Audit Pricing Decisions Research Articles

Corruption and audit fees: New evidence from EU27 countries

This study examines the relationship between country‐level corruption and audit pricing decisions across EU27 countries. Using a sample of 29,607 firm‐year observations for the period 2011–2021, I find that firms headquartered in more corrupt countries pay higher audit fees and have longer reporting lags. I also show that this relationship is stronger after the EU audit reform came into force in 2016. The results suggest that auditors respond to corruption risk stemming from the broader macroeconomic environment by increasing audit fees and audit effort. In additional analyses, I show how the association between audit fees and corruption varies across firm industries, and I document that female engagement partners tend to be more sensitive to corruption risk than their male counterparts. Ultimately, I find unexpected evidence indicating that financial reporting quality, proxied by discretionary accruals, is not adversely affected by corruption. This study addresses prior calls for a more granular understanding of external factors in audit research and provides the first European evidence of the association between corruption and auditor responses. The implications of this study should be particularly relevant for researchers, market participants and regulators.

Digital transformation, green innovation, and audit fees

Under the trend of synergistic development of digitalization and greening, this paper investigates the impact of enterprise digital transformation on audit fees and its mechanism, by using textual analysis and performing empirical tests on the data of Chinese listed companies from 2007 to 2021. It is found that enterprise digital transformation significantly increases audit fees, and green innovation partially mediates this process. The study results are robust, even after a series of robustness tests. When financing constraints and environmental regulations are low, the mediating role of green innovation between digital transformation and audit fees is more significant. In addition, green innovation has a stronger mediating role between the use of underlying technology and audit fees, while green substantive innovation has a stronger mediating role between digital transformation and audit fees. This study investigates the effect of enterprise digital transformation on audit fees from the standpoint of green innovation. It offers a new perspective on how accounting firms make audit pricing decisions, provides guidance for enterprise digital transformation and green innovation, and gives an opportunity for China to promote the synergistic transformation and development of digitalization and greening to achieve the dual-carbon goal.

Does Internal Competition among Audit Partners Affect Audit Pricing Decisions?

SUMMARY This study examines whether competitive pressure from peers within a local office (i.e., internal competition) affects audit partners’ audit pricing decisions. Using U.S. audit partner data from 2016 to 2022, we find that audit partners respond to internal competition by charging their clients lower audit fees. The effect is more pronounced for initial audit engagements, in more competitive local audit markets, and when peers share similar personal attributes, such as sex and experience. However, the effect is weaker for industry specialist audit partners. We also find evidence that internal competition is negatively associated with audit quality for non-Big 4 clients. Overall, this study provides initial evidence of the effect of internal competition among audit partners on audit outcomes.

What Does the Auditor Say? Auditors’ Disclosures of Critical Audit Matters and Audit Fees

SYNOPSIS We examine whether critical audit matter (CAM) disclosures contain information about material misstatement risks that is priced in audit fees. We find that textual features of auditors’ risk descriptions and the types of risks identified capture fee-relevant information. Further, the results are incremental to other determinants of audit fees considered in prior research and to managements’ disclosures in the related notes to the financial statements. Overall, we provide evidence that auditors’ perceptions of audit risks revealed in the newly expanded audit opinion capture information relevant for understanding audit pricing decisions. Data Availability: All data are publicly available from the sources identified in the paper. JEL Classifications: M41; M42; M48.

The impact of board reforms on audit fees: International evidence

AbstractIn this study, we investigate whether and to what extent country‐level board reforms affect audit pricing decisions. We find audit fees are positively associated with board reforms. An increase in audit fees is more pronounced for firms that switched up to Big N auditors following board reforms. After board reforms, firms are less likely to issue restatements, and both analyst forecast accuracy and management forecast frequency increase, indicating improved audit quality and information transparency in the postreform period. Moreover, the positive relation between board reforms and audit fees is more evident for firms in countries that lack institutional governance mechanisms, captured by emerging capital markets, high political risk, weak governmental enforcement actions and low corporate governance quality. Overall, our findings broadly support the view that audit fees increase upon demand for better audit quality.

Does Internal Competition among Audit Partners Affect Audit Pricing Decisions?

Does Internal Competition among Audit Partners Affect Audit Pricing Decisions?

Do Auditors Respond to Clients’ Climate Change-related External Risks? Evidence from Audit Fees

In this study, we investigate whether auditors consider their clients’ climate change-related external risks when making audit pricing decisions. Using county-level proxies based on the number of declared natural disasters and the level of societal climate change awareness, we discover that clients with greater exposure to climate change risks pay significantly higher audit fees. After performing several additional tests, we conclude that auditors consider climate change risks and their potential consequences as a systematic business risk that is factored into the audit fees. For instance, we demonstrate that clients’ climate risk exposure has become more strongly associated with audit pricing in recent years, as climate change has gained greater importance in public debate. Moreover, we discover that auditors place a greater emphasis on clients’ climate risks when they themselves are located in regions with higher climate change awareness, indicating that auditors’ climate change perception also matters. Given the growing interest in climate change-related risks in practice and research, as well as the significance expected to be placed on these risks in the future, our findings are timely and should appeal to a wide range of readers, including investors, regulators, and scholars.

Trust of the Crowd and Audit Pricing

Using a novel dataset that captures public perceptions of the trustworthiness of client firms by extracting and converting social media feeds into an index, we find that auditors charge higher fees for client firms with lower trustworthiness, as client firms with higher trustworthiness are less likely to incur lawsuits. This correlation is stronger for the shorter audit tenures, younger client firms, and more complex auditing practices after the enactment of the SOX Act. Our results are robust to: (i) including firm or county fixed effects, (ii) controlling for the internal control weaknesses and various corporate governance measures, and (iii) adding the trust index constructed from financial news. Our study highlights the role of the perceived trustworthiness of client firms in audit pricing decisions.

The Impact of Customer Psychological Price on Audit Pricing in the Start-Up Company Market.

Start-up companies are confronted with various risks and many uncertainties, and professional auditing can fully analyze start-up companies. In this way, both parties may maximize their interests through auditing the market activities. Based on the characteristics of start-up companies, this study explores the impact of customer psychological prices on audit pricing. The impact of customer psychological prices on audit pricing decisions was systematically analyzed from various angles, thereby determining whether it will affect the development of the product market. The results show that product market dominance reduces the agency costs between the owner and manager of the customer company. In other words, if the customers have greater control over the product market, they will have a lower business risk, and the auditor risk will be reduced accordingly, hence a lower audit fee. In the start-up company market, even if the financing dilemma restricts the survival and development of the company, customers still have psychological expectations for audit pricing. When their psychological price of products is different from the market price of products, it may affect the market advantage of products with lower audit fees, and further expands the previous research. In the market, customers also have certain psychological expectations for “auditing” products. Therefore, strengthening the relationship between auditors’ pricing and customers’ psychological prices has a positive effect on enhancing the competitiveness of product markets, which also increases the operating efficiency of start-up companies.

Organization capital and audit fees around the world

We examine whether auditors consider organization capital in audit pricing decisions. Utilizing an international sample from 40 countries spanning the period 2001–2017, we find that firms with high levels of organization capital pay high audit fees: a finding that is consistent with both the risk‐ and the agency‐based arguments for audit pricing. Additionally, our results indicate that the positive relationship between organization capital and audit fees is reinforced in firms with pronounced business risks and agency problems, whereas it is relatively weak in countries with protective employment legislation. Our study contributes to the voluminous literature on the determinants of audit fees by showing that auditors price the risks related to clients' intangible assets, especially those embodied in a firm's key talents. Our study also contributes to the scarce literature on the effects of organization capital in international markets.

CEO tenure and audit pricing

We examine the relationship between CEO tenure and audit fees. After controlling for client and auditor attributes in the analyses, we find that audit fees are higher in the initial 3 years of CEOs’ service, suggesting that CEOs in their early career are more likely to show high risk-taking behavior and manage earnings that increases the probability of financial misreporting. Auditors incorporate this risk in their audit pricing decisions resulting in higher audit fees. We also find that audit fees are higher in the final year of CEOs’ service, supporting the argument for departing CEOs’ horizon problem that CEOs in their final year are more likely to manage earnings, and auditors perceive this action as increasing reporting risk in their audit pricing decisions, resulting in higher audit fees. However, the firms with more effective audit committees pay relatively lower audit fees in initial years of CEOs’ service indicating that effective audit committees reduce auditors’ assessed risk during this time-period resulting in lower audit fees. We do not find any evidence on the effect of firms’ CFO power and corporate social responsibility performance on audit fees in these two time-periods of CEOs’ service. The main results hold in a battery of supplemental tests that include the effect of several CEO characteristics, client bargaining power and the effect of SOX. Our study extends CEO characteristics and audit fee literature, and have implications for auditors in their client acceptance and audit pricing decisions, and for regulators to identify the filers with higher financial reporting and audit engagement risk.

Optimistic tone and audit fees: Some Australian evidence

We examine whether the tone of corporate annual reports is associated with audit pricing decisions. A unique dataset drawn from annual reports of nonfinancial firms listed on the Australian Stock Exchange for the period from 2002 to 2014 is generated using textual analysis. We find that annual reports that convey optimistic tone are associated with lower audit fees, suggesting that annual report tone reflects factors that auditors consider in assessing audit risk. Consistent with the inverse association between tone and audit fees, results of additional analysis show that annual report tone is positively associated with earnings quality. Our results hold after controlling for firm characteristics that influence audit pricing decisions and remain robust to alternative variable measurement and test of endogeneity. Overall, the findings suggest that auditors could enhance their audit risk assessment practices by systematically considering linguistic attributes of qualitative corporate disclosures.

Local Gambling Norms and Audit Pricing

This study investigates whether local gambling norms are associated with audit pricing. Using a religion-based measure of local social gambling norms, we find strong evidence that public firms located in U.S. counties with more liberal gambling norms exhibit higher levels of audit fees. This result is consistent with our view that, as an important external risk factor, clients’ local gambling norms influence audit pricing decisions. Our findings are robust to a battery of sensitivity tests, including non-religion based measures of liberal gambling norms and a natural experiment.

CEO Political Ideology and Audit Pricing

We examine the association between CEOs’ political ideologies, proxied by CEOs’ federal-level personal political contributions to the Republican Party relative to the Democratic Party, and audit fees of the firms that the CEOs manage. We hypothesize and find that firms run by CEOs whose political ideologies are aligned with the Republican Party pay lower audit fees than firms run by CEOs whose political ideologies are aligned with the Democratic Party. This finding is robust to various sensitivity checks and to controls for potential endogeneity and self-selection concerns. In addition, we find that CEO political ideology affects audit risk as proxied by financial reporting quality and client business risk, which, in turn, influence audit fees, suggesting that financial reporting quality and client business risk are two channels through which CEO political ideology affects audit fees. Finally, we find that the association between CEO political ideology and audit fees is more pronounced when corporate governance is weaker. Overall, our results suggest that CEO political ideology is a factor that influences audit risk and auditors incorporate such a factor in their audit pricing decisions.

Excess audit committee compensation and audit pricing

In this study, we explore audit pricing decisions in the presence of excess audit committee compensation. Specifically, we examine whether excess compensation of audit committee members is related to audit fees. We find that excess compensation is positively associated with audit fees. We further examine whether the excess compensation affects auditors pricing of earnings manipulation, and find evidence suggesting that auditors perceive earnings manipulation risk relatively low when the audit committee members are paid excess compensation. Overall, our results support the notion that audit committee excess compensation represents greater monitoring over a firms financial reporting process, which affects auditors' risk assessment.

Anti-corruption reform and audit pricing

This paper examines how Chinese anti-corruption reform affects audit pricing. We show that auditors react to the increased audit risk resulting from anti-corruption reform and charge higher audit fees to the politically connected firms. We find that the treatment effect is stronger for firms with poor financial statement quality, with higher operating uncertainty, located in provinces experiencing larger effect of anti-corruption reform, and audited by audit firms with greater bargaining powers. Finally, the results suggest that earnings management and the probability of issuing an unqualified opinion of politically connected firms are reduced after the anti-corruption reform. Our findings provide further insight into the effect of anti-corruption reform on auditors in audit pricing decisions.

Excess audit committee compensation and audit pricing

In this study, we explore audit pricing decisions in the presence of excess audit committee compensation. Specifically, we examine whether excess compensation of audit committee members is related to audit fees. We find that excess compensation is positively associated with audit fees. We further examine whether the excess compensation affects auditors' pricing of earnings manipulation, and find evidence suggesting that auditors perceive earnings manipulation risk relatively low when the audit committee members are paid excess compensation. Overall, our results support the notion that audit committee excess compensation represents greater monitoring over a firm's financial reporting process, which affects auditor's risk assessment.

Do Auditors Respond to Unique Characteristics of Individual Executives? Evidence from Audit Pricing Decisions

Individual executives influence many aspects of corporate performance and financial reporting. In this study, we examine whether auditors observe and respond to characteristics of individual executives by adjusting the price of audit services. Using the group connection method for separating firm and executive effects, we find that unexplained audit fees exhibit a statistically and economically significant association with executive fixed effects after controlling for other factors related to the firm and environment. Our tests show only limited evidence that common, observable proxies are associated with the auditor’s perception of an individual executive’s style. Finally, we observe positive and significant associations between the executive fixed effect coefficients and measures of financial reporting risks and audit report delay, indicating auditors’ decisions to adjust fees for executive traits are related to factors representing audit risk and auditor effort. Our findings highlight the importance of differences across individual executives in the external auditor’s decision-making process.

Do Audit Fees Reflect Risk Premiums for Control Risk?

This study examines whether audit fees reflect risk premiums in the presence of control risk after controlling for audit effort through audit delay. Our results indicate that auditors adjust risk premiums as well as audit efforts in response to altered control risk. Further analysis shows that the extent of risk premium adjustment varies depending on the severity of the underlying internal control problems. Overall, these findings provide insights into the distinct role of audit effort and risk premium in audit pricing decisions.

Risk in Audit Pricing: The Role of Firm-Specific Dimensions of Risk

This chapter investigates the impact of the firm-specific dimensions of risk suggested in the finance literature, the financial risk, operating leverage and business risk on audit fees. It is hypothesized that audit fees are related to these three dimensions of risk, size, audit complexity and a set of the agency theory based control variables. The hypothesis is empirically tested using a sample from the U.K. audit market. The results of the study show that audit fees as hypothesized are positively related to financial leverage, operating leverage and business risk of a firm and that the control variables behave according to expectations. This implies that the three dimensions of the firm-specific risk are taken into account in audit pricing decisions and should therefore be incorporated into models when investigating the audit pricing issues.