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    Relevant but Delayed Information in Negotiated Audit Fees
    research summary posted March 30, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions, 02.05 Business Risk Assessment - e.g., industry, IPO, complexity 
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    Title:
    Relevant but Delayed Information in Negotiated Audit Fees
    Practical Implications:
    • The study is a first step in documenting the economically relevant information contained in negotiated fees.
    • The market is precluded from assimilating timely, consequential information embedded in the negotiated audit fee simply because the current mandate is to disclose the audit fee paid essentially one year after the negotiated audit fee is known by insiders.
    • The study does not address how accelerating the disclosure of audit fee information would complicate the auditor-auditee fee negotiation process, or more generally, the auditor-client relationship.

    For more information on this study, please contact Karl Hackenbrack.

    Citation:

    Hackenbrack, K., N.T. Jenkins and M. Pevzner. 2014. Relevant but delayed information in negotiated audit fees. Auditing: A Journal of Practice and Theory 33 (4): 95-117

    Keywords:
    Stock price crashes, audit fees, disclosure, client acceptance, business risk assessment
    Purpose of the Study:

    Audit fee negotiations conclude with the signing of an engagement letter, typically the first quarter of the year under audit. Yet investors do not learn of the audit fee paid until it is disclosed in the following year’s definitive proxy statement. We conjecture that negotiated audit fees impound auditors’ consequential private, client-specific knowledge about ‘‘bad news’’ events investors will learn eventually. We demonstrate that a proxy for the year-to-year change in the negotiated audit fee has an economically meaningful positive association with proxies for public realizations of ‘‘bad news’’ events that occur during the roughly 12-month period between the negotiation of the audit fee and the disclosure of the audit fee paid.

    Design/Method/ Approach:

    The approach is archival/empirical.  The sample selection process began with all available company-year observations in Audit Analytics for entities that filed either a 10-K or a definitive proxy statement during the period 2000 to 2011.  Company-years associate with first year engagements, multiple auditors, average share price less than $2.50, financial services companies and utilities were eliminated, as well as observations with incomplete data or not covered in CRSP or COMPUSTAT.  The resulting sample has 27,708 company-year observations.  All data is available from public sources.

    Findings:
    • Our analyses address whether changes in negotiated audit fees lead to public realizations of idiosyncratic risk and the consequent stock price crash.
    • Auditors appear to be aware of the buildup of company-specific bad news at the time the audit fee is negotiated and to adjust negotiated audit fees accordingly.
    • Our proxy for the change in the negotiated audit fee is positively associated with proxies for public realizations of idiosyncratic risk over the roughly 12 months between the negotiation of the audit fee and the disclosure of the audit fee paid.
    • On average, auditors negotiated a 2 to 3 percentage point increase in the audit fee in advance of a stock price crash event over and above changes necessitated by operational or structural changes in the client.
    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions, Business Risk Assessment (e.g. industry - IPO - complexity)