Elsevier

Journal of Accounting and Public Policy

Volume 27, Issue 5, September–October 2008, Pages 357-373
Journal of Accounting and Public Policy

Culture and auditor choice: A test of the secrecy hypothesis

https://doi.org/10.1016/j.jaccpubpol.2008.07.003Get rights and content

Abstract

The purpose of this study is to investigate whether firms’ auditor choice relates to national culture. We construct a novel measure of secretiveness based on Hofstede [Hofstede, G., 1980. Culture’s Consequences: International Differences in Work Related Values. Sage Publications, Beverly Hills, CA] cultural factors. Using a very large sample of firms from 37 countries and controlling for a number of firm- and country-level factors, we find that firms in “more secretive” countries are less likely to hire a Big 4 auditor. We also document that the relation between secrecy dimension of national culture and auditor choice is mitigated by the firms’ degree of internationalization. These results establish a link between national culture and financial reporting quality through the firm’s choice of auditor.

Introduction

There is extensive research suggesting that national cultural values influence managerial decisions (e.g., Hofstede, 1980, Gray, 1988, Salter and Niswander, 1995, Ralston et al., 1997, Stulz and Williamson, 2003, Hope, 2003a, House et al., 2004, Guiso et al., 2006). Accountants have also taken a strong interest in the role that culture plays in both financial and managerial accounting settings. In particular, researchers have employed Gray’s (1988) well-cited framework for linking commonly identified national cultural dimensions (based on Hofstede) to accounting values. For example, due to its relatively straightforward conceptual link to financial reporting decisions, researchers have tested Gray’s (1988) “secrecy” hypothesis primarily by examining its relation with reported financial accounting numbers and/or the amount of financial disclosure.

This paper contributes to the literature by focusing on whether culture – in particular “secrecy” – relates to firms’ choice of external auditor. An examination of determinants of auditor choice (Big 4/non-Big 4) is useful because prior research provides convincing evidence that, on average, audit quality increases with auditor size (DeAngelo, 1981, Datar et al., 1991, DeFond and Jiambalvo, 1993, Craswell et al., 1995). High-quality audits lend credibility to accounting information by improving the precision of accounting information (Simunic and Stein, 1987, Becker et al., 1998, Hope et al., accepted for publication), thus allowing them to serve as useful corporate governance mechanisms. As a consequence, high-quality audits reduce information asymmetries and agency conflicts between the firm and its debt holders and stockholders (e.g., Jensen and Meckling, 1976, Palmrose, 1984, Watts and Zimmerman, 1986, Francis and Wilson, 1988, Craswell et al., 1995).

No prior study examines whether national culture relates to firms’ auditor choice. Instead, to understand the association between culture and financial reporting, prior research has focused primarily on the association between culture and firm disclosure (e.g., Jaggi and Low, 2000, Hope, 2003a). A country’s disclosure requirements can change over time (e.g., implementation of International Financial Reporting Standards). In addition, firm-level disclosure scores are often available for only a limited number of firms from a particular period, reducing the power of tests (Doupnik and Tsakumis, 2004). By examining the relation between culture and auditor choice instead of disclosure levels, we can test the role of culture on financial reporting quality using a large number of recent firm-level observations from around the world. As such, our study complements and extends prior work that examines the association between national culture and firms’ financial reporting.

Since cultural values have been shown to influence management behavior and given that auditing can play an important role in resolving agency conflicts by acting as a monitoring device (e.g., Palmrose, 1984, Francis and Wilson, 1988, Craswell et al., 1995, Hope et al., accepted for publication), we hypothesize that managers’ auditor choices relate to their propensity to be secretive (as opposed to transparent). We construct a novel measure of how secretive societies are based on Hofstede’s (1980) cultural factors and employ a large sample of firms (i.e., 91,030 firm-year observations) from 37 countries. We find that firms are more likely to hire a Big 4 auditor in less secretive cultural environments.

We further examine whether the effect of national culture on firms’ auditor choice is mitigated by how internationally-oriented the firm is. As a firm’s operations become more geographically dispersed, local managers’ cultural values are more likely to be influenced by a variety of factors (e.g., non-local managers, foreign governments and regulations, greater shareholder base, foreign lenders, etc.). As such, the influence of any particular country’s national culture is likely to be lower with international expansion. Our evidence shows that the negative association between secrecy dimension of national culture and auditor choice is mitigated by the firms’ degree of internationalization. Our results are robust to controlling for both country-level factors (e.g., investor protection, capital market development, disclosure, etc.) and a number of firm-level factors. They are also robust to using other (non-Hofstede based) measures of secrecy.

This study contributes to the literature in several ways. Most importantly, this is the first study to relate national culture to firms’ auditor choice, and we provide strong evidence in support of Gray’s secrecy hypothesis. Since our sample is (unusually) large both in terms of number of firms and countries covered, our results should be representative for a large number of cultures (and firms) around the world. Furthermore, as our empirical tests control for other institutional factors (e.g., investor protection) and we still find a strong association between the secrecy dimension of national culture and firms’ auditor size, we conclude that the effects of culture on management’s audit quality choice is not subsumed by other factors discussed in the literature (e.g., related to the legal environment). Finally, this study contributes to the literature on determinants of auditor choice by identifying culture as an important country-level determinant. Lending support to the basic premise in culture studies in international business that national culture influences management behavior (e.g., Radebaugh, 1975, Gray, 1988, Radebaugh et al., 2006), our results suggest that managements’ auditor choice behavior relates to the national culture of secrecy/transparency.

The remainder of our paper is organized as follows. In the next section, we briefly review relevant literature and develop hypotheses. In Section 3, we describe our methodology and sample. In Section 4, we explain the results of the main tests and discuss results of sensitivity analyses. In Section 5, we conclude.

Section snippets

Related cultural studies in accounting1

Gray’s (1988) model defines four accounting values which are linked to Hofstede’s (1980) societal values.

Methodology

Following Gray’s (1988) framework, we measure secrecy based on the three operationalized dimensions of national culture developed by Hofstede (1980). In linking national culture attributes to accounting values, Gray (1988) argues that the higher a country ranks in terms of uncertainty avoidance and power distance and the lower it ranks in terms of individualism, then the more likely it is to rank highly in terms of secrecy.

Strong uncertainty avoidance is consistent with a preference for

Descriptive statistics and correlations

We begin by presenting descriptive statistics and pair-wise correlations of the regression variables. Panel A of Table 1 reports the pooled distribution of the firm-level regression variables. The overall mean of Big4 is 0.779, which indicates that approximately 78% of observations hire a Big 4 (or its predecessor) auditor in our sample. Foreign taxes on average make up about 13% of total taxes. Control variables have reasonable amounts.

Panel B of Table 1 reports country-level descriptive

Conclusion

In this study, we hypothesize that national culture is an important determinant of financial reporting quality through its effect on the firm’s choice of auditor. Specifically, we test whether the extent of secrecy in a country negatively relates to firms’ choice of a high-quality auditor (i.e., Big 4 audit firms). Using a large number of firms from 37 countries and constructing our measure of secrecy based on Hofstede’s (1980) cultural values, we find strong evidence consistent with this

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