Increase In Audit Fees Research Articles

Auditor Response to Negative Media Coverage of Client Environmental, Social, and Governance Practices

SYNOPSIS We use new data to examine auditor response to negative media coverage of client environmental, social, and governance (ESG) practices. This coverage can be indicative of an increased risk of material misstatement, which is an important assessment in client retention and pricing decisions. Specifically, media criticism can threaten a client's financial condition, as well as reveal management effectiveness and integrity issues that are further compounded by negative attention and related financial problems. We therefore predict that auditors will notice and incorporate media-provided ESG information in their risk response, which has not been examined by prior research. Supporting this prediction, we find that ESG-related negative media coverage of an audit client is associated with a higher likelihood of auditor resignation and increased audit fees. This response is incremental to the issues that underlie this media coverage. Overall, these findings identify an additional economic incentive for companies to avoid poor ESG practices.

Behind Audit Fee Increases: A Field Study into Auditors’ Billing Strategies

Audit research documents audit fee discounts associated with an auditor change, and that audit fees revert to average levels within a few years. This paper provides exploratory insights into the perceptions of board members vis-a-vis pricing practices used by auditors to achieve audit fee increases. In semi-structured interviews with 12 respondents (ten board members, two audit managers), we elicit perceptions on initial audit fee discounts, auditor pricing practices, and client reactions to these pricing practices. The key findings indicate that auditors combine two pricing practices to achieve audit fee increases. First, they negotiate higher fees prior to the annual audit cycle, citing changes in client structure/size and the institutional environment. Second, they charge higher than negotiated fees after completing the audit (‘extra-billing’), citing justifications such as chargeable hour overruns and findings warranting additional work. Potentially, such auditor pricing practices have negative implications for audit quality and damage the auditor-client relationship.

The Effect of Hedge Fund Activism on Auditors: A Stakeholder’s Perspective

Extant literature focuses on the governance effect of hedge fund activism on shareholders but overlooks other stakeholders. We fill this literature gap by investigating one important stakeholder who also plays a governance role: the auditor. We find that the governance effect of hedge fund activism spills over to incumbent auditors, leading to a 4.08% increase in audit fees. This relation holds in a range of robustness tests that address endogeneity, including a difference-in-differences model and a placebo test. Moreover, auditor turnover does not significantly change after hedge fund intervention, suggesting that hedge funds do not seek new auditors. The governance spillover effect on incumbent auditors occurs through the revelation of internal control weaknesses and replacement of financial personnel in target firms. Further tests show that the increased audit fees are allotted to more audit effort and reduce the likelihood of restatements, indicating improved audit quality. Our findings show that hedge fund activism and auditors are complementary at strengthening corporate governance.

Auditing Standards, Professional Judgment, and Audit Quality

ABSTRACTWe propose a model to study how auditing standards affect audit quality. We posit that both auditors' incentives and expertise are relevant for audit effectiveness. Auditing standards are useful in mitigating the auditors' possible misalignment of interest with investors. However, auditing standards also restrict auditors' exercise of professional judgment, which, in turn, leads to compliance mentality and reduces auditors' incentives to become competent in the first place. We identify the conditions under which stricter auditing standards increase or decrease audit quality. Moreover, stricter auditing standards always increase audit fees, but can benefit auditors at firms' expense. The model also generates many testable empirical predictions.

Number of Regional Accounting Firms and Audit Fees—Based on the Experience Data of Listed Companies in China in 2016

There are many research literatures on the influencing factors of auditing firms’ audit fees, but their influence on audit fees is rarely studied from geographical factors. This paper studies the relationship among the number of regional accounting firms, whether they are local and audit fees, and uses the 2016 A-share listed companies as a sample to collect the number of accounting firms in the cities where the listed companies are located through the Chinese CPA industry management information system; the CPA determines whether it is a local firm. The empirical results show that the number of regional accounting firms is significantly and positively related to audit fees. The greater the number of firms in the region, the higher the audit fees the company will pay. Moreover, this phenomenon is more prominent in the companies who employ local audits. Further research found that the increase in audit fees in the region is a significant manifestation of the improvement in audit quality.

The Effect of Regulation and Financial Distress on Banks' Auditor Fees

The purpose of this article is to provide a comparison of the impact on audit pricing of the Sarbanes–Oxley Act of 2002 to that of the 2008 financial collapse and the resulting Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010. While prior studies have documented increased audit costs due to SOX, they have not found such increases related to the other two events. We extend this research into the subsequent two events by focusing on audit pricing in the banking industry since that industry was most directly impacted by the financial crisis and Dodd–Frank. In contrast to the prior literature based on industrial firms, we find banks experienced significant increases in audit fees related to Dodd–Frank that were unexplained by traditional control variables. Finally, we find mixed evidence of economies of scale in dealing with the costs of implementing the legislation. While only smaller banks had a significant increase in audit fees as a percentage of total assets for Dodd–Frank, larger banks experienced significantly higher audit costs due to SOX. © 2019 Wiley Periodicals, Inc.

Do Auditors Price Breach Risk in Their Audit Fees?

ABSTRACTData security breaches have been shown in the literature to negatively affect firm operations. Auditors serve as an important, external governance mechanism with respect to a firm's overall risk management protocol. Consequently, our study examines whether auditors price breach risk into their fees and if a firm's internal governance can mitigate the potential increases in audit fees. Using a sample of breached firms ranging from 2005–2014, we adapt the Houston, Peters, and Pratt (2005) model to explore how auditors view audit risk related to breach risk. We find that breaches are associated with an increase in fees, but the result is driven by external breaches. Our evidence suggests the presence of board-level risk committees and more active audit committees may help mitigate the breach risk audit fee premium. Additional evidence suggests that both past breach disclosures as well as future disclosures are associated with audit fees.

FAIR VALUE OF NON-CURRENT ASSETS AND THE SECOND LARGEST OWNERSHIP ON AUDIT FEE

The use of fair value method has positive and negative impact. The positive impact of applying the fair value method is more relevant for the decision maker and shows the economic value according to the circumstances at that time. While its negative impact, can lead to manipulation and uncertainty. It takes greater effort for the auditor to assess fairness of fair non-current asset quality, resulting in increased audit fees. This study aims to determine the effect of fair value of non-current asset on the determination of audit fees and to know the multiple large shareholder moderation in the relationship between fair value of non-current asset and audit fee. Using the OLS regression, this study uses companies listed on the IDX from 2013 to 2015 with the exception of the financial sector. The result of this research indicates that fair value of non-current asset influences audit fee and this research shows that the second largest ownership can weaken the effect of fair value of non-current asset toward audit fees.

The Market Reaction to the Adoption of IFRS in the European Insurance Industry

This study examines the market reaction of the European insurance industry to the adoption of International Financial Reporting Standards (IFRS) in Europe. Using an event study methodology, we find that investors in the insurance industry reacted favourably to most of the events that led to the adoption of IFRS. However, the positive reaction is not consistent across all events, which may reveal some investor concern as to whether the benefits of IFRS adoption (i.e. comparability and transparency) exceed the costs (i.e. increase audit fees and/or managerial discretion). We also find that investors’ reaction to IFRS adoption differs between life and non-life insurers. Specifically, our multivariate results show that investors in the non-life insurance industry react more favourably to IFRS adoption, which indicates that they anticipate the benefits of IFRS will exceed the costs.

The impact of client information technology capability on audit pricing

This paper explores the question: “How does a client's information technology (IT) capability influence audit pricing?” Company data for the years 2004 through 2012 are employed. Firms appearing on the InformationWeek 500 (IW500) annual list of U.S. organizations with superior IT functions serve as a proxy for companies with superior IT capability. Our findings suggest that companies with superior IT capabilities incur higher levels of audit fees. In addition, as client size increases, the audit fees of firms with advanced IT capabilities increase at a greater rate than firms without such capabilities. These findings contrast with prior research by Chen et al. (2014) that found in the immediate post-Sarbanes-Oxley Act (SOX) period for the years 2004 through 2007, client IT capability reduced audit fee increases. In addition, we replicate the Chen et al. (2014) results and find that IT capability did not influence audit fee increases during the subsequent recession and recovery periods. Further, superior capability clients see smaller audit fee increases when exogenous shocks such as SOX regulations occur. These results suggest a revised interpretation of Chen et al. (2014) may be warranted. This study contributes to the literature by providing a more complete picture of how a client's IT capability affects audit fees.

Effects of CEO Turnover and Board Composition Reform on Improvements in the Internal Control Quality

Several serious accounting scandals have occurred in Japan in recent years (e.g., Olympus); however, the government, regulators, and auditing standard setters have struggled to identify new directions for corporate governance in listed companies, such as standard setting to address risks of fraud in an audit or the adoption of new corporate governance codes. The validity and effectiveness of monitoring by outside directors have received criticism within such a context. Nevertheless, in 2015, accounting fraud at Toshiba was discovered, which surprisingly involved upper management; the outside directors had failed to detect and prevent this fraud. Again, the monitoring function of the Japanese board of directors and outside directors was viewed with suspicion. Thus, this study examines Japanese corporations that disclose significant deficiencies (SDs) in internal controls over financial reporting (ICFR) and determines whether replacing the chief executive officer (CEO) and enhancing board members’ independence and financial expertise are followed by SD remediation. The results indicate that Japanese companies that disclose SDs in ICFR are more likely to replace their CEOs and enhance board independence. In addition, this study finds that although these actions do not affect SD remediation, upgrading the board’s accounting expertise does correlate positively with SD remediation. Moreover, if a company remediates a SD by increasing the number of accounting experts on the board, an increase in audit fees during the following term can be mitigated. These findings should be of interest to Japan’s regulators, auditing standard setters, and financial statement users when considering improvements in the quality of internal controls. In particular, these individuals must realize that the control environment is not improved in Japanese firms merely by replacing the CEO and increasing board independence, particularly because new CEOs encounter difficulties in changing the environment established by their predecessors.

Overcapacity and Auditing Governance: An Empirical Study Based on Risk Premium of Audit Fees

Since 1990s, due to the unique fiscal decentralization system, official promotion system, local government intervention and other institutional factors, China’s problem of overcapacity has become more and more serious. In 2008 after the global financial crisis, because of government relax control over industry capacity and the subsequent four trillion RMB economic stimulus plan, the serious overcapacity occurred in some industries. Coupled with the slowdown of economic demand, overcapacity problem becomes a more and more prominent contradiction in China’s economy. Resolving overcapacity is an important task of the supply-side reform under the new normal economy, and also a difficult problem to be solved to realize the sustained and healthy development of China’s economy. In order to resolve overcapacity, the central government has begun to introduce a series of administrative measures to regulate and guide local governments to cut capacity. Since 2009, the Ministry of Industry and Information Technology has issued the index of elimination of backward and excess capacity in every province, and has announced the completion of annual capacity indicators of different provinces. In this context, based on the administrative provisions from the Ministry of Industry and Information Technology about eliminating backward and excess capacity by every provinces and using the sample of Chinese A-share listed companies from 2009 to 2015, this paper examines the impact of overcapacity on audit fees. It finds that, due to overcapacity, business, financial and policy risks are rising, and accounting firms improve the audit fees in order to reduce the audit risk, indicating that there is a risk premium of audit fees. Further analysis shows that the risk premium of audit fees of state-owned enterprises having overcapacity is higher than that of private enterprises. The higher degree of marketization enterprises have, the higher risk premium of audit fees caused by overcapacity enterprises get. And there is a lower risk premium of audit fees caused by overcapacity of companies with political connections compared with companies without political connections. Finally, by using a new overcapacity indicator to examine based on the amount of eliminated capacity by provinces constrained by the Ministry of Industry and Information Technology, conclusions remain robust. In conclusion, in the context of China’s current overcapacity and cutting capacity through government intervention, this paper shows that China’s audit market is aware of and focuses on the specific risks of enterprises caused by overcapacity, and auditors increase audit fees by increasing audit procedures and risk costs to reduce audit risks. Risk premium of audit fees caused by overcapacity is essentially passing the risk information of excess capacity of enterprises to the regulators and investors through audit market, thus making auditing play a role of external governance in resolving the problem of overcapacity. This paper reveals the economic consequences of overcapacity at the microcosmic level, and finds out empirical evidence of the governance role of audit market in solving overcapacity problem, which is of great policy significance to capacity cutting, supply-side reform and economic transformation in the new normal economy.

Assessing the Impact of the New Auditor's Report

Changes to the auditor’s report have been proposed and issued internationally to provide more relevant information to users and enhance the perceived value of financial statement audits. This study investigates the impact of audit reporting changes on audit quality and audit fees in the New Zealand context. The new and revised audit reporting standards became effective for listed company financial statement audits in New Zealand on or after 15th December 2016. Our evidence suggests they were followed by an improvement in audit quality as proxied by a reduction in absolute abnormal accruals upon the adoption of the new audit reporting requirements. There was also a significant increase in audit fees. Although the new auditor reporting requirements are associated with improvements in audit quality, such benefit does not come without cost.

Responsiveness of Auditors to the Audit Risk Standards: Unique Evidence from Big 4 Audit Firms

We examine the effect of changes in audit risk standards on the conduct of financial statement audits in a European setting. We investigate this by analysing the audit hours and audit fees for clients of Big 4 audit firms in Finland in 1996 and 2010. Our results show that audit firms became more sensitive to clients’ business risk due to the introduction of the new audit risk standards, with more audit hours allocated to owner-managed companies in 2010 than in 1996, and fewer audit hours allocated to low-risk clients in 2010 than in 1996. Also, the labour mix in the audit team changed for owner-managed companies, with a greater work load carried by junior auditors in 2010 than in 1996. Regarding the price of audit, we find an increase in audit fees for clients with high business risk, while audit fees remained at roughly the same level for low-risk clients. These findings should be of interest to the auditing profession and those involved in the development of auditing regulations.

An Analysis of the Impact of Audit Firm Rotation on Audit Fees: A South African Perspective

The study contributes to research on audit fee determinants and the impact of firm rotation on fees. Through an analysis of companies listed on the Johannesburg Stock Exchange over a ten year period, the impact of audit firm rotations on audit fees was analysed considering the first years after rotation, the size of the audit firms involved and the existence of accounting restatements. The findings identify a strong link between client restatements and an increase in audit fees. Restatements issued after a rotation did have an impact on audit fees, suggesting that an increase in audit fees is likely when the newly appointed auditor requires restatement. Evidence was also found of fee discounting, which is more pronounced in smaller audit firms and which is attributed to increased levels of competition. Unexpectedly, it fails to detect solid evidence of a fee increase in the second year of a new auditor-client relationship.

An analysis of the impact of audit firm rotation on audit fees: a South African perspective

The study contributes to research on audit fee determinants and the impact of firm rotation on fees. Through an analysis of companies listed on the Johannesburg Stock Exchange over a ten year period, the impact of audit firm rotations on audit fees was analysed considering the first years after rotation, the size of the audit firms involved and the existence of accounting restatements. The findings identify a strong link between client restatements and an increase in audit fees. Restatements issued after a rotation did have an impact on audit fees, suggesting that an increase in audit fees is likely when the newly appointed auditor requires restatement. Evidence was also found of fee discounting, which is more pronounced in smaller audit firms and which is attributed to increased levels of competition. Unexpectedly, it fails to detect solid evidence of a fee increase in the second year of a new auditor-client relationship.

On the Economics of Audit Partner Tenure and Rotation: Evidence from PCAOB Data

This paper provides the first partner tenure and rotation analysis for a large cross-section of U.S. publicly listed firms over an extended period. We analyze the effects on audit quality as well as economic tradeoffs related to partner tenure and rotation with respect to audit hours and fees. On average, we find no evidence for audit quality declines over the tenure cycle and little support for fresh-look benefits after rotations. Nevertheless, partner rotations have significant economic consequences. We find increases in audit fees and decreases in audit hours over the tenure cycle, which differ by partner experience, client size, and competitiveness of the local audit market. More generally, our findings are consistent with efforts by the audit firms to minimize disruptions and audit failures around mandatory rotations. We also analyze special circumstances, such as audit firm switches and early partner rotations, and show that they are more disruptive than mandatory rotations, and also more likely to exhibit audit quality effects.

Interpretive Guidance and Financial Reporting Costs: Evidence from Audit Fees

We examine the effect of interpretive accounting guidance on a direct and observable cost of financial reporting: audit fees. Many contend that U.S. GAAP has too much interpretive guidance, making it complex and difficult to assimilate. This effect would lead to higher audit effort and higher fees. However, specific guidance could both lower litigation risk and increase audit efficiency by reducing the need for auditors to continually deliberate complicated accounting issues across engagements. These effects would lead to lower audit fees. Overall, using both levels and changes regressions, we find that interpretive accounting guidance is associated with higher audit fees. However, this effect is smallest for firms facing the highest ex-ante litigation risk. Finally, we examine whether increased audit fees persist and find that the audit fee effect disappears by the third year after the interpretive guidance becomes effective. Overall, we find no evidence that interpretive guidance decreases audit costs.

Short Sales Mechanism, Litigation Risk and Audit Fees

This paper examines how the short sales mechanism affects firms' audit fees through the changes in litigation risk, based on the natural experiment of securities margin trading in China. It comes to the conclusions that the introduction of short sales mechanism reinforces the pressure of the fall in stock prices and strengthens the incentive of investors to search bad news of companies, leading to the increase in audit litigation risk of companies and higher audit fees required by accounting firms. Further analysis suggests that the short sales mechanism plays a more obvious role in the increase in audit fees of state-owned enterprises, owing to poor information disclosure environment in state-owned enterprises; due to stronger compensation capacities of Big Four, the short sales mechanism significantly results in the rise in audit fees of Big Four; as for enterprises located in areas with poorer legal environment, because the management has the motivations to hide bad news, their audit fees significantly increase because of the existence of the short sales mechanism.

The Costs and Benefits of Public Oversight Design: Evidence from the EU

We examine the audit pricing and audit quality consequences of three public oversight design features: a) membership; b) powers; and c) the content of inspection reports. We hand-collect a new dataset covering 24 EU countries and we document significant variation in the design of public oversight systems across the EU. Further, using a large sample of listed firms during 2005-2013 we report a significant increase in audit fees when auditor oversight is performed only by non-practitioners, who are potentially more independent and objective, or by regulators with higher enforcement power, who are potentially more efficient. However, based on methodologies used in extant archival studies we do not provide any evidence suggesting that audit quality varies across alternative public oversight systems. Overall, our study provides evidence regarding the effect of different public oversight designs on audit fees and audit quality, including the long-standing debate about the merits of monitoring by experienced practitioners vs. monitoring by independent non-practitioners.