Do Auditors Price Audit Committee's Expertise? The Case of Accounting Vs. Non-Accounting Financial Experts

Abstract

The issue of whether audit pricing reflects the risk of corporate governance failure is of fundamental interest to auditors, managers, and others. Auditors are expected to price corporate governance risk because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key aspect of effective governance, i.e., the expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the SEC defined experts broadly to include accounting or non-accounting financial experts. Does audit pricing differentiate between accounting and non-accounting financial expertise? For a sample of S&P 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure, i.e., in weak boards the presence of audit committee financial expertise may not be effective in mitigating control risk. Overall, our evidence is consistent with the SEC's initial narrow definition to include only accounting financial experts that is valued by the auditors. The lack of a significant relationship between non-accounting financial expertise and audit fees suggests that auditors perceive only accounting financial expertise contributes to increased monitoring by the audit committee and thus, mitigates the risk of governance failure.