Abstract

This study examines the relation between excess audit fees and the cost of capital. I further examine the effects of audit quality attributes related to the auditor and the auditor－client relationship on the cost of capital. I focus on two auditor characteristics；auditor size and auditor industry specialization and three auditor－client relationship characteristics；excess audit fees,auditor tenure and the auditor's opinion. I use the client firm's weighted average cost of capital as a proxy for the cost of capital, I also measure excess auditor remuneration as the residuals from audit fees determinants's model. The auditor provides reasonable assurance that the financial statements are free from material misstatement. External auditing dilutes the adverse effects of the separation of ownership and control (Jensen and Meckling 1976) by reducing the information asymmetry between users of financial statements (e.g. investors and creditors) and its preparers. Thus, auditing is a means of reducing information risk for users of financial statements. This risk reduction should be matched by a reduction in cost of capital for the firm (Leuz and Verrecchia 2005). Prior research that suggests excess audit fees is associated with lower quality audits (Hope et al. 2009), I predict that use of excess audit fees (this is, positive abnormal audit fees) is associated with a higher cost of capital for the audit client. Prior studies also document that firms that use a Big 4 and industry specialist auditors have a lower cost of capital (both cost of equity and cost of debt) than those other auditors (Khurana and Raman 2004；Fernando et al. 2005；Abmed et al. 2008), and prior evidence suggests that auditor tenure and the auditor's opinion characteristics are negatively related to the cost of equity (Fernando et al. 2005). This study generates two sets of results. First, excess audit fees, auditor size, industry specialization, tenure, and type of auditor opinion are important determinants of perceived audit quality. The first characteristics are positively related to the cost of capital, and also the third characteristics are positively related to the cost of capital. However the second, the fourth, and the fifth characteristics are not significantly associated with cost of capital. These results are robust to including an extensive set of control variables. Second, these results indicate that with the assurance from lower quality auditing are perceived to have higher risk of these earnings generating lower future cash flows, which higher the cost of capital. Overall, this study results as supporting the view that auditor quality impacts on the cost of capital both directly and indirectly.

Keywords

• cost of capital
• weighted average cost of capital
• audit quality
• audit fees
• abnormal audit fees
• excess audit fees
• auditor size
• industry specialist auditor
• auditor tenure
• audit opinion24)

Related Articles

• A Reexamination of Abnormal Audit Fees or Audit Hours and Audit Quality29) －New Data and New Evidence－

  Jong-Il Park

  19(5) 9-53

  Abstract Full Text for PDF

• Earnings Management to Avoid Losses and Earnings Decreases and the Auditor’s Response －Some Empirical Evidence on the Private Firms－

  Jong-Il Park

  15(6) 9-53

  Abstract Full Text for PDF

• The Effect of Market Competition and Auditor Characteristics on the Association between Review Opinion of ICFR and Earnings Quality －in the KOSDAQ Market－

  Woo Jae Lee

  15(6) 207-236

  Abstract Full Text for PDF

• The Effect of Consolidated Financial Statements Principal Auditors’ Characterist ic on Real Earings Management

  Sook Min Kim

  15(4) 9-45

  Abstract Full Text for PDF

• Abnormal Audit Fees and Earnings Management －Focused on Privately Held Firms－

  Jong-Il Park

  14(3) 73-121

  Abstract Full Text for PDF