Is Audit Committee Equity Compensation Related to Audit Fees?

Posted: 11 Dec 2020 Last revised: 24 Mar 2021

See all articles by Xinming Liu

Xinming Liu

Xiamen University

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Hung-Chao Yu

National Chengchi University

Multiple version iconThere are 2 versions of this paper

Date Written: July 7, 2020

Abstract

Section 301 of SOX implicitly assumes that audit committees can independently determine audit fees. Critics of Section 301 have questioned this assumption, in particular, and the efficacy of Section 301, more generally. In response, the SEC issued a concept release in 2015 calling for public disclosure of the process that audit committees follow for determining auditor compensation. Motivated by these calls and the widespread use of stocks and options to compensate firms’ independent directors, we examine the relation between equity compensation granted to audit committee members and audit fees. Using a sample of 3,685 firm-year observations during 2007-2015, we find a negative relation between audit committee equity compensation and audit fees, consistent with larger equity pay inducing audit committee members to compromise independence by paying lower audit fees. These findings are robust to controlling for endogeneity, firm size, alternative measures of equity compensation, alternative samples, and an alternative treatment of extreme values. We further show that larger equity compensation is associated with lower earnings quality. We also find that the negative effect of equity compensation on audit fees is stronger when city-level audit market competition is high. However, this negative relation disappears when (1) firms face high litigation risk, (2) auditors have stronger bargaining power, (3) the audit committee includes a high proportion of accounting experts, and (4) auditors are industry experts. Our results are relevant to regulators and investors.

Keywords: Audit committee, Audit fees, Auditor independence, Equity compensation

JEL Classification: M41, G14

Suggested Citation

Liu, Xinming and Lobo, Gerald J. and Yu, Hung-Chao, Is Audit Committee Equity Compensation Related to Audit Fees? (July 7, 2020). Contemporary Accounting Research, Volume 38, Issue 1, pp. 740-769, 2021, Available at SSRN: https://ssrn.com/abstract=3729984

Xinming Liu

Xiamen University ( email )

Siming South Road
Duxing Building No.2
Xiamen, Fujian 361005
China

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Hung-Chao Yu (Contact Author)

National Chengchi University ( email )

No. 64, Sec. 2
Zhi-Nan Rd., Wenshan District
Taipei, Taipei 11605
Taiwan
+886-2-2938-7693 (Phone)
+886-2-2938-7113 (Fax)

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