Corporate Governance and Audit Fees: Evidence of Countervailing Relations
Journal of Contemporary Accounting and Economics, Forthcoming
Posted: 15 May 2008 Last revised: 4 Sep 2008
This study suggests that audit fees, and hence audit quality, and corporate governance are jointly determined. To show this, we derive and test a framework that reflects two countervailing relations between governance and audit fees, namely, a fee increase because of exogenous changes in expected liability that require greater auditing and other mechanisms to attain better governance, and a fee reduction because auditors reduce the price of risk to reflect the benefits of better governance. The study period provides an interesting setting to test the framework because it covers the passage of the Sarbanes-Oxley legislation, which imposed a substantial cost on many companies to strengthen governance, including increased auditing and internal control spending. Yet, after controlling for such increased spending, our results also suggest that better governance reduces the cost of auditing. Our framework explains that this offset occurs because even though better governance (including auditing) is costly, it also enhances the quality of financial statements and controls, which enables auditors to decrease the price of risk and reduce fees.
Keywords: Auditing, audit fees, corporate governance, Sarbanes-Oxley
JEL Classification: C30, G34, G38, K22, L84, M49
Suggested Citation: Suggested Citation