Do Auditors Consider Clients’ Compliance with Environmental Regulations?

Abstract

We examine whether auditors are sensitive to their clients’ compliance with environmental regulations. Under current auditing standards, auditors’ responsibilities with respect to the detection and reporting of violations of environmental regulations by their clients are limited and quite vague. However, a client’s non-compliance with environmental regulations potentially increases audit risk and audit task complexity. Thus, it is ex ante unclear whether auditors care about clients’ compliance with environmental regulations. Using a longitudinal sample from 2000 to 2012, we find that audit fees are higher for clients with environmental compliance risk. Further analysis indicates that the complexity in corporate environmental regulations has a more direct impact on audit fees than the magnitude of individual environmental risk factors. Our findings is consistent with auditors charging higher fees when auditing clients with environmental compliance issues. However, we do not find evidence that the magnitude of corporate environmental liability affects audit fees directly. This study contributes to both environmental accounting research and the auditing literature concerning the impact of environmental compliance risk on audit task complexity.

Keywords: environmental regulation; compliance; complexity; audit fees

JEL Classification: M42; M48