The Effect of Corporate Governance on Abnormal Audit Fees and Abnormal Audit Hours
Asian Tax Journal Vol. 12 No. 1 (2011), pp. 191-227
Abstract
This study examines the association between corporate governance (board characteristics) and audit quality (abnormal audit fees and abnormal audit hours), using data gathered under the recent FSS's DART system audit fee and hours disclosure rules. Data about boards characteristics (independence, activity, and expertise) are hand－collected from a business reporting. The role of the outside directors in corporate governance is a subject of increasing regulatory interest. Board independence are inversely related to the likelihood of earnings manipulation (Dechow et al. 1996) and financial statement fraud (Beasley 1996), the absolute values of abnormal accruals (Klein 2002), and the likelihood that firms avoid an earnings decline (Vafeas 2005). From the auditor's perspective, auditors seek to minimize total cost by balancing their resource (costs of performing more audit work) and their expected future losses from legal liability. Additional audit effort decreases the probability that the auditor will suffer liability losses, and the auditor provides a quantity of audit work that minimizes total cost (Carcello et al. 2002). Therefore, boards desiring additional assurance beyond the auditor's typical, cost－minimizing level would need to demand this additional assurance from their audit firm (additional work results in differentially higher audit quality). Providing differentially higher－quality audit services would be costly for the audit firm, thus increasing the audit fees and audit hours as these costs are passed on to the client. I hypothesize that abnormal audit fees and abnormal audit hours will be positively associated with board independence, activity, and expertise. This study focus on board characteristics rather than audit committee characteristics, in particular the firms have no audit committee. The uniqueness of this paper versus other papers relating board characteristics to audit quality (abnormal audit fees and audit hours) is that while previous papers either examine whether audit committee characteristics are related to audit fees (Abbott et al. 2003；Jung 2005)or audit hours (Park 2006). This study examines a large sample of 3,583 audit fees data and 2,816audit hours data nonregulated KSE firms in the period from 2000 to 2007.I find that board independence (defined as percent of outside directors on board of directors)and expertise (defined as an board composition containing at least one member with a business administration related professor) are significantly, positively associated with abnormal audit fees and abnormal audit hours. On the contrary, activity (meeting frequency) was not associated with higher audit fees and audit hours at conventional levels. However, this finding is conditional upon the strength of the overall governance structure, i.e., in boards on the presence of audit committee is significantly different. This study findings have implications for board of independence and expertise characteristics are considering measures to enhance the effectiveness of corporation governance. The results add to the growing body of literature documenting relations between corporate governance mechanisms and various facets of the financial reporting and audit processes,as well as to understanding of the determinants of audit fees and audit hours.
Keywords
- corporate governance
- board characteristics
- independence
- activity
- expertise
- abnormal audit fees
- abnormal audit hours
- audit quality
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