Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

2004 ◽  
Author(s):  
Gary F. Peters ◽  
Susan Parker ◽  
Lawrence J. Abbott
Keyword(s):  
Earnings Management ◽  
Litigation Risk ◽  
Audit Fee

Earnings Management, Litigation Risk, and Asymmetric Audit Fee Responses

2006 ◽  
Vol 25 (1) ◽  
pp. 85-98 ◽  
Author(s):  
Lawrence J. Abbott ◽  
Susan Parker ◽  
Gary F. Peters
Keyword(s):  
Earnings Management ◽  
High Growth ◽  
Audit Fees ◽  
Discretionary Accruals ◽  
Litigation Risk ◽  
Audit Fee ◽  
Growth Firms ◽  
Price Earnings Ratio ◽  
Year 2000 ◽  
Conservative Bias

This study examines the association between audit fees and earnings management, using publicly available fee data. We hypothesize that, due to asymmetric litigation effects, audit fees decrease (increase) with a client's risk of income-decreasing (increasing) earnings management risk. We also hypothesize that the positive relation between income-increasing earnings management risk and audit fees is heightened for clients that are high-growth firms. We test our hypotheses with a sample of 429 public, non-regulated, Big 5 audited companies, using fee data for the year 2000. We find that downward earnings management risk, as estimated by negative (i.e., income-decreasing) discretionary accruals, is associated with lower audit fees. We also document that upward earnings management risk, as estimated by positive discretionary accruals, is associated with higher audit fees and that the interaction of this risk with an industry-adjusted price-earnings ratio has an incrementally significant, positive effect on fees. We interpret our findings as consistent with a conservative bias on the part of auditors. The conservative bias arises from asymmetric litigation risk in which income-increasing discretionary accruals exhibit greater expected litigation costs than income-decreasing discretionary accruals (Simunic and Stein 1996; Palmrose and Scholz 2004; Palmrose et al. 2004; Richardson et al. 2002; Heninger 2001).

Fee Discounting and Audit Quality Following Audit Firm and Audit Partner Changes: Chinese Evidence

2014 ◽  
Vol 90 (4) ◽  
pp. 1517-1546 ◽  
Author(s):  
Hua-Wei Huang ◽  
K Raghunandan ◽  
Ting-Chiao Huang ◽  
Jeng-Ren Chiou
Keyword(s):  
Earnings Management ◽  
Audit Quality ◽  
Audit Fees ◽  
Audit Firm ◽  
Audit Fee ◽  
Significant Attention

ABSTRACT Issues related to low-balling of initial year audit fees and the resultant impact on audit quality have received significant attention from regulators in many countries. Using 9,684 observations from China during the years 2002–2011, we find that there is a significant initial year audit fee discount following an audit firm change when both of the signing audit partners are different from the prior year. The evidence is mixed if one or both of the signing partners from the prior year also moves with the client to the new audit firm. We find evidence of audit fee discounting in our analysis of fee levels, but not in our analysis of changes in audit fees from the prior year. Sanctions for problem audits and greater earnings management are more likely when there is an audit firm change that involves two new signing partners together with initial year audit fee discounting.

The contextual nature of the association between managerial ability and audit fees

2017 ◽  
Vol 16 (1) ◽  
pp. 2-20 ◽  
Author(s):  
Yutao Li ◽  
Yan Luo
Keyword(s):  
Linear Relationship ◽  
Contextual Factors ◽  
Audit Fees ◽  
Soft Information ◽  
Litigation Risk ◽  
Managerial Ability ◽  
Content Type ◽  
Pricing Decisions ◽  
Audit Fee ◽  
Non Linear

Purpose This study examines whether auditors’ pricing decisions on managerial ability are affected by auditor litigation risk (financial distress or financial crisis), auditor’s familiarity with their client or regulatory changes in the post-Sarbanes–Oxley Act of 2002 (SOX) era. Design/methodology/approach Building on the extant audit fee literature, this study constructs an audit fee determinants model to examine how context affects auditors’ pricing of managerial ability. Findings Auditors offer a larger fee discount to more able client management teams when auditors face lower litigation risks or are more familiar with the client. Furthermore, managerial ability has a more pronounced effect on audit fees in the post-SOX era when managers are mandated to play more active roles in financial reporting (i.e. certification of financial statements required by SOX 302). Research limitations/implications Based on the audit risk model (Simunic, 1980), Krishnan and Wang (2015) show that the managerial ability of an audit client is relevant and important to auditors’ pricing decisions. This study demonstrates that managerial ability exhibits a non-linear relationship with audit fees and contextual factors, such as litigation risk, and that auditors’ familiarity with managers can alter the negative association between audit fees and managerial ability. This study extends Krishnan and Wang’s study by offering additional insights into auditors’ use of soft information such as managerial ability. Furthermore, the findings add to the literature on the impact of SOX on audit fees by suggesting that SOX has not only increased overall audit fees (Ghosh and Pawlewicz, 2009; Huang et al., 2009), it has also increased auditors’ price sensitivity to soft information (e.g. managerial ability). Practical implications This study provides insights for audit firms and client companies who are interested in understanding audit fee-pricing decisions. The findings also suggest that auditors need to be sensitive and responsive to various contextual factors when making pricing decisions. Originality/value Previous studies have not addressed the non-linear relationship between audit fees and soft information about managerial ability.

Litigation Risk, Audit Quality, and Audit Fees: Evidence from Initial Public Offerings

2008 ◽  
Vol 83 (5) ◽  
pp. 1315-1345 ◽  
Author(s):  
Ramgopal Venkataraman ◽  
Joseph P. Weber ◽  
Michael Willenborg
Keyword(s):  
Earnings Management ◽  
Initial Public Offerings ◽  
Audit Quality ◽  
Audit Fees ◽  
Legal Liability ◽  
Litigation Risk ◽  
Substantial Portion ◽  
Public Offerings ◽  
Offering Price ◽  
Robust Evidence

ABSTRACT: We use the IPO setting to examine the relation between auditor exposure to legal liability and audit quality and audit fees. With regard to audit quality, we report robust evidence that pre-IPO audited accruals are negative and less than post-IPO audited accruals. In contrast to extant literature, our findings provide scant support for the inference that auditors acquiesce to opportunistic earnings management by issuers in an attempt to increase the offering price. With regard to audit fees, we find auditors earn higher fees for IPO engagements than post-IPO engagements. While inherent differences in auditor responsibilities between IPO audits and post-IPO audits should lead to higher fees for IPOs, a substantial portion of IPO audit fees (in levels and changes) is associated with our proxy for the auditor’s 1933 Act exposure. Overall, our results suggest that both audit quality and audit fees are higher in a higher-litigation regime, consistent with the effects an increase in litigation exposure should have on auditor incentives.

Litigation Risk and Abnormal Accruals

2011 ◽  
Vol 30 (2) ◽  
pp. 231-256 ◽  
Author(s):  
Jeff P. Boone ◽  
Inder K. Khurana ◽  
K. K. Raman
Keyword(s):  
Earnings Management ◽  
Equation System ◽  
Simultaneous Equation ◽  
Litigation Risk ◽  
Securities Litigation ◽  
Simultaneous Equation System ◽  
Specific Risk ◽  
Time Period ◽  
Abnormal Accruals ◽  
Auditor Litigation

SUMMARY In this paper, we examine the relation between auditor litigation risk and abnormal accruals over the 1989–2007 time period. We address potential endogeneity in prior studies by jointly modeling abnormal accruals and litigation risk in a simultaneous equation system. Our findings suggest that client-specific litigation risk affects auditor incentives to acquiesce to client demands for earnings management, i.e., the higher the risk of auditor litigation, the greater the auditor's restraining influence on the abnormal accruals reported by the client. We also find evidence that abnormal accruals increase the likelihood of auditor litigation. We also document that the 1995 Public Securities Litigation Reform Act (PSLRA) lowered the client-specific risk of auditor litigation. Litigation reform remains a topic of ongoing interest. Our findings contribute to a better understanding of the effects of litigation reform (and related changes in legal exposure) on auditor incentives and earnings management.

scholarly journals Pengaruh Kualitas Audit dan Auditor Switching Terhadap Manajemen Laba

2020 ◽  
Vol 9 (2) ◽  
pp. 117-129
Author(s):  
Felita Icasia Hadi ◽  
Sherly Tifani
Keyword(s):  
Earnings Management ◽  
Multiple Regression ◽  
Audit Quality ◽  
Annual Report ◽  
Stock Exchange ◽  
Secondary Data ◽  
Negative Direction ◽  
Auditor Switching ◽  
Audit Fee ◽  
The Relationship

The purpose of this study is to examine the effect of audit quality and auditor switching on earnings management with the audit fee as the intervening variable. Data in this study is secondary data derived from the annual report of listed companies in Indonesia Stock Exchange in 2016-2018. There are 117 samples and the method used for sampling is purposive sampling. The hypothesis in this study was tested using multiple regression. The result of this study showed that audit quality positively influences fee audit but not significant, auditor switching negatively influence fee audit, audit quality influence earnings management with negative direction, auditor switching positively influence earnings management but not significant, fee audit negatively influence earnings management but not significant, and there is no influence of intervening variable in the relationship between audit quality and auditor switching on earnings management.

Unsystematic Association between Earnings Management and Audit Fee

2018 ◽  
Vol 36 (2) ◽  
pp. 79-108
Author(s):  
Su-Kyung An ◽  
Byung-Chul Lee
Keyword(s):  
Earnings Management ◽  
Audit Fee

Do auditors care about real earnings management in their audit fee decisions?

2016 ◽  
Vol 25 (1-2) ◽  
pp. 21-41 ◽  
Author(s):  
Ahrum Choi ◽  
Byungcherl Charlie Sohn ◽  
Desmond Yuen
Keyword(s):  
Earnings Management ◽  
Real Earnings Management ◽  
Audit Fee

scholarly journals Does Litigation Deter or Encourage Real Earnings Management?

2019 ◽  
Vol 95 (3) ◽  
pp. 251-278 ◽  
Author(s):  
Sterling Huang ◽  
Sugata Roychowdhury ◽  
Ewa Sletten
Keyword(s):  
Earnings Management ◽  
Real Earnings Management ◽  
Litigation Risk ◽  
Court Ruling ◽  
Governance Mechanisms ◽  
Difference In Differences ◽  
Exogenous Shock ◽  
Ninth Circuit ◽  
The Impact

ABSTRACT In this paper, we rely on an exogenous shock to examine the impact of litigation risk on real earnings management (REM). We conduct difference-in-differences tests centered on an unanticipated court ruling that reduced litigation risk for firms headquartered in the Ninth Circuit. REM increases significantly following the ruling for Ninth Circuit firms relative to other firms, consistent with litigation risk deterring REM. Additional analyses reveal that REM rises more following the ruling when firms issue more optimistic disclosures. The evidence is consistent with litigation deterring REM by constraining managers' ability to issue optimistic and misleading disclosures that can conceal the myopic and opportunistic motives underlying REM. We further document that an increase in REM in response to a decline in litigation risk is more pronounced when managers have higher incentives to manipulate earnings and governance mechanisms are weaker.

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