Does Audit Committee Accounting Expertise Curtail Auditor Rent Extraction? Evidence from Two Natural Experiments

• In Event: Corporate Governance

Abstract

We investigate whether audit committee accounting expertise limits external auditors’ ability to extract rents from their clients. We posit that greater accounting expertise among audit committee members should reduce information asymmetries between the auditor and the client that arise from accounting and auditing complexities. Our tests use two natural experiments in which audit effort necessary to obtain reasonable assurance likely was reduced as a result of changes in professional standards. First, ASU 2011-08 significantly simplified how companies test goodwill for impairment purposes. We find that companies with goodwill that was not likely to be impaired paid significantly lower fees after ASU 2011-08 when they had accounting experts on their audit committees. Second, Auditing Standard No. 5 (AS5) eliminated the requirement that auditors issue an opinion on management’s assessment of internal controls and permitted the scaling of audits for smaller clients. We find that smaller companies and clients of non-Big 4 auditors paid significantly lower fees in the transition to AS5 when they had accounting experts on their audit committees. Our results in both of these settings highlight an important and previously undocumented benefit of audit committee accounting expertise – a reduction in auditors’ ability to extract rents.

Authors

• James C Hansen, Weber State University

• Ling Lisic, Virginia Tech

• Timothy Andrew Seidel, Brigham Young University

• Michael S Wilkins, University of Kansas