The Relation between Excess Audit Fees and Credit Ratings
57 Pages Posted: 1 Jul 2016 Last revised: 29 Nov 2016
Date Written: November 28, 2016
Credit rating agencies and auditors are complementary certification agents subject to a conflict of interest inherent in their compensation structure. We examine client firm credit ratings to test alternative hypotheses of abnormal audit fees. We predict and find both cross-sectional and time series variation in our results. Excess audit fees are associated with less favorable credit ratings, but only among speculative grade issuers. Among firms certified investment grade, we find evidence of economic bonding: excess fees are associated with more favorable ratings. As predicted by economic theory, economic bonding effects obtain during economic expansions when the probability of consequence is low. During economic contractions – when audit failure and ratings inflation are more likely consequential – certification agents protect their reputation value. Overall, our results suggest that excess compensation paid to one certifying agent might be useful to learn about the actions of the other.
Keywords: Audit Fees, Credit Ratings, Economic Bonding, Information Intermediary
JEL Classification: G24, G28, M42
Suggested Citation: Suggested Citation