Audit Committee and CEO Ethnicity and Audit fees: Some Malaysian evidence

This study extends the literature on audit pricing by examining the relationship between ethnicity (bumiputra vs non-bumiputra), corporate governance attributes, and audit fees using data from 559 publicly-listed companies in Malaysia in 2005. Drawing from theories of ethnicity and political economy, we discuss our two hypotheses that predict positive associations between audit fees and (1) the proportion of bumiputra members on audit committees, and (2) the presence of a bumiputra CEO. The results support the hypothesis that firms with bumiputra CEOs incur higher audit fees, but we do not find an association for firms with bumiputra-dominant audit committees. In additional analysis, we find that the audit premium paid by firms with a bumiputra CEO is higher for the smaller client firms. Further, we find that firms managed by a bumiputra CEO with a fully bumiputra-composed audit committee tend to pay higher audit fees than the other firms, indicating that there is a combined ethnicity effect on audit fees.     

Money laundering and audit fees

We investigate the association between state-level money laundering sentences and audit fees in the US. Money laundering measures a broad category of offenses involving financial transactions using funds or monetary instruments gained through criminal activities and tax evasion. We find that firms headquartered in US states with high rates of money laundering sentences pay more audit fees. Our results suggest that auditors incorporate, as a fee premium, the higher risks involved when clients operate in those states. Our result remains robust to alternative specifications of money laundering proxies, and to the inclusion of a number of firm-level and state-level control variables. We also conduct two-stage least squares and propensity score matching analysis to mitigate the endogeneity problem that might arise from omitted variables, reverse causality, or model misspecification problems.     

Local Gambling Attitudes and Audit Quality: Evidence from Audit Adjustments

This study examines the influence of local gambling attitudes on audit quality. As a preference for gambling correlates to a greater tendency to take risks, we hypothesize that auditors make a greater magnitude of audit adjustments for clients headquartered in gambling-prone areas to reduce heightened audit risk. Consistent with our hypothesis, the empirical results show a positive relation between local gambling attitudes and the magnitude of audit adjustments. Further analyses show that this association is more pronounced when the regulatory cost is higher, and when the board chair or CEO comes from a gambling-prone area. We also find evidence that gambling culture results in greater magnitudes of both upward and downward audit adjustments, audit firms appoint more experienced audit partners to gambling-prone clients, and there is a fee premium for gambling-prone clients.     

How does the executive pay gap influence audit fees? The roles of R&D investment and institutional ownership

Using a sample of US firms from 2003–2014, this study examines how the executive pay gap affects audit fees for firms with different levels of R&D investment and institutional ownership. Consistent with managerial power theory, we find that the executive pay gap is positively associated with audit fees, and that the positive association is attenuated by intense R&D investment and higher institutional ownership. We also find that the executive pay gap more strongly affects audit fees after the passage of the 2010 Dodd–Frank Act and the PCAOB's 2012 call to identify the audit risk related to executive incentive compensation. Additional analyses show that the moderating effects of R&D investment and institutional ownership on the pay gap–audit fees association are not conditional on auditor tenure, but the moderating effect of institutional ownership is stronger for firms hiring specialist auditors. Collectively, our findings suggest that auditors consider the business context, such as innovation initiative and external monitoring, when assessing audit risk related to the executive pay gap.     

Do political connections affect the role of independent audit committees and CEO Duality? Some evidence from Malaysian audit pricing

This study examines whether political connection to firms affects the association between audit committee independence and demand for higher quality audits. In line with Carcello et al. (2002), our findings show that there is a positive association between audit committee independence and audit fees thus supporting the hypothesis that more independent audit committees demand higher audit quality. However, we find that this relationship is weaker for politically connected (PCON) firms suggesting that the independence of audit committees in Malaysian PCON firms may be compromised. Additionally, we provide evidence that PCON firms that have CEO duality are perceived by audit firms as being of higher risk than CEO duality firms without political connection.     

Fair Value Exposure,Changes in Fair Value and Audit Fees: Evidence from the Australian Real Estate Industry

This paper investigates the relationship between audit fees and both fair value exposure and changes in fair value of investment properties. The study is motivated by the limited and inconclusive evidence on the effect on audit fees of full fair value reporting for illiquid assets. Using hand‐collected data from the Australian real estate industry, we find a negative (positive) association between audit fees and fair value exposure (changes in fair value of investment properties). Our findings also indicate that the use of unobservable inputs in fair value estimates for investment properties does not significantly increase audit risk and audit fees. Further, we find that audit fees are higher for firms with fair values of investment – properties estimated by external and mixed valuers – compared to firms with fair values estimated by directors alone. This study enriches the audit fee literature by documenting auditors’ pricing decisions in an area that involves significant estimation and valuation risks.     

R&D capitalization and audit fees: Evidence from China

Our study investigates the association between capitalized R&D costs and audit fees and whether this association reflects the effect of earnings management. By exploring Chinese listed firms, we find that capitalized R&D costs are positively associated with audit fees, where such positive association holds for both the discretionary and nondiscretionary portions of capitalized R&D costs. Moreover, the positive association between the discretionary portion of capitalized R&D costs and audit fees is more pronounced for firms with stronger incentives to manipulate earnings. Overall, our findings imply that firms' reporting incentives affect how auditors react to clients' accounting choices. This in turn suggests that auditors believe some firms capitalize R&D to manipulate earnings, and the resulting earnings-management concerns lead them to charge higher fees.     

Fees Paid to Audit Firms, Accrual Choices, and Corporate Governance

We examine the relation between the fees paid to auditors for audit and non-audit services, and the choice of accrual measures for a large sample of firms. Using our pooled sample, we find that the ratio of non-audit fees to total fees has a positive relation with the absolute value of accruals similar to Frankel, Johnson, and Nelson [2002]. However, using latent class mixture models to identify clusters of firms with a homogenous regression structure reveals that this positive association only occurs for about 8.5% of the sample. In contrast to the fee ratio results, we find consistent evidence of a negative relation between the level of fees (both audit and non-audit) paid to auditors and accruals (i.e., higher fees are associated with smaller accruals). The latent class analysis also indicates that this negative relation is strongest for client firms with weak governance. Overall, our results are most consistent with auditor behavior being constrained by the reputation effects associated with allowing clients to engage in unusual accrual choices.     

Corporate lobbying: Resource-seeking or rent-seeking? Evidence from audit fees

Theory and prior research suggest that corporate lobbying is a primary means that corporations use to influence government policies either for improving firm performance (i.e., strategic decisions) or for rent-seeking activities (i.e., agency costs) but the evidence between lobbying activities and auditor assessments of audit risk remains unclear. Our results show that lobbying firms are associated with higher audit risks and fees, consistent with the idea that lobbying is related to rent-seeking and higher agency costs. In cross-sectional analyses, we find that the positive association between lobbying and audit fees is weaker for firms with strong corporate governance. Further analysis shows that firm financial returns or low earnings quality mediate the relationship between lobbying and audit fees. The results suggest that practitioners, users of financial statements and regulators could benefit by recognizing that lobbying activities could signal managerial opportunistic behavior.     

The impact of customer firm data breaches on the audit fees of their suppliers

This study investigates whether audit risks that accompany data breaches of major customer firms can spillover into the supply chain and affect audit fees of their suppliers. Based on the economic bond that exists between supplier firms and their major customers, we predict that data breach incidents of customer firms will lead to higher audit fees for their respective suppliers. Consistent with customer breaches increasing the audit risk to the supplier, we observe a positive association between breach disclosures made by major customers and audit fees of the supplier firm. This association exists for both internal and external data breaches. We further find that audit fees are increasing with the number of major customers disclosing a breach in a given year. Our results are robust to both a matched sample design and a difference-in-difference approach. Interestingly, we find that while supplier auditors appear to price the risks associated with customer breaches, the breaches do not appear to affect audit quality. The findings of this study are timely and relevant to academics, practitioners, and regulators as supply chains continue to become larger and more complex.     

Auditor Independence,Non‐Audit Services,and Restatements: Was the U.S. Government Right?*

Do fees for non‐audit services compromise auditor's independence and result in reduced quality of financial reporting? The Sarbanes‐Oxley Act of 2002 presumes that some fees do and bans these services for audit clients. Also, some registrants voluntarily restrict their audit firms from providing legally permitted non‐audit services. Assuming that restatements of previously issued financial statements reflect low‐quality financial reporting, we investigate detailed fees for restating registrants for 1995 to 2000 and for similar nonrestating registrants. We do not find a statistically significant positive association between fees for either financial information systems design and implementation or internal audit services and restatements, but we do find some such association for unspecified non‐audit services and restatements. We find a significant negative association between tax services fees and restatements, consistent with net benefits from acquiring tax services from a registrant's audit firm. The significant associations are driven primarily by larger registrants.     

Auditor specialization, perceived audit quality, and audit fees in the local government audit market

Prior governmental research implies a positive relation between auditor specialization and audit quality, but the effect of specialization on audit fees is mixed. However, no single governmental study investigates the effect of auditor specialization on both audit quality and audit fees. Also, prior studies focus on either large- or small audit firms and often employ indirect proxies for audit quality. We study the effects of auditor specialization on perceived audit quality and audit fees. Our data represent both Big 5 and smaller audit firms and include three market-based measures of specialization. We survey 241 Florida local government finance directors and find that specialization is positively associated with perceived audit quality but not with audit fees. We also find that Big 5 auditors, often used as a proxy for higher audit quality in prior research, are not uniformly associated with increased perceived audit quality but consistently charge higher audit fees. Our results confirm a relation between measures of audit firm specialization and audit quality and raise questions regarding audit firm size and audit quality in the municipal sector. Our findings suggest that engaging specialized auditors may be good policy for many local governments.     

Auditor liability and excess cash holdings: Evidence from audit fees of foreign incorporated firms

Auditors of foreign cross-listed firms face liability arising from the nature of the institutional monitoring framework of legal claims that can potentially be brought against the auditor in both the home country and the US. This paper is the first to document the relationship between auditor liability and auditor pricing of excess cash holdings for foreign firms cross-listed in the US. Our findings indicate that auditors demand a fee premium for foreign incorporated clients with greater excess cash holdings, consistent with auditors recognizing the potential for legal exposure to agency conflict arising from foreign listed US traded clients. Furthermore, we examine aspects of foreign capital market protections, such as disclosure requirements, the strength of legal enforcement, and the strength of shareholder rights to better understand auditor perception of the liability they incur due to the agency costs associated with excess cash holdings. We find that there is a significant positive association between audit fees and excess cash holdings for firms where the country of incorporation permits greater liability of auditors in criminal and civil litigation. In addition, auditors assign higher audit fees to firms holding greater excess cash incorporated in countries with greater required accounting disclosure, stronger legal enforcement and stronger shareholder rights.     

Female tainted directors,financial reporting quality and audit fees

This paper examines the association between the presence of female tainted directors on corporate boards and audit committees and (1) financial reporting quality and (2) audit fees. Female tainted directors are defined as female directors who have been directors of the firms that have previously been involved in financial failures and integrity indiscretions. Using real earnings management and audit fees as proxies for effective governance and board reputation, we find that firms with female tainted directors have higher real earnings management and higher audit fees. However, since prior literature has demonstrated that audit fees are higher for firms with female directors because female directors demand better auditing, we corroborate a supply-side effect of auditors charging higher audit fees when female tainted directors exist. We demonstrate this by showing that while there is an association between audit fee and real earnings management, this association is higher for firms with female tainted directors. Arguably, the governance and reputational benefits of female directors on boards are negated if such directors have tarnished professional reputations.     

The Effect of Corporate Status on External Audit Fees: Evidence From the UK

Abstract:  This paper simultaneously examines, for the first time, the determinants of external audit fees of UK companies drawn from the quoted sector (Main Market, the Alternative Investment Market and Ofex), and the unquoted sector (public and private limited companies). The paper also provides new evidence on the effects of corporate failure and the persistence of the big four and mid-tier auditor premiums across the public and private corporate sectors. After controlling for firm size, audit risk and complexity, we find that quoted and unquoted public limited companies have significantly higher audit fees than their private limited counterparts. Our estimates imply that relative premiums for market/corporate form are as follows: Main Market over AIM, 6.8%; AIM over Ofex, 19.5%; Ofex over unquoted plc, 15.5%; and unquoted plc over private, 16.7%. However, despite indications in prior US research to the contrary, we find no evidence that insolvent firms that failed were charged higher audit fees in the year preceding failure. A positive relationship is also found between audit and consultancy fees – a result that persists using an instrumental variables approach to control for endogeneity.     

AUDIT FEES AND AUDITOR CHANGE; AN INVESTIGATION OF THE PERSISTENCE OF FEE REDUCTION BY TYPE OF CHANGE

Despite concern expressed over 'low-balling' or competitive price reduction in the market for audit services, the only empirical investigation of the relationship between initial audit fees, fee recovery and auditor change which has been carried out is by Simon and Francis (1988) using US cross-sectional data, although Pong and Whittington (1994, forthcoming) examine the impact on first year fees. We investigate the impact of auditor change on cross-sectional UK data for 1991 with the aim of discovering whether there is any evidence of price cutting and subsequent price recovery in a European, rather than a US context. We find that there is evidence of such a phenomenon, and investigate further to see whether this effect is robust with respect to the definition used of 'auditor change', and whether the effect varies according to whether the old auditor was a 'Big Six' or 'non-Big Six' firm. We find that the largest reductions (controlling for auditor size) are experienced by firms changing to 'Big Six' firms. We further show that involuntary changes (by auditor acquisition) are associated with positive (although statistically insignificant) increases in fees, whereasvoluntary changesare associated with negative (andsignificant) feereductions. These effects are shown to be robust with respect to model specification. This suggests that fee reductions cannot be ascribed to economies of scale or scope, but is consistent with a 'low-balling' model of behaviour.     

Audit fee lowballing: Determinants,recovery, and future audit quality

Prior research on the link between lowballing (LB) of audit fees and audit quality is inconclusive. Using more recent data and an innovative design, we define LB engagements as those where the audit fee discount is at least 30 percent. We consider three research questions to understand the possible link between LB and audit quality. First, we investigate whether the two variables that are often associated with auditor independence in the literature—non-audit fees and client importance—are related to LB. Second, we test whether lowballing auditors recoup initial audit fee discounts in the future period. Lastly, we investigate the relation between recovery of audit fees and future audit quality. We find that non-audit fees in the first year of engagement are negatively related to the propensity to LB. LB is significantly positively related to client importance for client firms switching from a non-Big N to another non-Big N auditor while the relation is insignificant for client firms switching from a Big N to another Big N auditor. The results of non-audit fees and client importance indicate that economic dependence does not motivate audit firms to lowball. Further, lowballing auditors tend to recoup their initial fee discounts in subsequent periods via increases in audit fees. Using multiple measures of audit quality, we do not find a significant relation between recovery of audit fees and future audit quality. Overall, contrary to regulators’ concerns, our results suggest that LB does not impair audit quality.     

Are non‐audit services associated with firm value? Evidence from financial information system‐related services

The purchase of non‐audit services from incumbent auditors has generated considerable attention. Surprisingly, limited empirical evidence exists on the association of non‐audit services with firm value. Focusing on services related to financial information system (FIS), we find that the market value of equity is greater for firms that purchase FIS‐related services from their incumbent auditors relative to firms that do not. The levels of FIS fees are also positively related to firm value after controlling for total other fees, or total other non‐audit fees. Hence, despite the negative perception associated with non‐audit services, investors regard FIS‐related services as value‐adding activities.     

The pricing of audit and non-audit services in a regulated environment: a longitudinal study of the UK life insurance industry

This paper studies the relationship between audit and non-audit service fees paid to the statutory auditor by UK life insurance firms, utilising an extensive panel-data sample set for the period 1999–2009. Consistent with a knowledge spillover (impairment of independence) hypothesis, we predict and find that audit fees are positively (negatively) associated with actuarial (tax service) fees. Additionally, our results indicate that regulatory changes enforced after 2004 deterred UK life insurance firms from purchasing non-audit services that are perceived to impair auditor independence. Finally, we find evidence concerning the inter-temporal determination of audit fees.     

Transaction costs and competition among audit firms in local markets

We develop a measure to capture an audit firm's competitive position in a local audit market based on the transaction costs of changing audit firms included in DeAngelo's (1981) multi-period audit pricing model. Our competition measure reflects the size difference between the largest audit firm in a market specified by client industry at the city level and the other audit firms operating in that market. We find that audit fees of a client decrease as this size difference increases. This result suggests that smaller audit firms charge lower audit fees because of their competitive disadvantage to the local largest firm.