Impact of Excess Auditor Remuneration on Cost of Equity Capital Around the World

Abstract:     
This study examines the relation between excess auditor remuneration and the implied required rate of return (IRR hereafter) on equity capital in global markets. We conjecture that when auditor remuneration is excessively large, investors may perceive the auditor to be economically bonded to the client, leading to a lack of independence. This perceived lack of independence increases the information risk associated with the credibility of financial statements, thereby increasing IRR. Consistent with this notion, we find that IRR is increasing in excess auditor remuneration, but only in countries with stronger investor protection. Finding evidence of a relation only in stronger investor protection countries is consistent with the more prominent role of audited financial statements for investors' decisions in these countries. In settings where investors are less likely to rely on audited financial statements and instead rely on alternative sources of information (i.e., in countries with weaker investor protection), the impact of client/auditor bonding should have less of an effect on investors' decisions.

Keywords: Auditing, auditor independence, economic bonding, cost of equity capital, international, investor protection

JEL Classification: F23, G15, G30, G38, M41, M49

Accepted Paper Series