Executive Equity Risk-Taking Incentives and Audit Pricing

Abstract

Using a large sample of U.S. firms spanning the period 2000–2010, we document a strong positive association between the sensitivity of CEO compensation portfolio to stock return volatility (vega) and audit fees. We also show that the positive association between vega and audit fees is weaker in the post-Sarbanes-Oxley Act (SOX) period. In supplementary tests, we show that the relation between vega and audit fees is stronger for firms with older CEOs and in firms where the CEO is also chairman of the board. Collectively, our results suggest that audit firms incorporate executive risk-taking incentives in the fees they charge for their services. JEL Classifications: M41; M42; M52.

Internal Control Opinion Shopping and Audit Market Competition

“…Specifically, SHOP(normal) is negative and significant for clients of all incumbent Big 4 auditors across all three competition proxies when competition is high, and is not significant 13 We use this method because interpreting the results is more intuitive than interpreting an interaction term, and the estimation of separate models for two groups is a common method used in cross-sectional tests [e.g., Jayaraman and Milbourn (2015), Chen, Gul, Veeraghavan, and Zolotoy (2015), Kirk, Reppenhagen, and Tucker (2014), Beck and Mauldin (2014)]. when competition is low.…”

Internal Control Opinion Shopping and Audit Market Competition

“…Specifically, SHOP(normal) is negative and significant for clients of all incumbent Big 4 auditors across all three competition proxies when competition is high, and is not significant 13 We use this method because interpreting the results is more intuitive than interpreting an interaction term, and the estimation of separate models for two groups is a common method used in cross-sectional tests [e.g., Jayaraman and Milbourn (2015), Chen, Gul, Veeraghavan, and Zolotoy (2015), Kirk, Reppenhagen, and Tucker (2014), Beck and Mauldin (2014)]. when competition is low.…”

CEO power and audit fees: Evidence from Malaysia

“…Since this study argues that firms with longer tenured CEOs are more likely to experience low variability in reported earnings and less risk of earnings management, auditors are likely to assign a lower risk of material misstatement. Moreover, due to the CEOs' extensive service, auditors can gain a detailed understanding of the firm's business operations, risk, and reporting structure during audit interviews (Chen et al, ). From the supply perspective, less time is required to complete audit work due to lower audit risk, and thus, lower audit fees.…”

“…In view of this, auditors increase their risk assessment and audit efforts to mitigate the risk of material misstatement and fraudulent reporting. Correspondingly, audit fees will be higher in firms with powerful CEOs (Chen et al, ). On the basis of the incentive (entrenchment) effect hypothesis, powerful CEOs are predicted to have lower (higher) audit fees.…”

“…Audit effort will determine the auditors' costs of gathering and validating financial information, leading to the issuance of an audit opinion (Ho & Kang, 2013). Besides ensuring that financial statements are prepared in accordance with accepted accounting standards, auditors also consider the CEO's power (Chen, Gul, Veeraraghavan, & Zolotoy, 2015).…”