Relevant but Delayed Information in Negotiated Audit Fees

Abstract

SUMMARY: Audit fee negotiations conclude with the signing of an engagement letter, typically the first quarter of the year under audit. Yet investors do not learn the audit fee paid until disclosed in the following year's definitive proxy statement. We conjecture that negotiated audit fees impound auditors' consequential private, client-specific knowledge about “bad news” events investors will learn eventually. We demonstrate that a proxy for the year-to-year change in the negotiated audit fee has an economically meaningful positive association with proxies for public realizations of “bad news” events that occur during the roughly 12-month period between the negotiation of the audit fee and the disclosure of the audit fee paid. Our results suggest that negotiated audit fees contain information meaningful to investors and that if disclosed proximate to the signing of the engagement letter instead of the following year, information asymmetry between managers and investors would be reduced. JEL Classifications: G19, D89, M40. Data Availability: Available from public sources identified in the text.

How do auditors view managers’ voluntary disclosure strategy? The effect of earnings guidance on audit fees

“…This may also be indicative of the fact that earnings guidance likelihood captures some other facet of auditors' business risk, such as perceived managerial aggressiveness or propensity to manage earnings in order to meet earnings targets. With respect to control variables, consistent with prior research (e.g, Whisenant et al (2003), Ashbaugh-Skaife et al (2003), Simunic (1980), and Hackenbrack et al (2010)), in annual forecasts regression, audit fees are positively associated with firm size (LOGASSET, coefficient of 0.51, significant at 0.01 level), debt level (LEVERAGE, coefficient of 0.30, significant at 0.01 level), complexity of inventory and receivables (INVREC, coefficient of 0.51, significant at 0.01 level), presence of foreign operations (FOREIGN, coefficient of 0.26, significant at 0.01 level), number of segments (SQSEGM, coefficient of 0.13, significant at 0.01 level), auditor size (BIG4, coefficient of 0.16, significant at 0.01 level), SPECIAL (coefficient of 0.12, significant at 0.01 level), presence of mergers during the year (MERGER, coefficient of 0.07, significant at 0.01 level), opinion other than pure non-qualified (QUALIFED, coefficient of 0.09, significant at 0.01 level), volatility of stock returns (STDRET, coefficient of 4.73, significant at 0.01 level), ratio of audit fees to total fees (FEERATIO, coefficient of 0.78, significant at 0.01 level), presence of material weaknesses in internal control (WEAKNESS, coefficient of 0.46, significant at 0.01 level), and firms that issue stock or debt (ISSUE, coefficient of 0.062, significant at 0.01 level). Also, audit fees are negatively correlated with firm performance, ROA, and sales growth (GR_SALES) (coefficients of À0.25, and À0.06, respectively, both significant at 0.01 level), and are lower for more mature firms (BTM, coefficient of À0.11, significant at 0.01 level).…”

“…First, we have found no empirical or anecdotal evidence that suggests that firms offer higher fees to auditors to do a more thorough audit. In fact, research documents that firms that pay higher audit fees have lower information quality (Hribar et al, 2009) and experience increases in idiosyncratic risk (Hackenbrack et al, 2010). Second, if firms with superior information quality are the ones to demand higher quality audits, we should observe these firms (firms with higher audit fees) to be associated with lower earnings forecast error and bias.…”

“…Year dummies are included but not reported. Standard errors are firm-level cluster-adjusted per Petersen (2009 year (Hackenbrack et al, 2010), auditors might not be able to observe bias in earnings forecasting behavior until after negotiating audit fees. Prior evidence in the literature suggests that reporting lags are generally short, and therefore this is not a serious concern (e.g.…”

Pro forma disclosures, audit fees, and auditor resignations

“…Then, we compute SUM_PF_GAIN (or SUM_PF_MBE) as the sum of PF_GAIN (or PF_MBE) for each year and use them as the alternative high risk pro forma measures. Untabulated results indicate that 37 See for example Whisenant et al (2003) and Hackenbrack et al (2011) for significant determinants of audit fees, and Lougee and Marquardt (2004) for factors affecting pro forma reporting. the coefficient on SUM_PF_GAIN is significantly (at the 0.0001 level) positive in our main tests of audit fees and auditor resignations; the coefficient on SUM_PF_MBE is also positive and significant (at the 0.10 level) in the basic fees model.…”

Comments of the Standards Committee of the Auditing Section of the American Accounting Association on the SEC's Concept Release No. 33-9862; 34-75344 File No. S7-13-15, Possible Revisions to Audit Committee Disclosures

“…Moreover, institutional investors are sensitive to voluntary disclosures provided by firms, and therefore would be likely to pick up any disclosure that they believe could provide information about future firm performance. For example, detailed information on how audit fees are set may be useful in predicting future crash risk (Hackenbrack, Jenkins, and Pevzner 2014), and therefore may be useful to institutional investors. However, we believe that any disclosure provided by ACs should be sufficiently clear to be interpretable and useful in making predictions.…”