Audit Fee Differential, Audit Effort, and Litigation Risk: An Examination of ADR Firms

Abstract

Prior studies find that audit fees are higher for cross-listed firms, and these studies primarily attribute the incremental fees to added litigation costs. In this study, we investigate whether the higher audit fees that foreign firms cross-listed in the United States pay are also attributable to incremental audit effort associated with U.S. disclosure requirements and a more stringent U.S. auditing environment. By comparing audit fees of foreign cross-listed firms to U.S. domiciled firms and to non-cross-listed foreign firms, we are able to decompose incremental audit fees into portions attributable to added audit effort and to added litigation costs. We find that, on average, foreign firms cross-listed in the United States pay significantly higher fees than domestic U.S. firms and foreign firms that do not cross-list. Furthermore, we find that audit effort is almost as important as litigation costs in explaining the higher fees associated with foreign cross-listed firms; our estimates suggest that between 29 percent and 48 percent of the incremental fees are attributable to incremental audit effort. In addition, the total cross-listing premium is increasing in the difference between the U.S. auditing regulatory environment and that of the home country of the cross-listed firm. Our study improves our understanding of the role of audit effort in explaining the added fees charged by auditors when foreign firms cross-list in the United States.

Auditing Research: A Review of Recent Research Advances

“…Also, significantly higher audit fees are documented in the presence of high control-risk assessment (Seidel, 2017). Overall, the studies examining the dynamics of audit fees were concerned with identifying the factors and situations where such fees increase, various empirical results were documenting items of concern as: bankruptcy risk or short-selling threats (Hope et al 2017;Lennox and Kausar, 2017); firms with new CEOs (Bills et al 2017); audit effort and litigation cost in the case of foreign firms crosslisted in USA (Bronson et al 2017); litigation risk and institutional investors demands in reverse mergers (Abbott et al 2017); debt covenant violations (Jiang and Zhou, 2017). On the other hand, audit fees decrease because of competitive disadvantages, as smaller audit firms tend to charge lower audit fees (Chu et al 2018).…”

Influência do Risco de Litígio do Auditor nos Honorários de Auditoria e não Auditoria

“…Esse achado indica que a partir da identificação de um alto risco de litígio, os auditores são instigados a despender um maior esforço e tempo no trabalho de auditoria, como, por exemplo, por meio do aumento da aplicação de testes (Bronson, Ghosh & Hogan, 2017;Simunic & Stein, 1996), fato que pode levar a firma de auditoria a cobrar um prêmio pelo trabalho e risco assumido (Bronson, Ghosh & Hogan, 2017). Entretanto, não é possível identificar a quantidade de horas despendidas pelo auditor em decorrência do aumento do trabalho (DeFond & Zhang, 2014) devido a um alto risco de litígio.…”

“…Na prática, este resultado indica que a partir do momento em que o auditor percebe um alto risco de litígio da empresa auditada, este é inclinado a despender um maior esforço e tempo na aplicação de testes para realizar o trabalho de auditoria (Bronson, Ghosh & Hogan, 2017;Simunic & Stein, 1996). Sendo que esse fato pode implicar no aumento do valor cobrado de honorários de auditoria, devido ao trabalho e risco assumido pelo auditor.…”

Organization capital and audit fees around the world

“…2 2 Prior studies document that institutional factors, such as legal environment, play a vital role in determining audit fees (e.g., Choi et al, 2008; Kuo & Lee, 2016; Taylor & Simon, 1999). Studies also find that firms need to pay higher audit fees when they cross‐list in countries with stronger legal environments compared to that of their home country (Bronson, Ghosh, & Hogan, 2017; Choi et al, 2009). Kuo and Lee (2018) document that the positive relationship between potential earnings management (via capitalizing development costs) and audit fees is mitigated by stronger investor protection.…”