Do Auditors Care About Clients’ Compliance with Environmental Regulations? Evidence from Environmental Risk and Audit Fees

• In Event: Audit Risk

Abstract

This study examines whether auditors charge higher audit fees when auditing clients with significant environmental compliance issues. We argue that compliance with environmental regulations increases audit risk and audit task complexity. We hypothesize that auditors will exercise more effort to reduce audit risk if their clients have environmental compliance risk. We characterise corporate environmental risk using actual corporate environmental compliance data and we use audit fees to proxy for audit effort. Using a longitudinal sample from 2000 to 2012, we find that audit fees are higher for clients with environmental compliance risk. Further analysis indicates that the complexity in corporate environmental regulations has a more direct impact on audit effort than the magnitude of individual environmental risk factors. Our findings provide direct evidence that auditors appear to exercise more effort when auditing clients with environmental compliance issues, despite the fact that the requirements of auditing standards in this area are limited and quite vague.

Authors

• Yue Li, University of Toronto

• Dan A Simunic, University of British Columbia

• Minlei Ye, University of Toronto