Effects of carbon emissions on audit fees

Abstract

Purpose This paper aims to examine the effect of carbon emissions on audit fees. The authors hypothesize that firms in cities with higher carbon emission levels have lower reporting transparency, higher return volatility or are subject to higher reputation risk, causing them to be charged higher audit fees for auditing services. Design/methodology/approach The authors use panel data of 25,960 firm-year observations from a sample of Chinese firms. The carbon emission data for each Chinese city are obtained from the China Emission Accounts and Datasets for Emerging Economies. This paper adopts a multiple regression model to study the impact of carbon emissions on audit fees. Findings The authors find that firms located in cities with higher carbon emission levels and firms with more carbon emissions are charged, on average, a higher audit fee. This audit fee effect of carbon risk is transmitted by lessened information transparency and elevated financial risk within these firms. This paper shows that auditors consider carbon risk in their audit fee decisions and other factors that could influence audit risk and effort. Originality/value This study draws a connection between carbon emissions and audit fees. It is especially relevant due to the increasing importance of environmental factors in the audit risk assessment. In addition, the findings suggest that a firm implementing a proactive environmental strategy benefits the economy and decreases the costs to the firm for services such as auditing.

The effect of environmental credit rating on audit fees: A quasi-natural experiment from China

“…However, Du et al (2018) found that auditors applauded environmentally friendly enterprises, thereby charging lower audit fees [ 67 ]; the relationship should be negative. A possible reason for the mixed conclusions was that previous studies focused on only the command-and-control environmental regulation [ 18 , 19 , 21 ] or the market-based incentive environmental regulation [ 20 , 24 ], which were defective and might be regarded as a good opportunity by some enterprises but treated as a significant burden by some other enterprises. Therefore, it is worthy of in-depth exploration.…”

“…Second, in terms of research interpretation, some researchers have explored the reaction of auditors to the environmental events or environmental risks; however, the existing research on how environmental regulation affects audit fees can still be broadly categorised into the ‘audit cost effect’ and the ‘risk compensation effect’ from the traditional perspective [ 20 , 24 ]. Nonetheless, related environmental channels are largely neglected.…”

“…Xin et al (2022) held a similar view on the environmental administrative penalties [ 19 ]. Tan et al (2023) explored the effect of carbon emissions and found that a firm with a higher carbon emission level would be charged a higher audit fee due to the potential carbon risk [ 20 ]. Liu et al (2021) found that auditors would charge higher audit fees due to China's new EPL, which further increased their perceived environmental risks [ 21 ].…”

“…1631: Consideration of environmental matters in the audit of financial reports suggested that the auditor should focus on the environmental matters of clients. It aims to reduce the risk of audit failure caused by environmental risk; however, only a small amount of literature has researched the reaction of external auditors to environmental events or risks [ [18] , [19] , [20] , [21] , [22] , [23] , [24] ], and some conclusions have not yet reached a consensus. Therefore, mitigating the environmental risks to reduce audit fees is worth in-depth exploration.…”