FAR Practice Note: The effect of mandatory fee disclosure on subsequent audit pricing and audit quality
In line with the EU Statutory Audit Directive (2006/43/EC), the Dutch legislation has required large companies to disclose audit and non-audit fees in their financial statements since 2008. The objective of this mandatory fee disclosure was to safeguard the independence of auditors and to ensure the quality of their audits. By making information about the level of fees and scope of work performed publicly available, stakeholders have a better understanding of the company-auditor relationship and, hence, are better able to assess whether auditor’s independence is impaired. However, practitioners and professional bodies have raised concerns that fee disclosure may also result in downward pressure on fees, as clients gain more bargaining power. This could potentially lead to a decrease in the quality of audit services as the auditor might no longer be able to perform sufficient and/or adequate audit procedures. Despite these concerns, there is only limited research available on the effects of mandatory fee disclosure. The limited research, moreover, mainly focuses on listed firms in Asia and the US. The effect of fee disclosure in European markets which are dominated by private firms, like the Netherlands, remains however largely unknown. As part of the FAR Replication Program, our project aims to address this research gap: by replicating existing studies that investigate the impact of mandatory fee disclosure in the context of listed companies (i.e., Francis and Wang (2005) and Chen et al. (2019)), our FAR replication project explores the actual consequences of the mandatory disclosure of fees on audit pricing and audit quality in the Dutch audit market, which is predominantly composed of private firms. Our goal is to uncover the benefits as well as the potential drawbacks of mandatory fee disclosure.
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