CEO Tenure and Audit Pricing

• In Event: Research Papers Dialogue Session—FARS and Auditing

Abstract

While prior studies examine the relation between various managerial characteristics and earnings quality, there is relatively few empirical evidence on whether managerial characteristics are informative to auditor’s pricing decisions. We examine the relationship between CEO tenure and audit fees. After controlling for client firm-level attributes in the analyses, we find that audit fees are higher in the initial three years of CEOs’ service, suggesting that CEOs in their early career is likely to show risk-taking behavior that increases the probability of financial misreporting and auditors incorporate this risk in their audit pricing decisions. We also find that audit fees are higher in the final year of CEOs’ service, supporting the argument for the departing CEOs’ horizon problem that CEOs in their final year before leaving firms are more likely to manage earnings, and auditors consider this action as an enhanced risk factor in their audit pricing decisions. The results hold for a battery of supplemental tests that include the effect of several CEO characteristics, CEOs’ equity incentives and the effect of SOX. Our findings extend CEO characteristics and audit fee literature and have implications for auditors in their client acceptance and audit pricing decisions and for regulators to identify the filers with higher financial reporting and audit engagement risk.

Authors

• Santanu Mitra, Wayne State University

• HakJoon Song, University of Akron