An Examination of the Relationship between Managerial Ability and Audit Fees

• In Event: Continental Breakfast and Research & Education Forum
  In Roundtable Session: Table 13: Auditor Pricing Studies

Abstract

This research investigates the relationship between managerial operating ability and audit fees. An association between the two is expected due to management’s effect on the organization’s risk profile. If managers indeed affect client risk, audit firms may differentially price audit services based on cross-sectional variations in managerial ability. Using a broad sample of companies across an eight-year time period, initial findings show that audit fees are 16.6% higher for companies with the least able managers compared to similar companies with the most able managers. Given the sample data, this corresponds to a difference of approximately $421,000. Further analysis suggests that this inverse relationship is concentrated in Big 4 observations and is increasing in client size, but not in client complexity. Findings from a mediation analysis imply that this fee reaction is due, in part, to differences in control risk, as well as the combination of business and inherent risks. Results are robust to various alternate research specifications and provide important evidence regarding the effect of management on the pricing of audit services.

Authors

• Ryan Seay, The University of Mississippi

• W. Mark Wilder, The University of Mississippi