The Impact of Takeover Threat on Audit Fees: Evidence from International M&A Laws and U.S. Antitakeover Laws

• In Event: Continental Breakfast & Research and Education Forum
  In Paper Session: Table 4: Audit Fees

Abstract

In this paper, we investigate whether and how the external governance from the takeover market affects audit fees. We exploit the staggered enactments of international M&A laws as an exogenous shock that increases the takeover threat substantially. We hypothesize and find that audit fees decrease significantly after the passage of M&A laws because the external governance strengthened by takeover laws reduces the agency risk accrued to shareholders and thereby decreases audit fees. The estimated reduction in audit fees amounts to 163 to 227 thousand U.S. dollars, equivalent to 11% to 15% of the average audit fee in our sample. We also find that the disciplinary effect of M&A laws, leading to the decrease in audit fees, is more pronounced in countries that experience larger growth in M&A activities and in countries with weaker investor protection. Moreover, we show that the inverse relation between takeover laws and audit fees is attributable to the improved firm performance (i.e., business risk channel) and the enhanced financial reporting quality (i.e., information risk channel) in the post-law-enactment period and is not significantly associated with the auditor’s litigation risk. Our results are robust to controlling for Big 4 auditors, auditor changes, and potential sample selection problems. Additional tests for the U.S. sample reveal that firms incorporated in states that passed anti-takeover laws pay significantly higher audit fees than those in states without anti-takeover laws. Moreover, the positive association between anti-takeover laws and audit fees is more pronounced in states with strong anti-takeover laws than in states with weak anti-takeover laws. Our findings contribute to the auditing literature by enhancing our understanding about auditors’ assessment of clients’ risk and auditor’s contacting decisions.

Authors

• Ahrum Choi, Hong Kong Baptist University

• Jay Junghun Lee, University of Massachusetts-Boston

• Jong Chool Park, Old Dominion University