Auditor choice and nonaudit fees: Evidence from group‐affiliated Indian firms

Abstract

We study the interplay between auditor as an instrument of corporate governance and the ownership structure of firms in the Indian context. Our study is motivated by the literature on agency problems occurring from both the conflicts of interests between owners and managers (Type I problem) and those between dominant and passive stockholders (Type II problems). Investors controlling Group-affiliated firms have incentives and influence to monitor their firms, resulting in amelioration of Type I problems, which is expected to result in lower demand for high-quality auditors. However, in situations where Type II problems dominate, the Group-affiliated firms have incentives to, (i) mitigate conflicts with minority shareholders by using high-quality auditors, and (ii) strengthen the perception that their auditors are independent. We find that Indian group-affiliated firms tend to choose BigN auditing firms and that upon selection of a BigN auditor, there is no difference in the magnitude of nonaudit services purchased by both the Group-affiliated and non-Group-affiliated firms, but when a non-BigN auditor is chosen, the Group-affiliated firms purchase significantly higher nonaudit services as compared to firms not affiliated to groups, suggesting that when Group-affiliated firms select reputed auditors they also strive to maintain the perception that auditors are independent.

Mandatory auditor rotation and audit quality

“…In emerging economies, concentrated ownership dominates the corporate landscape (Khanna and Palepu, 2000;Morck, 2000;Young et al, 2008). The shareholdings in Indian firms are often concentrated via cross-holdings and a pyramid structure, where controlling shareholders can be individuals or families having sizeable controlling ownership (Parkash et al, 2022;Singal and Singal, 2011). Basu and Sen (2015) estimate that business group firms or controlling firms account for 67% of the BSE market capitalization.…”