Agency Costs and Audit Pricing: Evidence on Discretionary Accruals

Abstract

This paper tests four hypotheses: (1) there is a positive association between the magnitude of discretionary accruals and audit fees, (2) this positive association is stronger for Big 6 auditees than for Non-Big 6 auditees, (3) there is a negative association between family ownership of companies and audit fees, and (4) there is a negative association between the percentage of independent non-executive directors and audit fees. The first two hypotheses are based on the assumption that when managers manipulate accruals to conceal poor performance or postpone earnings to future years, auditors revise upwards their assessments of inherent risk which will result in higher audit fees. More specifically, the second hypothesis is based on the premise that Big 6 auditors have more reputation capital to protect than Non-Big 6 auditors. Hypotheses three and four rely on the assumption that as a result of higher monitoring and lower agency costs associated with family ownership and higher percentage of non-executive directors, auditors assess lower levels of inherent risks and charge lower audit fees. Results using 134 company-year observations from 67 companies provide support for all four hypotheses.