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    Audit Fees and Social Capital.
    research summary posted July 23, 2015 by Jennifer M Mueller-Phillips, tagged 02.0 Client Acceptance and Continuance, 02.01 Audit Fee Decisions 
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    Title:
    Audit Fees and Social Capital.
    Practical Implications:

    By showing that the social capital where the firm is headquartered affects audit fees, this study makes an important contribution to the auditing literature. It shows that the social environment where the firm is headquartered can affect its relation with auditors and, consequently, the audit fees. This is a new way of looking at the auditor and client’s relation. Although the audit-fee literature is extensive, no studies the authors know of have investigated the possible impact of the social environment on how much the auditors charge. The study suggests that trust is an important component of the auditor-client relation, that local social capital proxies to some extent for auditor trust, and its impact on audit fees is meaningful.

    Citation:

    Jha, A., & Chen, Y. 2015. Audit Fees and Social Capital. Accounting Review 90 (2): 611-639.

    Keywords:
    audit effort, audit fees, client risk, social capital
    Purpose of the Study:

    Social capital is often defined as the mutual trust in society. The authors propose that the social capital in the county where a U.S. firm is headquartered can have an impact on how much the auditors trust the managers of the firm. Auditors arguably have less trust when a firm is headquartered in a county with low social capital. The authors argue that this lack of trust will increase the auditor’s effort and his or her fear of litigation and, therefore, will increase fees. The authors examine the impact of social capital on audit fees.

    Audit fees can increase due to more audit work and/or more expected losses. To further investigate which particular element drives up audit fees, the authors examine the impact of social capital on the auditor’s report lag, which is a proxy for the auditor’s effort, and on the firm’s litigation risk, which is a proxy for the auditor’s expected losses.

    Design/Method/ Approach:

    To test the hypothesis the authors use a multivariate regression. The sample includes 28,634 firm-year observations that represent 5,167 firms and 57 industries, and spans the years 2000 to 2009. The data is collected from Audit Analytics and Compustat. All the firms must be headquartered in the U.S. and belong to a nonfinancial and non-regulated industry.

    Findings:

    The audit fees are significantly lower in high social-capital counties. A firm that is headquartered in a county with social capital in the 75th percentile pays about 12 percent less in audit fees compared to a firm headquartered in a county with social capital in the 25th percentile. The auditors take more time to sign off on their report for low social-capital clients. Furthermore, the probability of litigation involving the auditor is also higher in low social-capital counties.

    When the auditors are either located within a 100-kilometer (62.13 miles) radius of the client or in the same metropolitan statistical area (MSA) as the client, the effect of social capital on audit fees is tripled compared to when they are further away. Because of the increase in audit complexity due to Sarbanes-Oxley Act (SOX), social capital’s effect is stronger post-2004.These results suggest that auditors take into consideration the social capital of where the firms are headquartered in assessing their audit fees.

    The results do not necessarily suggest that auditors are violating professional guidelines that require that they exercise "professional skepticism" in auditing their clients. Rather, the results suggest that the extent of the skepticism can vary based on where their clients are headquartered.

    Category:
    Client Acceptance and Continuance
    Sub-category:
    Audit Fee Decisions