An Experimental Investigation of the Influence of Audit Fee Structure and Auditor Selection Rights on Auditor Independence and Client Investment Decisions

Abstract

SUMMARY This study uses experimental markets to gain insights into the effect of audit fee structure and auditor selection rights on auditor independence and client investment decisions. I find that firm managers are more willing to make a high cost/return investment under a lowballing setting than when auditors are paid a flat rate. Auditor behavior is primarily summarized as a response to past manager choices; when managers are especially willing to invest and honest, auditors perform fewer tests of manager disclosures. I also show that under manager selection, when lowballing exists, auditors initially attribute a higher accuracy to investigations indicating high manager investment than tests that suggest low investment, but the difference in accuracy assessments dissipates with time. Under investor selection, accuracy assessments of test results do not differ according to their outcome. Further analysis indicates that auditor retention under manager selection is negatively impacted by both unreliable auditing and disagreements with managers, with only the former affecting retention under investor selection.