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Managerial overconfidence, ability, firm-governance and audit fees

  • Santanu Mitra
  • Bikki Jaggi
  • Talal Al-Hayale
Original Research
  • 130 Downloads

Abstract

Prior studies document that managerial overconfidence potentially increases the risk of financial misstatements, and that overconfident managers purchase lower quality audits and pay lower audit fees. As a part of the research that evaluates the information value of managerial characteristics to auditors, our study examines how the relationship between managerial overconfidence and audit fees is impacted by managerial ability, and board and audit committee effectiveness in the post-Sarbanes–Oxley (post-SOX) environment. In general, we find a significantly positive relationship between managerial overconfidence and audit fees consistent with the supply-side risk based perspective of audit pricing. However, this relationship is significantly attenuated in higher managerial ability firms where overconfident managers are better able to make proper accounting estimates and judgements required for producing reliable financial statements, and synthesize firm-specific information into appropriate forward looking projections. We find that on an average, the overconfident firms with higher managerial ability pay 6.3% lower audit fees than the overconfident firms with lower managerial ability. Our analyses further show that board characteristics positively impact the relationship between managerial overconfidence and audit fees, suggesting that stronger board monitoring increases the demand for higher quality audits to mitigate the reporting risk of the overconfident firms. On an average, the firms with managerial overconfidence pay additional 9.3% higher audit fees when they are subject to stronger and more effective board oversight. However, we find weaker evidence on the effect of audit committee characteristics on audit fees of the overconfident firms. Our primary results hold for a battery of supplemental tests including the tests using propensity-score matched sample. The study contributes to audit fee and corporate governance literature, and has useful implications for regulators, accounting practitioners, and auditors.

Keywords

Audit fees Audit risk Board and audit committee characteristics Managerial ability Managerial overconfidence 

JEL Classification

M40 M41 M42 

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Department of Accounting, Mike Ilitch School of BusinessWayne State UniversityDetroitUSA
  2. 2.Department of Accounting, Business Ethics and Information Systems, Rutgers Business SchoolRutgers, The State University of New JerseyPiscatawayUSA
  3. 3.Department of Accounting, Odette School of BusinessUniversity of WindsorWindsorCanada

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