Do Auditors Price Audit Committee's Expertise? The Case of Accounting versus Nonaccounting Financial Experts

Abstract

The issue of whether audit pricing reflects the effectiveness of the audit committee is of fundamental interest to auditors, managers, and others. Auditors are expected to price the effectiveness of the audit committee because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key determinant of the audit committee's effectiveness—that is, the financial expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the Securities and Exchange Commission (SEC) broadly defined experts to include accounting or nonaccounting financial experts. Does audit pricing differentiate between accounting and nonaccounting financial expertise? For a sample of Standard & Poor's (S&P) 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure. We do not find a significant relation between audit fees and accounting financial expertise for observations with weak governance structure. Overall, our evidence is consistent with the SEC's initial narrow definition to include only the accounting financial experts. The lack of a significant relationship between nonaccounting financial expertise and audit fees suggests that auditors perceive that only accounting financial expertise contributes to audit committee's effectiveness.

Indicators of audit fees and fraud classification: impact of SOX

“…On the other hand, in model (4), the financial expert variable (FINEXP) is negative and significant. This finding indicates that audit fees are lower for those companies who have a financial expert on their board, similar to the finding of Krishnan and Visvanathan (2009).…”

Examining Audit Committees in the Corporate Governance of Public Bodies

“…Board and audit committee members with corporate or financial backgrounds are associated with firms that have smaller discretionary current accruals (Xie, Davidson, and DaDalt 2003). However, Krishnan and Visvanathan (2009) find no significant relationship between non-accounting financial expertise and audit fees, suggesting that auditors perceive that only accounting financial expertise contributes to the effectiveness of the audit committee.…”

“…On the one hand, some studies have found that corporate governance is associated with lower audit fees (e.g. Griffin, Lont, and Sunb 2008;Krishnan and Visvanathan 2009). This result may be due to external auditors perceiving that better corporate governance is associated with stronger internal controls and lower risk of financial misreporting.…”

“…The influence of expertise of the committee on audit fees is analysed using the ACexpert variable, which captures the number of members of the committee with financial experience. We adopt a narrow concept of expertise following Krishnan and Visvanathan (2009) and FRC guidance. We consider experts as only those committee members reported as members, or former members, of a UK professional accountancy body or of an audit firm.…”

“…This approach is also used by Rainsbury, Malthus, and Capper (2012). Krishnan and Visvanathan (2009) conclude that auditors consider that only accounting expertise contributes to the effectiveness of audit committees. Both audit committee size and audit expertise have been coded according to the composition of the audit committee reported at the end of the financial year.…”