Dual-Class Shares and Audit Pricing: Evidence from the Canadian Markets

Abstract:     
This study investigates whether i) audit fees vary with the discrepancy, or wedge, between cash flows rights and control rights arising from the presence of dual class shares structures, and whether ii) directors' independence and institutional block holders presence moderate this association. Relying on a dual framework for audit pricing, we posit that dual class shares affect audit fees through their effect on the supply and demand for assurance services (Wang 2006). On the supply side, external auditors conduct wider (narrower) scope audits in dual (single) class firms depending on whether dual class shares increase (reduce) auditors' litigation risk. Independent directors and institutional block holders are likely to induce more intense monitoring, thus potentially leading auditors to reassess downward auditors' litigation risk. Such reassessment could lead to a reduction in audit procedures, audit costs, and audit fees. Regarding the demand for audit services, block holders in dual class firms are likely to demand narrower (wider) scope audits in dual (single) class firms in order to reduce the likelihood of detecting material misstatements in financial statements (to enhance contracting terms with external parties wary about agency costs arising from dual class shares; Wang 2006). Independent directors and institutional block holders are likely to demand wider scope audits in order to protect shareholders' interests, to safeguard their reputation, and to reduce their exposure to legal liability. Results are primarily consistent with prior findings documented by Fan and Wong (2005). Audit fees are positively associated with the wedge between cash flow rights and control rights. However, the association between audit fees and the wedge ratio is not moderated by board independence or institutional investors' presence.

Number of Pages in PDF File: 25

Keywords: Audit pricing, Audit fee, Dual class shares, Private benefits of control

JEL Classification: G32, G34, M41, M49, K22

working papers series