Managerial Stock Ownership, Internal Control Weaknesses, and Audit fees

• In Event: Auditing Research

Abstract

The study examines the relationship between managerial stock ownership and audit fees for the firms having material internal control weaknesses (ICW). We find that though audit fee and managerial stock ownership are negatively related in the low managerial ownership firms, the negative relationship is significantly attenuated for the ICW firms compared to the matched non-ICW firms. The results suggest that auditors make relatively smaller downward adjustment of audit fees in response to an increase in managerial stock ownership (leading to more alignment of manager-shareholder interest) as considerable audit risk continues to exist in absence of effective internal controls in those firms. The audit fee-ICW relationship is, however, significantly positive for the ICW firms with high managerial ownership suggesting that as ownership increases, managers of those firms are more likely to purchase higher quality audits to minimize the financial reporting risk and promote shareholder interests. The result provides support to the incentive-alignment view but no evidence in support of managerial entrenchment for the high managerial ownership firms. Additionally, our findings show that audit fee decline is relatively more gradual and slower for the ICW firms with low managerial ownership that undertake remedial action compared to the medium and high managerial ownership firms. The ICW firms continue to pay higher audit fees compared to the matched non-ICW firms in all three years after the remediation year in the low managerial ownership firms. But for the medium and high ownership firms, audit fee reduction takes place at a faster pace, and the difference in audit fees between those firms and their matched non-ICW counterparts becomes insignificant over time in the post-remediation period.

Authors

• Santanu Mitra, Wayne State University

• Bikki Jaggi, Rutgers University - Newark

• Talal Al-Hayale, University of Windsor

• Mahmud Hossain, American University of Sharjah