When International Expansion Enhances Audit Quality: Evidence from Foreign Subsidiaries in U.S. Firms

Abstract

This study aims to examine the effect of foreign subsidiaries on the audit quality of U.S. firms and to assess how institutional distance between European and non-European regions moderates this relationship. The study employs a quantitative approach using panel data regression on 18,849 firm-year observations from 2017–2024. The analysis controls for firm and year fixed effects and applies two-way clustered standard errors to ensure robust estimations. The results show that the presence of foreign subsidiaries has a positive and significant effect on audit quality, supporting the response-dominant hypothesis, which posits that auditors respond to higher audit risks through increased diligence and effort. The effect is stronger for firms with subsidiaries in Europe, where institutional systems and audit practices more closely resemble those in the United States, compared to non-European regions. Overall, the results suggest that cross-border complexity does not necessarily impair audit quality but can enhance it when supported by a strong regulatory environment. The findings extend agency, information complexity, and audit demand theories to a cross-border setting and reinforce the relevance of institutional distance theory. Practically, they highlight the need for enhanced auditor coordination, global audit integration, and adaptive oversight for partially internationalized firms. This study provides new evidence that firms in the early stages of internationalization, those with foreign subsidiaries but not yet full MNCs, can improve audit quality when auditors effectively manage cross-border complexity and institutional differences.