Offshore Trading Activities and Audit Fees: A Textual Approach

Abstract

This paper examines whether and how auditors’ pricing decisions are affected by their clients’ offshore activities, which are comprehensively measured through a textual analysis technique. We find that offshore activities are positively associated with audit fees, suggesting that offshore activities are likely to increase client firm’s business risk and/or the extent of client complexity. This main finding is robust to using alternative measures of offshore activities and applying methods to mitigate the omitted correlated variables problem. We also find that auditors charge higher audit fees only to firms with inputs produced by its own assets overseas not to firms that buy inputs produced by local firms oversea. Moreover, the association between offshore activities and audit fees is more pronounced for offshore activities that are in countries with high trading centrality, high income, or high political stability, for Big 4 auditors, or for auditors with industry expertise. In additional analyses, we find that offshore activities are positively associated with tax fees, audit effort and audit quality. This evidence suggests that both client business risk and client complexity are the plausible channels through which offshore activities affect audit fees.

Keywords: Audit Fees, Offshore Activities, Perceived Audit Risk, Audit Effort