Audit fees and Corporate Innovation

Abstract

Purpose - Investigates the extent to which a client’s innovative effort affects the level of audit effort and whether the innovative-effort efficiency can attenuate the demand for greater audit effort associated with a client’s risky research-and-development (R&D) investments.

Design/methodology/approach - We treat R&D expenditure as an input measure and the patent obtained/cited in a given year as an output measure of a firm’s innovative effort. We estimate innovation efficiency as the number of patents granted to a firm in a given year, scaled by its R&D capital. As a proxy for audit effort, we use audit fees. Combining firm-year observations for fiscal years 2000 to 2010 from Compustat, patent data from the United States Patent and Trademark Office, and Audit Analytics provided a sample of 11,646 observations from 2,051 unique firms.

Findings - Results confirm that a client firm’s strategic emphasis on corporate innovations may require greater audit effort. However, we find evidence that the efficiency of a firm’s innovative effort can attenuate the demand for heightened audit effort against risky innovative efforts, implying that the external auditor’s role is not necessarily detrimental to corporate innovation, which suggests that the efficiency of a firm’s innovation effort lowers the client business risk perceived by an auditor related to corporate innovation.

Originality/value - Contributes to a stream of literature identifying facilitators and impediments to corporate innovation. Our findings also complement an emerging body of literature on the effect of a firm’s business strategies on the auditor’s decision. Prior studies have not considered the input‒output conversion of a firm’s R&D expenditure as something that the firm values. By using the number of patents obtained and cited as an output measure of a firm’s innovative effort, we extend understanding of the influence of a firm’s business strategies on the level of audit effort.

Keywords: Corporate Innovation, Auditors, Research and Development, Risk Management