Audit Pricing for Strategic Alliances: An Incomplete Contract Perspective

Abstract

We study the pricing of audit services for strategic alliances, a governance structure involving an incomplete contract between separate firms. Since incomplete contracts do not specify all future contingencies, we expect that the nonverifiability of information and potential agency behavior in alliances increase audit complexity, resulting in higher audit fees. Our findings support this prediction. We then separate strategic alliances into joint ventures and contractual alliances, as the latter involve more complexity. We find that our audit fee results are largely driven by contractual alliances. We perform additional tests to rule out the concern that our audit fee results might be attributable to the impact of strategic alliances on distress risk, audit risk, or control risk. Contrary to the distress risk argument, we find that auditors are less likely to issue going‐concern modified opinions when there is an increase in strategic alliances. Contrary to the audit risk argument, we find that an increase in strategic alliances is unrelated to the likelihood of financial misstatements. Contrary to the control risk argument, we find that an increase in strategic alliances is unrelated to internal control weakness opinions.

Social Networks Analysis in Accounting and Finance*

“…A separate line of studies examines the determinants (Habib and Mella‐Barral 2007; Ozmel et al 2013) and the consequences (Gomes‐Casseres et al 2006; Boone and Ivanov 2012; Demirkan and Zhou 2016; Ge et al 2021) of strategic alliances defined as relational contracts that blur firm boundaries (Lindsey 2008).…”

“…However, we notice that industry links can also facilitate the diffusion of non-detrimental governance practices such as liquidity management (Gao 2021) and disclosure policies (Jung 2013;Seo 2021;Cho and Muslu 2021). A separate line of studies examines the determinants (Habib and Mella-Barral 2007;Ozmel et al 2013) and the consequences (Gomes-Casseres et al 2006;Boone and Ivanov 2012;Demirkan and Zhou 2016;Ge et al 2021) of strategic alliances defined as relational contracts that blur firm boundaries (Lindsey 2008).…”

Hometown sentiment: CEO hometown identity and company audit fees

“…The worse the company's information transparency, the more difficult it is for auditors to guarantee audit quality, and they often face greater audit risk and will charge higher audit fees (Demirkan and Zhou, 2016). Compared with non-local CEO, local CEO with "hometown identity" exhibits strong regional embeddedness, which promotes network connections with related subjects, increases information transparency between each other and reduces information risk of the company they work for.…”

Determinants of audit fees: Evidence from Poland

“…Following this, the auditor needs more resources (more employees involved in the audit) which results in a audit fee increase. Researchers usually determine the company size based on the total assets (Wallace & Naser, 1996;Inchausti, 1997;Ali, Ahmed & Henry, 2004;Galani, Alexandridis, & Stavropoulos, 2011;Ali & Aulia, 2015;Demirkan & Zhou, 2016;Liu, 2017), sales volume (Inchausti, 1997;Depoers, 2000;Prencipe, 2004;Rouf, 2011) or market capitalisation (Naser, Al.-Kwari, & Nuseibeh, 2006;Chatterjee & Mir, 2008). The company size is also determined based on various combinations of data from the balance sheet of the company, such as the volume of inventories, debt, liabilities or receivables (Simunic, 1980;Taylor & Simon, 1999;Hay, Knechel, & Wong, 2006;Hassan & Naser, 2013).…”