Managerial overconfidence and audit fees

Abstract

We investigate the association between managerial overconfidence and audit fees, as well as the effect of a strong audit committee on this relation. Overconfident managers tend to overestimate their ability and the future payouts of projects but underestimate the likelihood and impact of adverse events. If auditors perceive managerial overconfidence as increasing audit risk, they will charge additional fees to compensate for the increased audit effort. Conversely, audit fees for companies with an overconfident manager will be lower if managers demand less audit services due to either hubris in their companies' financial reporting or a desire to reduce auditor scrutiny over aggressive accounting practices. We find evidence of a negative relation between managerial overconfidence and audit fees for companies lacking a strong audit committee. Additionally, we find that overconfident managers are less likely to use an industry specialist auditor.