Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

2006 ◽  
Vol 25 (1) ◽  
pp. 85-98 ◽  
Author(s):  
Lawrence J. Abbott ◽  
Susan Parker ◽  
Gary F. Peters
Keyword(s):  
Earnings Management ◽  
High Growth ◽  
Audit Fees ◽  
Discretionary Accruals ◽  
Litigation Risk ◽  
Audit Fee ◽  
Growth Firms ◽  
Price Earnings Ratio ◽  
Year 2000 ◽  
Conservative Bias

This study examines the association between audit fees and earnings management, using publicly available fee data. We hypothesize that, due to asymmetric litigation effects, audit fees decrease (increase) with a client's risk of income-decreasing (increasing) earnings management risk. We also hypothesize that the positive relation between income-increasing earnings management risk and audit fees is heightened for clients that are high-growth firms. We test our hypotheses with a sample of 429 public, non-regulated, Big 5 audited companies, using fee data for the year 2000. We find that downward earnings management risk, as estimated by negative (i.e., income-decreasing) discretionary accruals, is associated with lower audit fees. We also document that upward earnings management risk, as estimated by positive discretionary accruals, is associated with higher audit fees and that the interaction of this risk with an industry-adjusted price-earnings ratio has an incrementally significant, positive effect on fees. We interpret our findings as consistent with a conservative bias on the part of auditors. The conservative bias arises from asymmetric litigation risk in which income-increasing discretionary accruals exhibit greater expected litigation costs than income-decreasing discretionary accruals (Simunic and Stein 1996; Palmrose and Scholz 2004; Palmrose et al. 2004; Richardson et al. 2002; Heninger 2001).

CEO Domination, Growth Opportunities, and their Impact on Audit Fees

2001 ◽  
Vol 16 (3) ◽  
pp. 189-208 ◽  
Author(s):  
Judy S. L. Tsui ◽  
Bikki Jaggi ◽  
Ferdinand A. Gul
Keyword(s):  
High Growth ◽  
Chief Executive ◽  
Audit Fees ◽  
Negative Association ◽  
Corporate Boards ◽  
Growth Opportunities ◽  
Audit Fee ◽  
Monitoring Mechanism ◽  
Growth Firms ◽  
The Relationship

This study examines the relationship between a firm's internal monitoring mechanism and its impact on the audit fee. The first hypothesis investigates whether firms with independent corporate boards (chief executive officer and chairman being separate individuals) provide a more effective internal monitoring mechanism and are thus associated with lower control risk, resulting in lower audit effort and fees as compared to nonindependent, CEO-dominated boards. The second hypothesis examines whether the effectiveness of the internal monitoring mechanism provided by independent corporate boards is independent of the firms' growth opportunities. High-growth firms are by nature more difficult to monitor due to the existence of discretionary investments and measurement problems associated with future assets. Thus, the negative association between independent corporate boards and audit fees is expected to be affected by a firm's growth. Results using 650 observations from Hong Kong companies provide support for both hypotheses.

Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence

2014 ◽  
Vol 90 (4) ◽  
pp. 1517-1546 ◽  
Author(s):  
Hua-Wei Huang ◽  
K Raghunandan ◽  
Ting-Chiao Huang ◽  
Jeng-Ren Chiou
Keyword(s):  
Earnings Management ◽  
Audit Quality ◽  
Audit Fees ◽  
Audit Firm ◽  
Audit Fee ◽  
Significant Attention

ABSTRACT Issues related to low-balling of initial year audit fees and the resultant impact on audit quality have received significant attention from regulators in many countries. Using 9,684 observations from China during the years 2002–2011, we find that there is a significant initial year audit fee discount following an audit firm change when both of the signing audit partners are different from the prior year. The evidence is mixed if one or both of the signing partners from the prior year also moves with the client to the new audit firm. We find evidence of audit fee discounting in our analysis of fee levels, but not in our analysis of changes in audit fees from the prior year. Sanctions for problem audits and greater earnings management are more likely when there is an audit firm change that involves two new signing partners together with initial year audit fee discounting.

Explaining the Growth Potential of a Market Leader and Challenger: Evidence from Japan’s Telecommunications Services Industry

2021 ◽  
pp. 227853372198952
Author(s):  
Mostafa Saidur Rahim Khan ◽  
Naheed Rabbani
Keyword(s):  
High Growth ◽  
Growth Potential ◽  
Book Value ◽  
Good Investment ◽  
Growth Firms ◽  
Price Earnings Ratio ◽  
Equity Ratio ◽  
Market Leader ◽  
Services Industry ◽  
Telecommunications Services

This study examines the growth potential of the market leader and market challenger in Japan’s telecommunications services industry. We focus on Nippon Telegraph and Telephone Corporation (NTT) and KDDI, the market leader and challenger (respectively) in terms of sales revenue, total assets, and market share. Following finance literatures, we use higher values of price–earnings ratio (P/E) and market-to-book-value-of-equity ratio (MV/BV) as the indicators of growth potential. High growth firms have the potential to outperform the overall market over a significant period of time providing a good investment opportunity for retail and institutional investors. This study uses financial data of the NTT and KDDI from the period between 2001 and 2016 and applies several regression models to examine the growth potential of the market leader and market challenger in Japan’s telecommunications services industry. Using the P/E and MV/BV as indicators of growth potential, we show that the market challenger’s growth potential is significantly higher than that of the market leader, even after controlling for firm size, liquidity, profitability, leverage, cash flow, and age.

scholarly journals Do Abnormally High Audit Fees Impair Audit Quality?

2010 ◽  
Vol 29 (2) ◽  
pp. 115-140 ◽  
Author(s):  
Jong-Hag Choi ◽  
Jeong-Bon Kim ◽  
Yoonseok Zang
Keyword(s):  
Financial Reporting ◽  
Normal Level ◽  
Audit Quality ◽  
Audit Fees ◽  
Discretionary Accruals ◽  
Negatively Associated ◽  
Audit Fee ◽  
The Difference

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.

Small Audit Firm Membership in Associations, Networks, and Alliances: Implications for Audit Quality and Audit Fees

2015 ◽  
Vol 91 (3) ◽  
pp. 767-792 ◽  
Author(s):  
Kenneth L. Bills ◽  
Lauren M. Cunningham ◽  
Linda A. Myers
Keyword(s):  
Audit Quality ◽  
Matched Control ◽  
Audit Fees ◽  
Discretionary Accruals ◽  
Audit Firm ◽  
Association Member ◽  
Big 4 ◽  
Audit Firms ◽  
Audit Fee ◽  
Control Samples

ABSTRACT In this study, we examine the benefits of membership in an accounting firm association, network, or alliance (collectively referred to as “an association”). Associations provide member accounting firms with numerous benefits, including access to the expertise of professionals from other independent member firms, joint conferences and technical trainings, assistance in dealing with staffing and geographic limitations, and the ability to use the association name in marketing materials. We expect these benefits to result in higher-quality audits and higher audit fees (or audit fee premiums). Using hand-collected data on association membership, we find that association member firms conduct higher-quality audits than nonmember firms, where audit quality is proxied for by fewer Public Company Accounting Oversight Board (PCAOB) inspection deficiencies and fewer financial statement misstatements, as well as less extreme absolute discretionary accruals and lower positive discretionary accruals. We also find that audit fees are higher for clients of member firms than for clients of nonmember firms, suggesting that clients are willing to pay an audit fee premium to engage association member audit firms. Finally, we find that member firm audits are of similar quality to a size-matched sample of Big 4 audits, but member firm clients pay lower fee premiums than do Big 4 clients. Our inferences are robust to the use of company size-matched control samples, audit firm size-matched control samples, propensity score matching, two-stage least squares regression, and to analyses that consider changes in association membership. Our findings should be of interest to regulators because they suggest that association membership assists small audit firms in overcoming barriers to auditing larger audit clients. In addition, our findings should be informative to audit committees when making auditor selection decisions, and to investors and accounting researchers interested in the relation between audit firm type and audit quality.

The Relation between Auditors' Fees for Nonaudit Services and Earnings Management

2002 ◽  
Vol 77 (s-1) ◽  
pp. 71-105 ◽  
Author(s):  
Richard M. Frankel ◽  
Marilyn F. Johnson ◽  
Karen K. Nelson
Keyword(s):  
Earnings Management ◽  
Audit Fees ◽  
Discretionary Accruals ◽  
Negative Association ◽  
Present Evidence ◽  
Negatively Associated ◽  
Management Indicators ◽  
Earnings Surprises ◽  
Using Data ◽  
Auditor Fees

This paper examines whether auditor fees are associated with earnings management and the market reaction to the disclosure of auditor fees. Using data collected from proxy statements, we present evidence that nonaudit fees are positively associated with small earnings surprises and the magnitude of discretionary accruals, while audit fees are negatively associated with these earnings management indicators. We also find evidence of a negative association between nonaudit fees and share values on the date the fees were disclosed, although the effect is small in economic terms.

Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

2004 ◽  
Author(s):  
Gary F. Peters ◽  
Susan Parker ◽  
Lawrence J. Abbott
Keyword(s):  
Earnings Management ◽  
Litigation Risk ◽  
Audit Fee

The contextual nature of the association between managerial ability and audit fees

2017 ◽  
Vol 16 (1) ◽  
pp. 2-20 ◽  
Author(s):  
Yutao Li ◽  
Yan Luo
Keyword(s):  
Linear Relationship ◽  
Contextual Factors ◽  
Audit Fees ◽  
Soft Information ◽  
Litigation Risk ◽  
Managerial Ability ◽  
Content Type ◽  
Pricing Decisions ◽  
Audit Fee ◽  
Non Linear

Purpose This study examines whether auditors’ pricing decisions on managerial ability are affected by auditor litigation risk (financial distress or financial crisis), auditor’s familiarity with their client or regulatory changes in the post-Sarbanes–Oxley Act of 2002 (SOX) era. Design/methodology/approach Building on the extant audit fee literature, this study constructs an audit fee determinants model to examine how context affects auditors’ pricing of managerial ability. Findings Auditors offer a larger fee discount to more able client management teams when auditors face lower litigation risks or are more familiar with the client. Furthermore, managerial ability has a more pronounced effect on audit fees in the post-SOX era when managers are mandated to play more active roles in financial reporting (i.e. certification of financial statements required by SOX 302). Research limitations/implications Based on the audit risk model (Simunic, 1980), Krishnan and Wang (2015) show that the managerial ability of an audit client is relevant and important to auditors’ pricing decisions. This study demonstrates that managerial ability exhibits a non-linear relationship with audit fees and contextual factors, such as litigation risk, and that auditors’ familiarity with managers can alter the negative association between audit fees and managerial ability. This study extends Krishnan and Wang’s study by offering additional insights into auditors’ use of soft information such as managerial ability. Furthermore, the findings add to the literature on the impact of SOX on audit fees by suggesting that SOX has not only increased overall audit fees (Ghosh and Pawlewicz, 2009; Huang et al., 2009), it has also increased auditors’ price sensitivity to soft information (e.g. managerial ability). Practical implications This study provides insights for audit firms and client companies who are interested in understanding audit fee-pricing decisions. The findings also suggest that auditors need to be sensitive and responsive to various contextual factors when making pricing decisions. Originality/value Previous studies have not addressed the non-linear relationship between audit fees and soft information about managerial ability.

Litigation Risk, Audit Quality, and Audit Fees: Evidence from Initial Public Offerings

2008 ◽  
Vol 83 (5) ◽  
pp. 1315-1345 ◽  
Author(s):  
Ramgopal Venkataraman ◽  
Joseph P. Weber ◽  
Michael Willenborg
Keyword(s):  
Earnings Management ◽  
Initial Public Offerings ◽  
Audit Quality ◽  
Audit Fees ◽  
Legal Liability ◽  
Litigation Risk ◽  
Substantial Portion ◽  
Public Offerings ◽  
Offering Price ◽  
Robust Evidence

ABSTRACT: We use the IPO setting to examine the relation between auditor exposure to legal liability and audit quality and audit fees. With regard to audit quality, we report robust evidence that pre-IPO audited accruals are negative and less than post-IPO audited accruals. In contrast to extant literature, our findings provide scant support for the inference that auditors acquiesce to opportunistic earnings management by issuers in an attempt to increase the offering price. With regard to audit fees, we find auditors earn higher fees for IPO engagements than post-IPO engagements. While inherent differences in auditor responsibilities between IPO audits and post-IPO audits should lead to higher fees for IPOs, a substantial portion of IPO audit fees (in levels and changes) is associated with our proxy for the auditor’s 1933 Act exposure. Overall, our results suggest that both audit quality and audit fees are higher in a higher-litigation regime, consistent with the effects an increase in litigation exposure should have on auditor incentives.

Sign in / Sign up

Export Citation Format

Share Document