2020B05 - An analysis of the effect of mandatory fees disclosure on subsequent period fees and audit quality (Dr. M.L. Vandenhaute)

What?

The aim of our study is twofold. The first purpose is to investigate which effect mandatory fee disclosure has on subsequent period audit pricing. To this end, we will replicate the study by Francis and Wang (2005) which report that the disclosure of fees results in greater audit pricing precision and reduces the variance in audit fees across clients. According to the authors a reduction in information asymmetry concerning fees between auditors and clients allows overcharged clients to demand lower fees and auditors of undercharged clients to demand higher fees. Interestingly, clients seem to gain relatively more bargaining power than auditors on average.

Relatedly, the second objective of this project is to go beyond the effect of mandatory fee disclosure on audit pricing, and also focus on the effect on audit quality. To this end, we will, in a second step, partially replicate the study by Chen et al. (2019) to examine whether fee adjustments in periods subsequent to the regulatory implementation of mandatory fee disclosure affect audit quality. We infer audit quality by three widely used proxies: (i) discretionary accruals, (ii) the propensity to issue going-concern opinions, and (iii) the incidence of small profits. Using multiple measures ‘provides a more comprehensive understanding of the effect on audit quality’ (DeFond and Zhang 2014, 291).

Why?

Over the past few decades, regulators across the globe have required companies to disclose in the financial statements both audit and non-audit fees billed by the auditor. Regulators were particularly concerned that economic bonding due to the level of fees received from an audited company or the provision of non-audit services may impair auditor’s independence. 

The overall purpose of this proposed project is to obtain a better understanding of the complex consequences of mandatory fee disclosure. Regulators believe that public disclosure of audit and non-audit fees is essential in preserving auditor independence and ensuring audit quality (European Commission 2006; SEC 2000). Accordingly, during the last few decades mandatory fee disclosure was implemented in many countries, such as the United States, Australia and the EU countries. We seek to identify the actual consequences in terms of audit pricing and audit quality in the context of mandated fee disclosure. By doing so, we assess whether the regulator’s goals of ensuring high-quality audits is achieved.

Knowledge Dissemination

FAR Literature Review - The effect of mandatory fee disclosure on subsequent audit pricing and audit quality

FAR Practice Note - The effect of mandatory fee disclosure on subsequent audit pricing and audit quality