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The association between audit committees, compensation incentives, and corporate audit fees

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Abstract

This study uses audit fee data from the 2001–2003 reporting periods to examine the relationship between measures of audit committee effectiveness and compensation incentives with corporate audit fees. Our results suggest that audit committee size, committee member expertise, and committee member independence are positively associated to audit fee levels, consistent with the notion that audit committees serve as a complement to external auditors in monitoring management. In contrast, CEO long-term pay and insider ownership are inversely related to audit fee levels, substituting for external audit effort in motivating management. Notwithstanding results on the full sample of firm-years, we uncover significant differences in the determinants of audit fees between the years examined. An important implication of these results is that explaining the intra-firm variation in audit fees over time is clearly necessary in order to understand the antecedents and consequences of audit fees.

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Notes

  1. See, for example, Carcello et al. (2002), Craswell et al. (2002), Felix et al. (2001), Frankel et al. (2002), and Seetharaman et al. (2002) for evidence on audit fees; Abbott et al. (2003), and Gul et al. (2003), for evidence on non-audit fees.

  2. Early finance research attempting to explain variation in other governance mechanisms adopted a cross-sectional approach focusing on variable levels (e.g., Morck et al., 1988; Hermalin and Weisbach, 1988; McConnell and Servaes, 1990; Hermalin and Weisbach, 1991). Work by Agrawal and Knoeber (1996) attempts to treat endogeneity cross-sectionally, via a system of equations. More recently, motivated by endogeneity considerations, researchers addressed variation in governance variables using a panel of data and focusing partly on differences in, rather than levels of, the variables of interest (e.g., Yermack, 1996; Vafeas, 1999; Himmelberg et al., 1999).

  3. Some studies have used assets or the log of assets as a proxy for size. We did additional analysis using the log of assets as a proxy for size and the results are qualitatively the same. Assets are correlated to industry and sensitive to historical cost considerations so sales may be a better size proxy.

  4. The effects of insider ownership may be non-monotonic. We ran additional analysis and split the sample based on firms with less than 5% insider ownership, >5% and <25% insider ownership, and greater than or equal to 25% insider ownership. For inside ownership, results primarily stem from the sample of firms with inside ownership less than 5%. and results are much weaker for the rest of the firms. Only 33 firms have ownership over 25%, so no real analysis can be carried out on those. We have sampled Fortune firms, so ownership tends to be widely dispersed.

  5. One drawback of our change analysis is that the tests do not control for contemporaneous changes in other governance variables. However, given the limited degree of intertemporal variation across governance variables (i.e., governance variables are “sticky”), it is unlikely that changes in other variables account for our results. Thus we did not collect data on control variables from proxy statements for 2003. Our approach is in line with other studies similarly examining the univariate correlation between a change in corporate governance and performance variables, assuming other variables are not correlated with such a change (e.g., Klein, 2002; JAE).

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Authors and Affiliations

  1. Department of Public and Business Administration, University of Cyprus, Kallipoleos 75, Nicosia, 1678, Cyprus

    Nikos Vafeas

  2. School of Business, Emporia State University, 1200 Commercial St., Box 4057, Emporia, KS., 66801-5087, USA

    James F. Waegelein

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  1. Nikos Vafeas
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  2. James F. Waegelein
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Correspondence to James F. Waegelein.

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JEL Classification M41

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Vafeas, N., Waegelein, J.F. The association between audit committees, compensation incentives, and corporate audit fees. Rev Quant Finan Acc 28, 241–255 (2007). https://doi.org/10.1007/s11156-006-0012-9

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