The Importance of Business Risk in Setting Audit Fees: Evidence from Cases of Client Misconduct

32 Pages Posted: 3 Nov 2004

See all articles by Michael W. Maher

Michael W. Maher

University of California, Davis - Graduate School of Management

John D. Lyon

The University of Melbourne, Department of Accounting and Business Information Systems

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Abstract

Previous research provides evidence that, for the clients of a large audit firm, audit clients with higher perceived business risk bear the expected costs of this risk with higher audit fees. We extend the literature, which focuses on the relation between litigation risk and audit fees, by examining alleged client misconduct that is not illegal but possibly increases business risk. In particular, we examine the relation between audit fees and business risk for audit clients doing business in developing countries where bribery of top government officials has been accepted business practice. We hypothesize that bribery-paying clients are riskier both because of client business risk and audit business risk. Using data collected from SEC filings and audit fee data in the 1970s, prior to the passage of the Foreign Corrupt Practices Act, we provide evidence that audit fees were higher for clients that disclosed paying bribes. This evidence is consistent with an audit market where auditors assess business risk at the client level, then pass its expected costs to the client in the form of higher audit fees.

Keywords: Audit fees, audit risk, economics of auditing, corporate misconduct, bribery

JEL Classification: F23, G38, K22, K42, L84, M49

Suggested Citation

Maher, Michael W. and Lyon, John D., The Importance of Business Risk in Setting Audit Fees: Evidence from Cases of Client Misconduct. Journal of Accounting Research, March 2005, Available at SSRN: https://ssrn.com/abstract=613121

Michael W. Maher (Contact Author)

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Davis, CA 95616
United States
530-752-7034 (Phone)
530-752-0723 (Fax)

John D. Lyon

The University of Melbourne, Department of Accounting and Business Information Systems ( email )

Victoria
Melbourne, 3010
Australia

HOME PAGE: http://www.abis.unimelb.edu.au/who/staff/john_lyon.html

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