How do abnormal audit fees, investor protection and political influence across jurisdictions affect IPO audit quality? Evidence from Hong Kong

Abstract: This study aims to examine the effect between abnormal audit fee, which is the difference between actual audit fee and normal audit fee levels, on the audit quality proxied by accrual discretionary. The study was conducted on 414 samples of manufacturing companies listed on the Indonesia Stock Exchange for the 2013-2018 observation period. The multiple linear regression test results show a relationship between the main variables is asymmetric, which depends on the sign of abnormal audit fees. For observations with negative abnormal audit fees or below normal audit fee levels, it’s showed that there is no significant effect between audit quality and abnormal audit fees. In fact, the findings indicate that there is a negative effect between abnormal audit fees and audit quality when tested on observations with negative abnormal audit fees or above normal audit fees levels. These results indicate that there is a dependence between the auditor and the client when the client pays a high audit fee so that it is possible to let the client manage earnings through discretionary accruals, which decreases the audit quality.

This study investigates the impact of abnormal audit fees on audit quality. An abnormal audit fee is the difference between the actual fee paid by the auditee to the external auditor and the normal fee. If the actual audit fee is above the normal audit fee, it is called a positive abnormal audit fee (premium) and if the actual audit fee is below the normal audit fee, it is called a negative abnormal audit fee (discount). The samples for this study were 3,694 selected companies from Indonesia, Malaysia, Singapore, the Philippines, and Thailand. Data were analyzed using regression analysis and it was found that positive abnormal audit fees could decrease the audit quality. This is because of the economic arrangement between the auditors and the clients as the auditor will be more tolerant towards the earnings management carried out by the client. On the other hand, negative abnormal audit fees have an insignificant relationship with the audit quality, which means if auditors are paid below the normal fees, they have no incentive to compromise the audit quality. Because audit fees can affect audit quality, regulators need to make policies so that audit fees paid to the external auditors should not be more than the normal fees.
 Keywords: audit quality, audit fees, negative abnormal audit fees, positive abnormal audit fees, abnormal working capital accruals

Purpose This paper aims to examine how the relationship between abnormal audit fees and audit quality changed after adoption of the International Financial Reporting Standards (IFRS) in Korea. Design/methodology/approach Using empirical data collected over the period from 2008 to 2013, this study analyzes the association between abnormally high/low audit fee and audit quality. This study uses linear regression to test the hypothetical relation using discretionary accrual as a proxy for audit quality. Findings This study finds that there exists no significant relationship between abnormally high audit fees and audit quality measured by the magnitude of discretionary accruals in the pre-IFRS adoption period. However, the relationship between abnormally high audit fees and the magnitude of discretionary accruals turns to be positive in the post-IFRS adoption period. These finding suggests that the IFRS enables some clients to engage more discretion in the choice of discretionary accruals and auditors charge higher audit fees in return for allowing the discretion for such clients. Practical implications This study provides insight to regulators of the need to review carefully the financial statements of firms with abnormally high audit fees, and to investors to be more cautious when using financial information about these firms. Originality/value To the best of authors’ knowledge, this is the first study to assess IFRS impact on audit fee-quality relation. Also, unique Korean audit market with intensifying competition and discounting audit fee provides interesting setting to review the impact of abnormal audit fee on audit quality.

SUMMARY: This study examines whether and how audit quality proxied by the magnitude of absolute discretionary accruals is associated with abnormal audit fees, that is, the difference between actual audit fee and the expected, normal level of audit fee. The results of various regressions reveal that the association between the two is asymmetric, depending on the sign of the abnormal audit fee. For observations with negative abnormal audit fees, there is no significant association between audit quality and abnormal audit fee. In contrast, abnormal audit fees are negatively associated with audit quality for observations with positive abnormal audit fees. Our findings suggest that auditors’ incentives to deter biased financial reporting differ systematically, depending on whether their clients pay more than or less than the normal level of audit fee. Our results are robust to a variety of sensitivity checks.

Do Abnormally High Audit Fees Impair Audit Quality?

We assess the unexplained information content of abnormal audit fees using a sample of initial public offering (IPO) audits in China. We find that abnormal IPO audit fees are positively associated with manipulation of pre-IPO real activities, suggesting lower audit quality for IPO financial statements. We further find that abnormal IPO audit fees are negatively associated with post-IPO financial performance. These results suggest a strong alignment of interests between the principal (pre-IPO shareholders), whose main interest is to gain listing status, and its agent (the auditor), who is willing to cooperate with the principal for extra economic rents (abnormal audit fees). Our findings that abnormal IPO audit fees are associated with lower audit quality and can help predict post-IPO financial performance have important implications for audit regulators, IPO market participants, and the applicability of agency theory in the context of IPO audits. JEL Classifications: M43; M49.

Positive abnormal audit fees lower the quality of the audit. A high abnormal audit fee degrades the audit's quality since it jeopardizes the auditor's objectivity and impartiality. High audit fees also give auditors and clients the opportunity to establish a financial connection. A negative abnormal audit fee also degrades the audit's quality. This is because the auditor alters both the scope and tactics of the audit in accordance with the charge collected from the customer. Because of the IFRS, auditors must put up more effort by examining a larger range of accounting options and managing increasing complexity. Due to the increased audit operations required when the IFRS were implemented, audit fees have grown in many firms. As a result, the purpose of this article is to define how the implementation of IFRS has affected the correlation between abnormal audit fees and the quality of audit. The information gathered from the annual reports of the top 100 Egyptian businesses listed on the EGX for the years 2019 to 2020. The study found that IFRS had an insignificant effect on the relationship between abnormal audit fees and audit quality.

PurposeThis paper aims to examine the relationship between abnormal audit fees and accrual-based and real-based earnings management by using a sample of 1,055 UK firm-year observations from 2006 to 2015.Design/methodology/approachLinear regression was used to test the hypothetical relation between abnormal audit fees and accrual and real earnings management. Following prior research, several proxies have been used to measure abnormal audit fees, accrual earnings management and real earnings management.FindingsAbnormal audit fees were negatively associated with real earnings management. A higher level of abnormal audit fees was the major driver of enhanced audit quality, in turn reducing managers’ flexibility to use real earnings management and to manipulate reported earnings. Abnormal audit fees were found to be negatively associated with abnormal discretionary expenses, abnormal production costs and the aggregated measure of real earnings management.Practical implicationsThis paper outlines the importance of considering any abnormal audit fees paid to audit firms. It is expected that the abnormal audit fees might compromise auditor independence and lead to a higher level of earnings management. However, the findings of this paper provide a new insight to many interested parties, e.g. regulators, audit firms, investors and creditors, that abnormal audit fees are associated with higher audit quality and higher financial reporting quality in the UK. Regulators in the meanwhile should reform the audit market by, e.g. revising the types of non-audit services that are provided for the same client, setting a cap on the maximum fees that can charged by auditors and monitoring earnings management practices. Audit firms should take into consideration that any charged abnormal level of audit fees may have a direct impact on audit quality.Originality/valueThis is the first study to examine the impact of abnormal audit fees on accruals and real earnings management after major regulatory changes that took place in the UK. These major changes are the adoption of the International Financial Reporting Standards in 2005 and the new legislation concerning the ethical standards issued by the UK Audit Practice Board in 2004. These two major changes are expected to have a direct impact on both earnings management and audit fees, notably for the largest public listed firms. This study also focuses on one of the very developed and attractive stock markets in the world, the UK FTSE 350 stock index, that incorporates that largest 350 public firms.

Do abnormally high or low audit fees reflect audit quality? In this paper, we re-examine this issue after controlling for the confounding effect of audit hours by using a sample of public firms in the Korean audit market, which publicly discloses both audit fees and audit hour information. While we do not find a significant association between abnormally high audit fees and audit quality, we find that abnormally low audit fees are associated with larger discretionary accruals and a higher likelihood of meeting or beating analyst earnings forecasts. Further, we find that the relationship between abnormally low audit fees and audit quality indicators persists regardless of the level of audit hours. To the extent that audit hours represent audit effort, these findings suggest that greater audit effort alone may not lead to higher audit quality as fee pressure from abnormally low fees may discourage the provision of high-quality audit services. JEL Classifications: M42; M48.

We examine the association between abnormal audit fees and audit quality using Australian data. We find that audit quality, measured by auditors’ propensity to issue going concern opinions for financially distressed companies, discretionary accruals, and clients’ propensity to meet or beat earnings benchmarks, declines as positive abnormal audit fees increase in magnitude. Our findings support an economic bonding argument that positive abnormal audit fees reflect the extent of economic bonding between the auditor and the client. We also find that negative abnormal audit fees are negatively associated with the absolute value of discretionary accruals. Our findings suggest that academic researchers, practitioners, regulators, and others interested in assessing the effect of auditor remuneration on auditor independence and audit quality should be concerned with audit fees that are above a normal level rather than audit fees that are below a normal level of audit fees. JEL Classification: M42, M49

Auditor independence and the quality of audit report is of growing concern to regulators, institutional investors and stakeholders as a series of accounting scandals have undermined the professionalism of auditors. The findings from this study produced an insight of how auditor’s independence improve audit quality and that abnormal audit fees is as a result of additional effort for auditor to carry out rigorous audit engagement as a result of wider audit scope; that mandatory audit firm rotation will enhance auditor independence, and that audit committee with nonexecutive independence will promote audit quality. The study also finds that in terms of auditor size, smaller audit firms that belong to professional bodies will provide higher audit quality. The main conclusion of this research is that where an auditor is fully independent in carrying out audit engagement with strong resistance to fees pressure will enhance audit quality. This research provides insight into the impact of IFRS adoption on audit fees.

The problem of abnormal audit fees in the audit market is more prevalent. To study the impact on audit quality, China's A-share listed companies in Shanghai and Shenzhen from 2013 to 2020 were selected as the research objects, and the abnormal audit fees calculated using the pricing model were split into positive abnormal audit fees and negative abnormal audit fees, and the relationship between them and audit quality was analyzed using a regression model, and on this basis, the audit market was examined. The study also examines the mediating effect of concentration in the relationship between negative abnormal audit fees and audit quality. The study shows that abnormal audit fees are significantly and negatively related to audit quality regardless of whether they are high or low, and that audit market concentration plays a partially mediating role in the relationship between negative abnormal audit fees and audit quality, with the lower abnormal fees, the lower the audit market concentration and the higher the audit quality. The study provides new ideas and policy recommendations for the classic problem of abnormal audit fees and audit quality from the perspective of audit market concentration.

In the course of our country's economic development, the financial frauds and auditing failures remain rampant, which has aroused public attention and seriously deteriorated the healthy development of the capital market. The purpose of this research is to determine the factors affecting audit quality, and provide feasible and practical proposals to improve audit quality and promote the healthy development of the capital market. Aiming to Figure out the influence mechanism of abnormal audit fee on the audit quality, this empirical study investigates the influence of abnormal audit fee on the audit quality and the adjustment function of the audit firm size based on panel data from the Chinese A-Share listed companies from 2014 to 2018. We find abnormal audit fee is negatively and significantly associated with audit quality. Our results suggest that abnormal audit fee does harm to the audit quality, but auditor size plays a moderating role in their relationship, that is, large-size accounting firms can reduce the harm. Taking positive abnormal audit fee and negative abnormal audit fee into account, we find that both of them result in poor audit quality, while large-size accounting firms can reduce the effect as well.

This study examines whether auditors compromise accounting quality by charging abnormally high audit fees. In particular, by drawing on the audit pricing theory, we investigate the relationship between abnormal audit fees and accounting quality, using fee residuals derived from an audit fee model that includes audit hours and hourly fees. Using listed firms in the Korean stock market, we find that the negative relationship between abnormal audit fees and accounting quality does not hold when we use abnormal audit fees estimated after controlling for audit hours. In contrast, we find a negative association between abnormally high audit fees, estimated after controlling for hourly fees, and accounting quality. Collectively, these findings support the interpretation that the negative relationship between abnormal audit fees and accounting quality, identified in previous studies, is driven by increased audit hours owing to lower accounting quality. Furthermore, we find that these results are driven by audit partner hours and senior auditor hours rather than junior auditor hours. This suggests that audit firms impose higher-level audit hours in the presence of low accounting quality, which results in higher audit fees.

The objective of the study is to examine moderating effects of client characteristics on the relationship between abnormal audit fee and audit quality. Specifically the study examines the moderating of client risk, client complexity and client profitability on the relationship between abnormal audit fee and audit quality.  A random sample of fifty-two quoted companies was used for the study and data covering fifteen years (2001-2015) were extracted from the reports of selected firms. The study employed least square regression technique analyse data collected from field. The study found that there is no significant relationship between abnormal audit fee and audit quality. The result also showed client complexity and client profitability have negative moderating influence on the relationship between abnormal audit fee and audit quality. The study further revealed that client risk has no significant moderating influence on the relationship between abnormal audit fee and audit quality. The study recommended that statutory bodies should further securitize the audited financial reports of firms that declare huge profit. Â