefficient on the
interaction between PBIG4 and CONNECTED is negative and statistically
significant at the 1% level, implying that earnings management is lower
in politically connected firms with Big 4 auditors. In this regression, CON-
NECTED is positive and statistically significant at the 1% level, suggesting
that earnings management is worse in politically connected firms. This re-
sult reconciles with Chaney, Faccio, and Parsleys [2011] evidence that po-
litically connected firms exhibit lower earnings quality. Lending support
to the prediction in H4, our evidence implies that this effect is less pro-
nounced in politically connected firms that appoint a Big 4 auditor.
We extend our analysis to consider three measures of firm-level trans-
parency examined in recent research (e.g., Lang and Maffett [2011], Lang,
Lins, and Maffett [2012]). This includes analyzing in model 2 the number
of analysts following a firm (ANALYSTS). Lang, Lins, and Maffett [2012]
hold that greater analyst coverage and forecast accuracy are likely to reflect
greater transparency in the firms information environment. Besides our
test variables, we include a set of controls motivated by prior research (e.g.,
Lang, Lins, and Miller [2003, 2004]): firm size (SIZE); cross-listing (CROSS-
LISTING); the ownership stake of the largest shareholder (LARGEOWN);
state ownership (STATEOWN); firm growth (GROWTH); the standard devi-
ation of monthly returns over the previous year (VARIANCE); earnings sur-
prise (EARNINGS SURPRISE); as well as industry, year and country effects.
We find a negative and statistically significant (at the 5% level) coefficient
on CONNECTED, indicating that connected firms have lesser analyst cov-
erage. In additional evidence supporting the prediction in H4, we provide
evidence at the 5% level that this effect subsides for politically connected
firms that are Big 4 clients.
In model 3, we complement the evidence in model 2 by analyzing
forecast accuracy (ACCURACY), defined as the negative absolute value of
the difference between the median forecast and the actual earnings per
share (EPS) deflated by the stock price after Lang and Lundholm [1996]
and Hope [2003]. We follow Hopes [2003] cross-country research by in-
cluding these control variables in the regression: firm size (SIZE); analyst
following (ANALYSTS); cross-listing (CROSS-LISTING); an indicator vari-
able for loss firms (NEG EARNINGS); the absolute value of the change in
earnings over the previous year (CHANGE EARNINGS); as well as country-

level measures for earnings management (EARNINGS MGN), the quality of
financial reporting (CIFAR), domestic listed firms (LISTED FIRMS), in-
vestor protection (ANTISELF), Hofstedes [2001] cultural dimensions un-
certainty avoidance (UAI) and individualism (IDV), along with industry and
year effects. Consistent with Chen, Ding, and Kim. [2010], the results in
model 3 suggest that political connections adversely affect analyst forecast
accuracy. Importantly for our purposes, we find that the coefficient on the
interaction term PBIG4CONNECTED is positive and statistically significant
at the 1% level, suggesting that connected firms that appoint a Big 4 auditor
benefit from more accurate analyst earnings forecasts.
In model 4, we develop another conditioning variable by identify-
ing whether a firm adopts international accounting standards (IAS). Ac-
counting quality is generally higher for these firms according to Barth,
Landsman, and Lang [2008] and Lang and Maffett [2011]. In this re-
gression, we follow prior research (e.g., Hope, Jin, and Kang [2006],
Barth, Landsman, and Lang [2008], Kim and Shi [2012]) by control-
ling for firm size (SIZE), the ownership stake of the largest shareholder
(LARGEOWN), firm growth (GROWTH), firm leverage (LEVERAGE), cash
flows from operating activities (CF), cross-listing (CROSS-LISTING), sales
turnover (TURNOVER), level of financing activities (FINANCING), foreign
sales (FOREIGNSALES), the logarithm of GDP per capita (LGDPC), investor
protection (ANTISELF), stock market development (STOCKTRAD), and a
countrys quality of financial reporting (CIFAR) as well as industry and year
fixed effects. Reinforcing our earlier evidence, the results indicate that the
coefficient on CONNECTED is significantly negative while the mean inter-
active effect of PBIG4CONNECTED loads positively at the 5% level. Col-
lectively, these results support that the presence of a high-quality auditor
mitigates the lower transparency of politically connected firms.
We consider in model 5 the role that auditor choice plays in shaping
firm value, measured by the market-to-book ratio (MTB). In this regression,
we include other factors shown in prior research to affect firm value (e.g.,
Durnev and Kim [2005]): firm size (SIZE), cross-listing (CROSS-LISTING),
firm growth (GROWTH), the ownership stake of the largest shareholder
(LARGEOWN), foreign sales to total assets (FOREIGNSALES), capital expen-
ditures (CAPEX), and investor protection (ANTISELF) in addition to year
and industry fixed effects. We report that the coefficient on the interaction
between PBIG4 and CONNECTED loads positively at the 5% level, implying
that connected firms that appoint a Big 4 auditor are valued at a premium.
This finding extends evidence in Fan and Wong [2005] that the economic
consequences of the presence of a high-quality auditor are larger for East
Asian firms with highly concentrated control.
Recent research suggests that accounting transparency at the country-
(e.g., Hail and Leuz [2006]) and firm-level (e.g., El Ghoul, Guedhami,
and Pittman [2012]) is associated with a lower cost of equity capital. Ac-
cordingly, we extend our analysis in model 6 by gauging the links among
political connections, auditor choice, and equity pricing. We follow exten-

sive prior research by using analysts earnings forecasts and stock prices
to derive the ex ante cost of equity (e.g., Hail and Leuz [2006], Dhaliwal,
Heitzman, and Li [2006], Chen, Chen, and Wei [2011]). This approach
constitutes a useful alternative given the failure of asset pricing models to
proxy for the cost of equity (e.g., Fama and French [1997], Pastor, Sinha,
and Swaminathan [2008]). More specifically, we adopt four implied cost
of equity capital models, namely those developed by Gebhardt, Lee, and
Swaminathan ([2001]; KGLS ), Claus and Thomas ([2001]; KCT ), Ohlson
and Juettner-Nauroth ([2005]; KOJN ), and Easton ([2004]; KES ). To reduce
concerns that the results are driven by the assumptions underpinning any
particular model, we specify as the dependent variable the median implied
cost of equity obtained from the four models (KMED ). Moreover, to allevi-
ate the concern that optimism inherent in analysts earnings forecasts ad-
mits bias that inflates the equity premium estimates, we follow Hail and
Leuz [2006] by running a weighted least square regression that assigns
less (more) weight to inaccurate (precise) forecasts. In this regression, the
weight is equal to the forecast error (absolute value one-year ahead earn-
ings forecast minus realized earnings deflated by assets per share).
In addition to our test variables, we include several control variables: the
natural logarithm of total assets (SIZE), the market value of common equity
plus book value of debt scaled by total assets (MTB), forecast error defined
as the difference between the one-year-ahead earnings forecast and real-
ized earnings deflated by beginning of the period assets per share (FBAIS),
the volatility of stock returns over the previous 12 months (VARIANCE),
the realized inflation rate over the next year (INFLATION), disclosure stan-
dards (DISCLOSE), law and order (LAWORDER), and macroeconomic vari-
ability (MACVAR). In model 6, which also includes year and industry fixed
effects, we observe a negative and statistically significant (at the 1% level)
coefficient on the interaction between PBIG4 and CONNECTED, implying
that connected firms that appoint a Big 4 auditor attract cheaper equity
financing.
Notwithstanding that the implied cost of capital approach has been
widely used in the accounting and finance literature (see, e.g., Hail and
Leuz [2006], Chen, Chen, and Wei [2011]), it is beset by another limita-
tion apart from deviations between analysts and investors earnings expec-
tations. This limitation relates to the sensitivity of the implied cost of equity
estimates to the assumptions of long-term growth rates beyond analysts
forecast horizons (e.g., Easton [2004]). In particular, the cost of equity es-
timates derived from the models of Claus and Thomas [2001] and Ohlson
and Juettner-Nauroth [2005] assume that the perpetual growth rate is equal
to the future (realized) inflation rate. To verify that our findings in model
6 are robust to addressing this concern, we follow Hail and Leuz [2006] by
re-estimating the median cost of equity capital (KMED ) after applying these
alternative growth assumptions for the models of Claus and Thomas [2001]
and Ohlson and Juettner-Nauroth [2005]: (i) a constant long-run growth of
3% and (ii) a perpetual growth rate equal to the annual real GDP growth
plus long-run inflation rate, respectively. The untabulated results include
that the PBIG4CONNECTED coefficient is negative and statistically signif-
icant at the 5% level, corroborating our earlier evidence that politically
connected firms with Big 4 auditors enjoy equity financing costs that are
closer to the risk-free rate. Overall, the evidence reported in this section
provides empirical support for our fourth hypothesis that politically con-
nected firms with Big 4 auditors exhibit lower earnings management and
greater transparency, and benefit from higher valuations as well as cheaper
equity financing costs.
5. Conclusions
In response to calls for research on this issue (e.g., Wang, Wong, and Xia
[2008]), we examine the importance of corporate insiders political con-
nections, which exacerbate the expropriation of minority investors accord-
ing to recent evidence (e.g., Faccio [2006], Qian, Hongbo Pan, and Yeung
[2011]), to auditor choice in public firms worldwide. The tension that con-
nected insiders experience in deciding whether to appoint a Big 4 auditor
to constrain their discretion over financial reporting motivates our analysis.
In one direction, insiders eager to persuade outside investors that they are
not exploiting their political connections to divert corporate resources may
rely on a Big 4 auditor to strengthen external monitoring. In the other di-
rection, connected insiders depriving outside investors may prefer to hire
a nonBig 4 auditor to help conceal their diversion by rendering the finan-
cial statements less informative about underlying firm performance. Using
a unique data set on political connections around the world constructed by
Faccio [2006], we analyze which financial reporting incentive dominates by
estimating the role that political connections play in auditor choice. Our
evidence that public firms with political connections are more likely to ap-
point a Big 4 auditor lends support to the intuition that these firms respond
to the serious agency problems that connections engender by improving ac-
counting transparency evident in auditor choice.
Next, we separately isolate whether connected firms with ownership
structures conducive to self-dealing by insiders or operating in countries
with relatively poor institutional infrastructure are even more eager to re-
duce information asymmetry by engaging a Big 4 auditor. In a set of re-
sults consistent with these predictions, we find that the link between au-
ditor choice and political connections is stronger when firms ownership
characteristics lead to severe agency conflicts and country-level governance
institutions are worse. This evidence implies that Big 4 auditors in these
situations are more valuable for protecting outside investors by disciplining
insiders against diverting corporate resources.
Finally, we consider some economic outcomes stemming from auditor
choice in politically connected firms. This analysis contributes to resolving
what is behind our evidence that connected firms have greater demand
for Big 4 auditors. We begin by documenting that connected firms that

appoint Big 4 auditors exhibit lower earnings management and greater
transparency evident in analyst coverage and forecast accuracy as well as
the adoption of international accounting standards. Additional evidence
implies that the capital markets reward connected firms that are Big 4
clients with higher valuations and cheaper equity financing costs. Impor-
tantly, despite that our core results persist when we tackle this issue with
several standard techniquesincluding various matching procedures, es-
timating a treatment effects model, controlling for firm heterogeneity in
random effects models, and narrowing our analysis to firms with long au-
ditor tenurewe stress that we cannot dismiss endogeneity as a competing
explanation for our evidence.
TABLE A1
Variables, Definitions, and Sources
Variable Definition Source
Firm-Level Variables
CONNECTED A dummy variable equal to one for politically connected firms, and zero Faccio [2006]
otherwise.
BIG 4 A dummy variable equal to one for firms with Big 4 auditors, and zero Worldscope
otherwise.
EM Equal to |Accruals|/Total Assets. Worldscope
We compute the accrual component of earnings as Accrualsit = (CAit
Cashit ) (CLit STDit TPit ) Depit , where CAit = change in total
current assets, Cashit = change in cash/cash equivalents, CLit = change in
total current liabilities, STDit = change in short term debt included in
current liabilities, TPit = change in income taxes payable, and Depit =
depreciation and amortization expense for firm i in year t. If a firm does not
report information on taxes payable or short-term debt, then the change in
both variables is assumed to be zero.
LARGEOWN The largest shareholders equity stake. Worldscope
CONTROLRIGHTS The voting rights of the largest shareholder. Claessens et al. [2000] and Faccio and
Lang [2002]
CASHFLOWRIGHTS The cash flow rights of the largest shareholder. Claessens et al. [2000] and Faccio and
Lang [2002]
SINGLELARGEOWN A dummy variable equal to one if there is only a single large shareholder that Claessens et al. [2000] and Faccio and
controls at least 10% of the voting rights, and zero otherwise. Lang [2002]
BUSINESSGROUP A dummy variable equal to one if the firm belongs to a business group, and Claessens et al. [2000], Faccio and Lang
zero otherwise. [2002], and authors calculations
OWNERSHIPWEDGE A dummy variable equal to one if the largest shareholders share of control Claessens, Djankov, and Lang [2000] and
rights is higher than his share of ownership rights, and zero otherwise. Faccio and Lang [2002]
CONTROLRIGHTS>50 A dummy variable equal to one if the voting rights of the largest shareholder is Claessens et al. [2000] and Faccio and
greater than 50%, and zero otherwise. Lang [2002]

Log(1+NUMBER OF The natural logarithm of one plus the number of shareholders that control Claessens et al. [2000] and Faccio and
LARGE OWNERS) more than 10% of the voting rights. Lang [2002]
149
(Continued)
T A B L E A 1Continued
150

STATEOWN The states equity stake in percentage. Worldscope
MTB Market value of common equity plus book value of debt divided by total assets Worldscope
at the end of year.
PBIG4 Predicted probability that the auditor is a Big 4 public accounting firm. Authors calculations
CAPEX The ratio of capital expenditures divided by total assets. Worldscope
GROWTH Asset growth in the past year. Worldscope
LEVERAGE The ratio of long-term debt divided by total equity. Worldscope
SIZE The natural logarithm of total assets denominated in US dollars. Worldscope
COMPLEXITY The number of business segments based on two-digit SIC codes. Worldscope
FOREIGNSALES The fraction of sales from foreign operations. Worldscope
FINANCING A dummy variable that takes the value of one if the sum of new long-term debt Worldscope
plus new equity exceeds 20% of total assets, and zero otherwise.
CROSS-LISTING A dummy variable that is equal to one if the firm is cross-listed in the United Worldscope
States, and zero otherwise.
INV Total inventory divided by total assets. Worldscope
ROA Net income divided by total assets. Worldscope
XDOPS A dummy variable that takes the value of one if the company reports Worldscope
extraordinary items or discontinued operations, and zero otherwise.
BANKRUPTCY One-year change in Zmijewskis probability of bankruptcy score. Worldscope
PROBABILITY z = 4.3364.513(net income/total assets)+5.679(total liabilities/total

assets) + 0.004(current assets/current liabilities).
CURRENT ASSETS The ratio of current assets to total assets. Worldscope
ANALYSTS The number of analysts averaged over the fiscal year. Authors calculations based on I/B/E/S
NEG EARNINGS An indicator variable for loss firms. Worldscope
CHANGE EARNINGS The absolute value of the change in earnings over the previous year scaled by Worldscope
the previous years earnings.
EARNINGS SURPRISE The absolute value of the difference between current earnings per share and Authors calculations based on CRSP
earnings per share from the prior year, divided by the firms stock price. data.
(Continued)
CF Annual net cash flow from operating activities divided by end-of-year total Worldscope
assets.
TURNOVER Sales divided by end-of-year total assets. Worldscope
FBIAIS Signed forecast error defined as the difference between the one-year-ahead Authors calculations based on I/B/E/S
consensus earnings forecast and realized earnings deflated by beginning of
period assets per share.
VARIANCE Volatility of stock returns over the previous 12 months. Authors calculations based on
Compustat, CRSP, and CFRMC data
IAS A dummy variable equal to one for firms that adopted international accounting Authors calculations based on
standards, and zero otherwise. Compustat data
ACCURACY The negative of the absolute difference between actual EPS and analysts Authors calculations based on I/B/E/S
forecasts scaled by stock price.
KGLS Implied cost of equity capital estimated from the Gebhardt, Lee, and Authors calculations based on I/B/E/S
Swaminathan [2001] model 10 months after the fiscal year-end. and Compustat data
KCT Implied cost of equity capital estimated from the Claus and Thomas [2001] Authors calculations based on I/B/E/S
model 10 months after the fiscal year-end. and Compustat data
KOJN Implied equity premium capital estimated from the Ohlson and Authors calculations based on I/B/E/S
Juttner-Nauroth [2005] model 10 months after the fiscal year-end. and Compustat data
KMPEG Implied cost of equity capital estimated from the Easton [2004] model 10 Authors calculations based on I/B/E/S
months after the fiscal year-end. and Compustat data
KMED The median of KGLS , KCT , KOJN , and KMPEG . Authors calculations based on I/B/E/S
and Compustat data
Country-Level Variables
INFLATION Realized inflation rate over the next year. World Development Indicators [2008]
OPENNESS Imports plus exports as fraction of GDP. World Development Indicators [2008]
NEWSPAPER Circulation of daily newspapers divided by population. Dyck and Zingales [2004]
ELECTION A dummy variable equal to one for election years, and zero otherwise. Database of Political Institutions
(Continued)
151
152
POLITICALOPPO The strength of the opposition. High values reflect strong opposition. Database of Political Institutions
PROTECTION The principal component of the indices for anti-director rights, disclosure La Porta, Lopez-de-Silanes, and Shleifer
requirements, and liability standards. [2006]
ANTISELF Average of ex-ante and ex-post private control of self-dealing. Djankov et al. [2008]
SECREG Strength of securities regulation. Equals the arithmetic mean of: (i) disclosure La Porta, Lopez-de-Silanes, and Shleifer
index, (ii) liability standard index, and (iii) public enforcement index. [2006]
LAWORDER The law and order in the country. International Country Risk Guide
STOCKTRAD Stock market total value traded divided by GDP. Beck, Demirguc-Kunt, and Levine [2009]
BANKDEP The total value of demand, time, and saving deposits at domestic deposit International Financial Statistics
money banks as a share of GDP.
FINSYSDEP Demand, time, and saving deposits in deposit money banks and other financial International Financial Statistics
institutions as a share of GDP.
JUDICIAL Assessment of the efficiency and integrity of the legal environment as it affects La Porta, Lopez-de-Silanes, and Shleifer
business, particularly foreign firms, produced by the country risk rating [2006]
agency Business International Corp. It may be taken to represent investors
assessment of conditions in the country in question. Average between 1980
and 1983. The scale ranges from 0 to 10 with lower scores representing lower
efficiency levels.
RESTRICTIONS A regulatory score constructed based on regulations that prohibit or set limits Faccio [2006]
on the business activities of public officials.
CIFAR Index created by examining and rating companies 1995 annual reports on La Porta, Lopez-de-Silanes, and Shleifer
their inclusion or omission of 90 items. These items fall into seven [2006]
categories: general information, income statements, balance sheets, funds
flow statement, accounting standards, stock data, and special items. A
minimum of three companies in each country were studied. See Bushman,
Piotroski, and Smith [2004].
(Continued)
RULEOFLAW Measures the extent to which agents have confidence in and abide by the rules La Porta et al. [2006]
of society. These include perceptions of the incidence of both violent and
nonviolent crime, the effectiveness and predictability of the judiciary, and
the enforceability of contracts. See Kaufmann, Kraay, and Mastruzzi [2008].
LISTED FIRMS The number of domestic listed firms divided by population in 2000. A measure La Porta, Lopez-de-Silanes, and Shleifer
of the importance of the stock market. [2006]
MACVAR MACVAR is the first principal component of four proxies for macroeconomic Authors calculations
variability: (i) the country-year median standard deviation of annual earnings
per share over the last five years scaled by total assets per share, (ii) the
country-year median standard deviation of accounting returns on equity over
the last five years, (iii) the standard deviation of the residuals from a
regression of annual gross domestic product growth rates on a time index
over the sampling period, and (iv) the coefficient of variation of yearly
average exchange rates (US$ to local currency) over the sampling period.
IDV A preference for a loosely knit social fabric or an independent, tightly knit Hofstede [2001]
fabric.
UAI The degree to which people feel uncomfortable with ambiguity and an Hofstede [2001]
uncertain future.
PREDATION An index that incorporates multiple attributes capturing the effectiveness of Durnev and Fauver [2009]
institutional and political systems in curbing government extortion.
EXPROPRIATION Assessment of the risk of a modification in a contract taking the form of a La Porta et al. [1998]
repudiation, postponement, or scaling down due to budget cutbacks,
indigenization pressure, a change in government, or a change in
government economic and social priorities. This variable is recoded to vary
between 0 to 10 with higher scores indicating greater risk of expropriation.

(Continued)
153
154

EARNINGS MGN Aggregate earnings management score: the average rank across four measures, Leuz, Nanda, and Wysocki [2003]
EM1EM4. EM1 is the countrys median ratio of the firm-level standard
deviations of operating income and operating cash flow (both scaled by
lagged total assets). EM2 is the countrys Spearman correlation between the
change in accruals and the change in cash flow from operations (both scaled
by lagged total assets). EM3 is the countrys median ratio of the absolute
value of accruals and the absolute value of the cash flow from operations.
EM4 is the number of small profits divided by the number of small
losses for each country.
DISCLOSE An assessment of disclosure requirements relating to: (i) prospectus; (ii) La Porta, Lopez-de-Silanes, and Shleifer
compensation of directors and key officers; (iii) ownership structure; (iv) [2006]
inside ownership; (v) contracts outside the ordinary course of business; and
(vi) transactions between the issuer and its directors, officers, and/or large
shareholders. The index ranges from 0 to 1, with higher values indicating
more extensive disclosure requirements.
SUE AUDITOR Index of the procedural difficulty in recovering losses from the auditor in a La Porta, Lopez-de-Silanes, and Shleifer
civil liability case for losses due to misleading statements in the audited [2006]
financial information accompanying the prospectus. Equals one when
investors are only required to prove that the audited financial information
accompanying the prospectus contains a misleading statement. Equals

two-thirds when investors must also prove that they relied on the prospectus
and/or that their loss was caused by the misleading accounting information.
Equals one-third when investors must also prove that the auditor acted with
negligence. Equals zero if restitution from the auditor is either unavailable
or the liability standard is intent or gross negligence.
LGDPC The natural logarithm of the countrys GDP per capita denominated in US World Development Indicators [2008]
dollars.
FDI Foreign direct investment divided by GDP. World Development Indicators [2008]
TABLE A2
Means for Country Level Institutional Infrastructure Variables
Country RESTRICTIONS EXPROPRIATION ANTISELF PROTECTION
Austria 2.00 0.31 0.21 0.10
Belgium 0.00 0.37 0.54 0.07
Canada 2.00 0.33 0.64 0.96
Chile 2.00 2.50 0.63 0.61
Denmark 1.00 0.33 0.46 0.36
Finland 1.00 0.33 0.46 0.47
France 2.00 0.35 0.38 0.47
Germany 2.00 0.10 0.28 0.00
Greece 4.00 2.88 0.22 0.32
Hong Kong 1.00 1.71 0.96 0.85
India 0.00 2.25 0.58 0.77
Indonesia 0.00 2.84 0.65 0.51
Ireland 4.00 0.33 0.79 0.48
Israel 4.00 1.75 0.73 0.59
Italy 0.00 0.65 0.42 0.20
Japan 0.00 0.33 0.50 0.42
Korea, South 1.00 1.69 0.47 0.36
Malaysia 0.00 2.05 0.95 0.73
Mexico 0.00 2.71 0.17 0.10
Philippines 6.00 4.78 0.22 0.81
Singapore 3.00 0.70 1.00 0.77
Spain 3.00 0.48 0.37 0.55
Sweden 1.00 0.60 0.33 0.39
Switzerland 2.00 0.02 0.27 0.30
Taiwan 0.00 0.88 0.57 0.55
Thailand 3.00 2.58 0.81 0.37
United Kingdom 2.00 0.29 0.95 0.78
United States 4.00 0.02 0.65 1.00
This table reports the means for the four conditioning variables capturing countries governance
institutions.
156
TABLE A3
Correlations Between the Main Regression Variables
BIG 4
CONNECTED
LARGEOWN
STATEOWN
COMPLEXITY
FOREIGNSALES
FINANCING
CROSS-LISTING
SIZE
ROA
LEVERAGE
GROWTH
INV
FDI
LGDPC
CONNECTED 0.06
LARGEOWN 0.00 0.01
STATEOWN 0.13 0.04 0.15
COMPLEXITY 0.02 0.05 0.02 0.08
FOREIGNSALES 0.11 0.04 0.05 0.05 0.02
FINANCING 0.04 0.02 0.01 0.03 0.06 0.00
CROSS-LISTING 0.09 0.10 0.11 0.02 0.00 0.13 0.03
SIZE 0.11 0.04 0.06 0.11 0.15 0.16 0.13 0.16
ROA 0.11 0.02 0.08 0.01 0.04 0.04 0.04 0.02 0.11
LEVERAGE 0.02 0.11 0.00 0.03 0.04 0.03 0.07 0.05 0.20 0.05
GROWTH 0.05 0.04 0.02 0.03 0.08 0.00 0.42 0.02 0.00 0.24 0.00
INV 0.04 0.09 0.04 0.05 0.09 0.08 0.06 0.07 0.10 0.09 0.14 0.04
FDI 0.06 0.03 0.02 0.03 0.09 0.19 0.08 0.03 0.39 0.03 0.03 0.07 0.02
LGDPC 0.15 0.23 0.27 0.23 0.08 0.19 0.03 0.06 0.19 0.06 0.04 0.07 0.05 0.08
SUE AUDITOR 0.07 0.08 0.24 0.01 0.06 0.05 0.02 0.01 0.03 0.02 0.15 0.04 0.08 0.01 0.16
This table reports correlations for the regression variables while allowing for country and firm level clustering for a sample of 1,371 politically connected firms and 1,911
nonconnected firms from 28 countries. Boldface indicates statistical significance at the 1% level. The definitions and data sources for the variables are outlined in table A1.
REFERENCES
ADHIKARI, A.; C. DERASHID; AND H. ZHANG. Public Policy, Political Connections, and Effective
Tax Rates: Longitudinal Evidence from Malaysia. Journal of Accounting and Public Policy 25
(2006): 57495.
AGRAWAL, A., AND C. R. KNOEBER. Do Some Outside Directors Play a Political Role? Journal
of Law and Economics 44 (2001): 17998.
AI, C., AND E. NORTON. Interaction Terms in Logit and Probit Models. Economic Letters 80
(2003): 12329.
BABER, W. R.; K. R. KUMA; AND T. VERGHESE. Client Security Price Reactions to the Laventhol
and Horwath Bankruptcy. Journal of Accounting Research 33 (1995): 38595.
BACKMAN, M. Asian Eclipse: Exploring the Dark Side of Business in Asia. Singapore: John Wiley &
Sons, 1999.
BAE, K.H.; J.-K. KANG; AND J.-M. KIM. Tunnelling or Value Added? Evidence from Mergers by
Korean Business Groups. Journal of Finance 57 (2002): 2695740.
BARTH, M.; W. LANDSMAN; AND M. LANG. International Accounting Standards and Accounting
Quality. Journal of Accounting Research 46 (2008): 46798.
BECK, T.; G. CLARKE; A. GROFF; P. KEEFER; AND P. WALSH. New Tools in Comparative Political
Economy: The Database of Political Institutions. World Bank Economic Review 15 (2001):
16576.
BECK, T.; A. DEMIRGUC-KUNT; AND R. LEVINE. Financial Institutions and Markets Across Coun-
tries and Over Time: Data and Analysis. Policy Research Working paper no 4943, World
Bank, 2009.
BECKER, C.; M. L. DEFOND; J. JIAMBALVO; AND K. R. SUBRAMANYAM. The Effect of Audit Quality
on Earnings Management. Contemporary Accounting Research 15 (1998): 124.
BENNEDSEN, M., AND D. WOLFENZON. The Balance of Power in Closely Held Corporations.
Journal of Financial Economics 58 (2000): 11339.
BERKMAN, H.; R. A. COLE; AND L. J. FU. Political Connections and Minority Shareholder
Protection: Evidence from Securities-Market Regulation in China. Journal of Financial and
Quantitative Analysis 45 (2010): 1391417.
BERTRAND, M.; F. KRAMARAZ; A. SCHOAR; AND D. THESMAR. Politicians, Firms and the Political
Business Cycle: Evidence from France. Working paper, University of Chicago, 2007.
BOCKUS, K., AND F. GIGLER. A Theory of Auditor Resignation. Journal of Accounting Research
36 (1998): 191208.
BOUBAKRI, N.; J.-C. COSSET; AND W. SAFFAR. Political Connections of Newly Privatized Firms.
Journal of Corporate Finance 14 (2008): 65473.
BOUBAKRI, N.; O. GUEDHAMI; D. MISHRA; AND W. SAFFAR. Political Connections and the Cost
of Equity Capital. Journal of Corporate Finance 18 (2012): 54159.
BUNKANWANICHA, P., AND Y. WIWATTANAKANTANG. Big Business Owners in Politics. Review of
Financial Studies 22 (2009): 213368.
BUSHMAN, R., AND J. PIOTROSKI. Financial Reporting Incentives for Conservative Accounting:
The Influence of Legal and Political Institutions. Journal of Accounting and Economics 42
(2006): 10748.
BUSHMAN, R.; J. PIOTROSKI; AND A. SMITH. What Determines Corporate Transparency? Jour-
nal of Accounting Research 42 (2004): 20752.
CARAMANIS, C., AND C. LENNOX. Auditor Effort and Earnings Management. Journal of Ac-
counting and Economics 45 (2008): 11638.
CHANEY, P. K.; M. FACCIO; AND D. C. PARSLEY. The Quality of Accounting Information in
Politically Connected Firms. Journal of Accounting and Economics 51 (2011): 5876.
CHANG, X.; S. DASGUPTA; AND G. HILARY. The Effect of Auditor Choice on Financing Deci-
sions. The Accounting Review 84 (2009): 1085117.
CHEN, K. C. W.; Z.-H. CHEN; AND K. C. J. WEI. Agency Costs of Free Cash Flow and the Ef-
fect of Shareholder Rights on the Implied Cost of Equity Capital. Journal of Financial and
Quantitative Analysis 46 (2011): 171207.
CHEN, C. J. P.; Y. DING; AND C. KIM. High-Level Politically Connected Firms, Corruption,
and Analyst Forecast Accuracy Around the World. Journal of International Business Studies 41
(2010): 150524.
CHOI, J.-H.; R. DOOGAR; AND A. R. GANGULY. The Riskiness of Large Audit Firm Client Port-
folios and Changes in Audit Liability Regimes: Evidence from the U.S. Audit Market. Con-
temporary Accounting Research 21 (2004): 74785.
CHOI, J.-H., AND T. J. WONG. Auditors Governance Functions and Legal Environments: An
International Investigation. Contemporary Accounting Research 24 (2007): 1346.
CLAESSENS, S.; S. DJANKOV; J. P. H. FAN; AND L. H. P. LANG. Disentangling the Incentive and
Entrenchment Effects of Large Shareholders. Journal of Finance 57 (2000): 274171.
CLAESSENS, S.; S. DJANKOV; AND L. H. P. LANG. The Separation of Ownership and Control in
East Asian Corporations. Journal of Financial Economics 58 (2000): 81112.
CLAESSENS, S.; E. FEIJEN; AND L. LAEVEN. Political Connections and Preferential Access to
Finance: The Role of Campaign Contributions. Journal of Financial Economics 88 (2008):
55480.
CLAUS, J., AND J. THOMAS. Equity Premia as Low as Three Percent? Evidence from Analysts
Earnings Forecasts for Domestic and International Stock Markets. Journal of Finance 56
(2001): 162966.
CORREIA, M. Political Connections, SEC Enforcement, and Accounting Quality. Working
paper, London Business School, 2010.
DAVIS, L. R.; D. N. RICCHIUTE; AND G. TROMPETER. Audit Effort, Audit Fees, and the Provision
of Nonaudit Services to Audit Clients. The Accounting Review 68 (1993): 13550.
DEANGELO, L. Auditor Size and Audit Quality. Journal of Accounting and Economics 3 (1981):
18399.
DEFOND, M. L.; M. ETTREDGE; AND D. SMITH. An Investigation of Auditor Resignations. Re-
search in Accounting Regulation 11 (1997): 2546.
DEFOND, M. L.; T. J. WONG; AND S. LI. The Impact of Improved Auditor Independence on
Auditor Market Concentration in China. Journal of Accounting and Economics 28 (2000):
269305.
DHALIWAL, D. S.; S. HEITZMAN; AND O. Z. LI. Taxes, Leverage, and the Cost of Equity Capital.
Journal of Accounting Research 44 (2006): 691723.
DINC, S. Politicians and Banks: Political Influences on Government-Owned Banks in Emerg-
ing Markets. Journal of Financial Economics 77 (2005): 45379.
DJANKOV, S.; R. LA PORTA; F. LOPEZ-DE-SILANES; AND A. SHLEIFER. The Law and Economics of
Self-Dealing. Journal of Financial Economics 88 (2008): 43065.
DJANKOV, S.; R. LA PORTA; F. LOPEZ-DE-SALINES; AND A. SHLEIFER. Disclosure by Politicians.
American Economic Journal: Applied Economics 2 (2010): 179209.
DUCHIN, R., AND D. SOSYURA. The Politics of Government Investment. Journal of Financial
Economics 106 (2012): 2448.
DURNEV, A., AND L. FAUVER. Stealing from Thieves: Firm Governance and Performance When
States Are Predatory. Working paper, McGill University, 2009.
DURNEV, A., AND E. H. KIM. To Steal or Not to Steal: Firm Attributes, Legal Environment, and
Valuation. Journal of Finance 60 (2005): 146193.
DYCK, A., AND L. ZINGALES. Private Benefits of Control: An International Comparison. Journal
of Finance 59 (2004): 537600.
DYE, R. A. Auditing Standards, Legal Liability, and Auditor Wealth. Journal of Political Economy
101 (1993): 887914.
EASTON, P. PE Ratios, PEG Ratios, and Estimating the Implied Expected Rate of Return on
Equity Capital. The Accounting Review 79 (2004): 7395.
EL GHOUL, S.; O. GUEDHAMI; AND J. A. PITTMAN. Cross-Country Evidence on the Importance
of Big Four Auditors to Equity Pricing: The Mediating Role of Legal Institutions. Working
paper, 2012.
EL GHOUL, S.; O. GUEDHAMI; C. LENNOX; AND J. A. PITTMAN. External Versus Internal Moni-
toring: The Importance of Multiple Large Shareholders and Families to Auditor Choice in
Western European Firms. Working paper, 2013.
FACCIO, M. Politically Connected Firms. American Economic Review 96 (2006): 36986.

FACCIO, M. Differences Between Politically Connected Firms and Non-Connected Firms: A
Cross Country Analysis. Financial Management 39 (2010): 90528.
FACCIO, M. AND L. H. P. LANG. The Ultimate Ownership of Western European Corporations.
Journal of Financial Economics 65 (2002): 36595.
FACCIO, M.; L. H. P. LANG; AND L. YOUNG. Dividends and Expropriation. American Economic
Review 91 (2001): 5478.
FACCIO, M.; R. MASULIS; AND J. J. MCCONNELL. Political Connections and Corporate Bailouts.
Journal of Finance 61 (2006): 2597635.
FAMA, E. F., AND K. R. FRENCH. Industry Costs of Equity. Journal of Financial Economics 43
(1997): 15393.
FAN, J. P. H., AND T. J. WONG. Do External Auditors Perform a Corporate Governance Role
in Emerging Markets? Evidence from East Asia. Journal of Accounting Research 43 (2005):
3572.
FAN, J. P. H.; T. J. WONG; AND T. ZHANG. Politically Connected CEOs, Corporate Governance
and post-IPO Performance of Chinas Newly Partially Privatized Firms. Journal of Financial
Economics 84 (2007): 33057.
FELTHAM, G. A.; J. S. HUGHES; AND D. A. SIMUNIC. Empirical Assessment of the Impact of Au-
ditor Quality on the Valuation of New Issues. Journal of Accounting and Economics 14 (1991):
37599.
FERRARINI, G., AND P. GUIDICI. Financial Scandals and the Role of Private Enforcement: The
Parmalat Case. European Corporate Governance Institute Working paper no. 40/2005,
2005.
FISMAN, R. Estimating the Value of Political Connections. American Economic Review 91
(2001): 1095102.
FORTIN, S., AND J. A. PITTMAN. The Role of Auditor Choice in Debt Pricing in Private Firms.
Contemporary Accounting Research 24 (2007): 85996.
FRANCIS, J. R. What Do We Know About Audit Quality? The British Accounting Review 36
(2004): 34568.
FRANCIS, J. R., AND J. K. REYNOLDS. Do Large Accounting Firms Screen Out Risky Clients?
Working paper, University of Missouri at Columbia, 2003.
FRANCIS, J. R., AND D. WANG. The Joint Effect of Investor Protection and Big 4 Audits on
Earnings Quality Around the World. Contemporary Accounting Research 25 (2008): 15791.
GEBHARDT, W.; C. LEE; AND B. SWAMINATHAN. Towards an Implied Cost of Capital. Journal of
Accounting Research 39 (2001): 135176.
GUEDHAMI, O.; J. A. PITTMAN; AND W. SAFFAR. Auditor Choice in Privatized Firms: Empirical
Evidence on the Role of State and Foreign Owners. Journal of Accounting and Economics 48
(2009): 15171.
GUMBEL, P. How It All Went So Sour. Time, November 21, 2004.
HAIL, L., AND C. LEUZ. International Differences in Cost of Equity Capital: Do Legal Institu-
tions and Securities Regulations Matter? Journal of Accounting Research 44 (2006): 485531.
HAY, D. C.; W. R. KNECHEL; AND N. WONG. Audit Fees: A Meta-Analysis of the Effect of Supply
and Demand Attributes. Contemporary Accounting Research 23 (2006): 14191.
HECKMAN, J.; H. ICHIMURA; AND P. TODD. Matching as an Econometric Evaluation Estimator:
Evidence from Evaluating a Job Training Programme. Review of Economic Studies 64 (1997):
60554.
HECKMAN, J.; H. ICHIMURA; AND P. TODD. Matching as an Econometric Evaluation Estimator.
Review of Economic Studies 65 (1998): 26194.
HOFSTEDE, G. Cultures Consequences: Comparing Values, Behaviors, Institutions, and Organizations
Across Nations, Second edition. Thousand Oaks, CA: Sage Publications, 2001.
HOPE, O.-K. Disclosure Practices, Enforcement of Accounting Standards, and Analysts Fore-
cast Accuracy: An International Study. Journal of Accounting Research 41 (2003): 23583.
HOPE, O.-K.; J. JIN; AND T. KANG. Empirical Evidence on Jurisdictions That Adopt IFRS.
Journal of International Accounting Research 5 (2006): 120.
HUMPHREY, C.; A. LOFT; AND M. WOODS. The Global Audit Profession and the International
Financial Architecture: Understanding Regulatory Relationships at a Time of Financial Cri-
sis. Accounting, Organizations and Society 34 (2009): 81025.
JOH, S. W. Corporate Governance and Firm Profitability: Evidence from Korea Before the
Economic Crisis. Journal of Financial Economics 68 (2003): 287322.
JOHNSON, S.; R. LA PORTA; F. LOPEZ-DE-SILANES; AND A. SHLEIFER. Tunneling. American Eco-
nomic Review 90 (2000): 2227.
JOHNSTONE, K., AND J. C. BEDARD. Audit Firm Portfolio Management Decisions. Journal of
JONES, F. L., AND K. RAGHUNANDAN. Client Risk and Recent Changes in the Market for Audit
Services. Journal of Accounting and Public Policy 17 (1998): 16981.
KAUFMANN, D.; A. KRAAY; AND M. MASTRUZZI. Governance Matters VIII: Aggregate and Indi-
vidual Governance Indicators, 19962008. Policy Research Working paper no. 4978, World
Bank, 2008.
KHURANA, I. K., AND K. K. RAMAN. Litigation Risk and the Financial Reporting Credibility of
Big 4 Versus Non-Big 4 Audits: Evidence from Anglo-American Countries. The Accounting
Review 79 (2004): 47395.
KHWAJA, A. I., AND A. MIAN. Do Lenders Favor Politically Connected Firms? Rent Provision in
an Emerging Financial Market. Quarterly Journal of Economics 120 (2005): 1371411.
KIM, J. B., AND H. SHI. Voluntary IFRS Adoption, Analyst Coverage and Information Quality:
International Evidence. Journal of International Accounting Research 11 (2012): 4576.
LANG, M.; K. V. LINS; AND M. MAFFETT. Transparency, Liquidity, and Valuation: International
Evidence on When Transparency Matters Most. Journal of Accounting Research 50 (2012):
72974.
LANG, M.; K. V. LINS; AND D. MILLER. ADRs, Analysts, and Accuracy: Does Cross-Listing in
the U.S. Improve a Firms Information Environment and Increase Market Value? Journal of
LANG, M. H.; K. V. LINS; AND D. P. MILLER. Concentrated Control, Analyst Following, and Val-
uation: Do Analysts Matter Most When Investors Are Protected Least? Journal of Accounting
Research 42 (2004): 589623.
LANG, M. H., AND R. J. LUNDHOLM. Corporate Disclosure Policy and Analyst Behavior. The
Accounting Review 71 (1996): 46792.
LANG, M., AND M. MAFFETT. Transparency and Liquidity Uncertainty in Crisis Periods. Journal
of Accounting and Economics 52 (2011): 10125.
LA PORTA, R.; F. LOPEZ-DE-SILANES; AND A. SHLEIFER. Corporate Ownership Around the
World. Journal of Finance 54 (1999): 471518.
LA PORTA, R.; F. LOPEZ-DE-SILANES; AND A. SHLEIFER. What Works in Securities Laws? Journal
of Finance 61 (2006): 132.
LA PORTA, R.; F. LOPEZ-DE-SILANES; A. SHLEIFER; AND R. W. VISHNY. Law and Finance. Journal
of Political Economy 106 (1998): 111355.
LA PORTA, R.; F. LOPEZ-DE-SILANES; A. SHLEIFER; AND R. W. VISHNY. Investor Protection and
Corporate Valuation. Journal of Finance 57 (2002): 114770.
LARCKER, D. F., AND T. O. RUSTICUS. On the Use of Instrumental Variables in Accounting
Research. Journal of Accounting and Economics 49 (2010): 186205.
LENNOX, C. S. Management Ownership and Audit Firm Size. Contemporary Accounting Research
22 (2005): 20527.
LENNOX, C.; J. R. FRANCIS; AND Z. WANG. Selection Models in Accounting Research. The
Accounting Review 87 (2012): 589616.
LENNOX, C. S., AND J. A. PITTMAN. Big Five Audits and Accounting Fraud. Contemporary Ac-
counting Research 27 (2010): 20947.
LEUZ, C.; D. NANDA; AND P. WYSOCKI. Earnings Management and Investor Protection: An
International Comparison. Journal of Financial Economics 69 (2003): 50527.
LEUZ, C., AND F. OBERHOLZER-GEE. Political Relationships, Global Financing, and Corporate
Transparency. Journal of Financial Economics 81 (2006): 41139.
MANSI, S. A.; W. MAXWELL; AND D. P. MILLER. Does Auditor Quality and Tenure Matter to
Investors? Evidence from the Bond Market. Journal of Accounting Research 42 (2004): 755
93.
MITTON, T. A Cross-Firm Analysis of the Impact of Corporate Governance on the East Asian
Financial Crisis. Journal of Financial Economics 64 (2002): 21541.
MORCK, R. K.; D. A. STANGELAND; AND B. YEUNG. Inherited Wealth, Corporate Control, and
Economic Growth: The Canadian Disease, in Concentrated Corporate Ownership, edited by R.
Morck, Chicago: University of Chicago Press, 2000: 31969.
MYERS, J. N.; L. A. MYERS; AND T. C. OMER. Exploring the Term of the Auditor-Client Relation-
ship and the Quality of Earnings: A Case for Mandatory Auditor Rotation? The Accounting
Review 78 (2003): 77999.
OHLSON, J., AND B. JUETTNER-NAUROTH. Expected EPS and EPS Growth as Determinants of
Value. Review of Accounting Studies 10 (2005): 34965.
PAGANO, M., AND A. ROELL. The Choice of Stock Ownership Structure: Agency Costs, Moni-
toring, and the Decision to Go Public. Quarterly Journal of Economics 113 (1998): 187225.
PASTOR, L.; M. SINHA; AND B. SWAMINATHAN. Estimating the Intertemporal Risk-Return Trade-
Off Using the Implied Cost of Capital. Journal of Finance 63 (2008): 285997.
PINKOWITZ, L.; R. STULZ; AND R. WILLIAMSON. Does the Contribution of Cash Holdings and
Dividends to Firm Value Depend on Governance? A Cross-Country Analysis. Journal of Fi-
nance 61 (2006): 272551.
PIOTROSKI, J. D.; T. J. WONG; AND T. ZHANG. Political Incentives to Suppress Negative Finan-
cial Information: Evidence from State-Controlled Chinese Firms. Working paper, Stanford
University, 2008.
PITTMAN, J. A., AND S. FORTIN. Auditor Choice and the Cost of Debt Capital for Newly Public
Firms. Journal of Accounting and Economics 37 (2004): 11336.
QIAN, M.; P. HONGBO PAN; AND B. YEUNG. Expropriation of Minority Shareholders in Politi-
cally Connected Firms. Working paper, National University of Singapore Business School,
2011.
ROBERTS, B. A Dead Senator Tells No Lies: Seniority and the Distribution of Federal Benefits.
American Journal of Political Science 34 (1990): 3158.
ROGERSON, W. Reputation and Product Quality. The Bell Journal of Economics 14 (1983): 508
16.
ROSENBAUM, P. AND D. RUBIN. The Central Role of the Propensity Score in Observational
Studies for Causal Effects. Biometrika 70 (1983): 4155.
SANKARAGURUSWAMY, S.; S. WHISENANT; AND M. WILLENBORG. Pricing and Audit Quality of
Initial Pricing Engagements. Working paper, National University of Singapore, the Univer-
sity of Houston, and the University of Connecticut, 2013.
SHLEIFER, A., AND R. W. VISHNY. Politicians and Firms. Quarterly Journal of Economics 109
(1994): 9951025.
SHLEIFER, A., AND R.W. VISHNY. A Survey of Corporate Governance. Journal of Finance 52
(1997): 73783.
SHU, S. Auditor Resignations: Clientele Effects and Legal Liability. Journal of Accounting and
Economics 29 (2000): 173205.
SKINNER, D. J., AND S. SRINIVASAN. Audit Quality and Auditor Reputation: Evidence from
Japan. The Accounting Review 87 (2012): 173765.
STULZ, R. The Limits of Financial Globalization. Journal of Finance 60 (2005): 1595638.
SYLVERS, E. Founders Children Arrested in Parmalat Inquiry. New York Times, February 18,
2004.
WANG, Q.; T. J. WONG; AND L. XIA. State Ownership, Institutional Environment, and Auditor
Choice: Evidence from China. Journal of Accounting and Economics 46 (2008): 11234.
WANG, X. Increased Disclosure Requirements and Corporate Governance Decisions: Evi-
dence from Chief Financial Officers in the Pre- and Post-Sarbanes-Oxley Periods. Journal of
WATTS, R. L., AND J. L. ZIMMERMAN. Agency Problems, Auditing, and the Theory of the Firm:
Some Evidence. Journal of Law and Economics 26 (1983): 61333.
WEBER, J.; M. WILLENBORG; AND J. ZHANG. Does Auditor Reputation Matter? The Case of
KPMG Germany and ComROAD AG. Journal of Accounting Research 46 (2008): 94172.
WHISENANT, S.; S. SANKARAGURUSWAMY; AND K. RAGHUNANDAN. Evidence on the Joint Deter-
mination of Audit and Non-Audit Fees. Journal of Accounting Research 41 (2003): 72144.
WORLD DEVELOPMENT INDICATORS. 2008 CD-ROM. World Bank, Washington, DC, 2008.
YU, F., AND X. YU. Corporate Lobbying and Fraud Detection. Journal of Financial and Quanti-
tative Analysis 46 (2011): 186591.

Auditor Choice in Politically Connected Firms: Printed in U.S.A

Diunggah oleh

Informasi Dokumen

Judul Asli

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Auditor Choice in Politically Connected Firms: Printed in U.S.A

Diunggah oleh

Hak Cipta:

Format Tersedia

DOI: 10.1111/1475-679X.

Auditor Choice in Politically

Received 26 April 2011; accepted 15 September 2013

We extend recent research on the links between political connections and

Moore School of Business, University of South Carolina; SKKU Business School,

most 8% of the worlds stock market capitalization (Faccio [2006]).

We evaluate which of these financial reporting incentives dominates by

Pittman, and Saffar [2009]). Second, we apply several matching techniques

information, which Piotroski, Wong, and Zhang [2008] partly attribute to

commit to refrain from diverting corporate resources (all hypotheses are

H1: In comparison to other public firms, politically connected firms are

2.2 THE MEDIATING ROLE OF FIRMS OWNERSHIP STRUCTURES

management, enabling them to enjoy greater transparency, lower equity

which is important when examining the interplay between political connec-

3.2 VARIABLES AND DESCRIPTIVE STATISTICS

3.2.2. Measuring Political Connections. We rely on Faccios [2006] data-

close relationship to a top official). Faccio [2006] classifies a firm as con-

3.2.3. Measuring Country-Level Governance Institutions. We rely on four

institutions. The first variable is Faccios [2006, p. 373] regulatory score

(COMPLEXITY), which we measure with the number of business segments

choice hinges on the quality of a countrys governance institutions. Finally,

11 In another strategy for isolating the importance of political connections to auditor

(3.60) (2.30) (0.40) (2.38) (0.41) (2.38)

assets.12 Reflecting its material economic impact, the coefficient estimate

12 Reflecting the importance of political connections to auditor choice, the incremental R 2

for CONNECTED is 0.037 relative to 0.027 for SIZE.

Collectively, the results in table 3 using different matching techniques

4.1.2. Sensitivity Analyses. In this section, we evaluate whether our ear-

(0.04) (0.49) (0.14) (0.09) (0.40)

variables and implement various matching procedures, we address linger-

expropriation (PREDATION) using Durnev and Fauvers [2009] predation

auditor nor downgrade from a Big 4 to a nonBig 4 auditor between 1998

4.2POLITICAL CONNECTIONS AND AUDITOR CHOICE: THE MEDIATING

[Marginal effect of #VARIABLES CONNECTED in %] [0.25] [35.20] [6.86] [0.13] [0.13]

Pseudo R 2 0.11 0.09 0.09 0.10 0.10

at the bottom of panel B are statistically significant. In contrast, we find no

RESTRICTIONS RESTRICTIONS EXPROPRIATION EXPROPRIATION ANTISELF ANTISELF PROTECTION PROTECTION

(2.51) (2.07) (2.69) (1.82) (0.93) (2.83) (0.80) (2.70)

that the incentives of politically connected firms to appoint a Big 4 auditor

4.4 ECONOMIC OUTCOMES STEMMING FROM AUDITOR CHOICE

(1.14) (9.00) (10.24)

earnings over the previous year (CHANGE EARNINGS); as well as country-

political connections, auditor choice, and equity pricing. We follow exten-

for Big 4 auditors. We begin by documenting that connected firms that

greater than 50%, and zero otherwise. Lang [2002]

Variable Definition Source

PROBABILITY z = 4.3364.513(net income/total assets)+5.679(total liabilities/total

between 0 to 10 with higher scores indicating greater risk of expropriation.

Variable Definition Source

accompanying the prospectus contains a misleading statement. Equals

FACCIO, M. Politically Connected Firms. American Economic Review 96 (2006): 36986.

Anda mungkin juga menyukai