Joint Meeting of the Mid-Atlantic and Northeast Regions

Do Auditors Prioritize Pricing their Client’s Risk or Their Circumstance? Evidence from Political Risk

• In Event: Audit and Advisory Fees

Abstract

Motivated by the significant increase in global political risk in the United States and around the world, we employ Hassan et al.’s (2019) firm-level measure of political risk to investigate the relationship between political risk and audit pricing. To set the context of our analysis, we first evaluate and find a negative relationship between political risk and financial reporting quality. We then document a negative association between political risk and audit fees; however, this relation is only significant when political risk is low (i.e., below the median) or when the auditor has relatively less bargaining power than the client. We also find that auditors price the client’s sentiment related to their current political risk exposure and increase fees as clients express an increasingly positive outlook, even though increases in sentiment are not correlated with increases in financial reporting risks. These results suggest that auditors more readily incorporate client sentiment into fees than political and financial reporting risks. Overall, our results indicate that audit pricing decision is driven more by the auditor’s role as a business owner than by the client’s risk assessment, particularly when political risks are low. Our results have important implications for regulators seeking to close the audit expectation gap.

Author

• Mohamed Mekhaimer, St. John Fisher University