Auditors' governance functions and legal environments: An international investigation

This paper uses firm-level data collected from 39 countries to study whether national legal environments increase or decrease auditors' governance functions in serving the bonding and signaling role. On the one hand, Big 5 auditors may play a stronger governance role in weaker legal environments because they are good substitutes for legal protection of outside investors and risky firms find Big 5 auditors more affordable because of lower litigation costs. On the other hand, a country's poor legal environment may significantly weaken the demand for and supply of quality audits, lessening their role as a bonding mechanism and a credible signaling mechanism. Our empirical results provide support for the former view that Big 5 auditors fulfill a stronger governance function in weaker legal environments.