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Auditing: A Journal of Practice & Theory Vol. 29, No. 2 November 2010 pp. 115–140

American Accounting Association DOI: 10.2308/aud.2010.29.2.115

Do Abnormally High Audit Fees Impair Audit Quality?
Jong-Hag Choi, Jeong-Bon Kim, and Yoonseok Zang
SUMMARY: This study examines whether and how audit quality proxied by the magnitude of absolute discretionary accruals is associated with abnormal audit fees, that is, the difference between actual audit fee and the expected, normal level of audit fee. The results of various regressions reveal that the association between the two is asymmetric, depending on the sign of the abnormal audit fee. For observations with negative abnormal audit fees, there is no significant association between audit quality and abnormal audit fee. In contrast, abnormal audit fees are negatively associated with audit quality for observations with positive abnormal audit fees. Our findings suggest that auditors’ incentives to deter biased financial reporting differ systematically, depending on whether their clients pay more than or less than the normal level of audit fee. Our results are robust to a variety of sensitivity checks. Keywords: audit quality; abnormal audit fees; earnings management. Data Availability: Data are publicly available from sources identified in the paper.

INTRODUCTION his study examines whether the association between audit fees and audit quality is asymmetric and thus nonlinear in the sense that the association is conditioned upon the sign of abnormal audit fees. We define abnormal audit fees as the difference between actual audit fees i.e., actual fees paid to auditors for their financial statement audits and the expected, normal level of audit fees. Actual audit fees consist of two parts: 1 normal fees that reflect auditors’

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Jong-Hag Choi is an Associate Professor at Seoul National University, Jeong-Bon Kim is a Chair Professor at City University of Hong Kong, and Yoonseok Zang is an Assistant Professor at Singapore Management University. We thank Rajib Doogar, Lee-Seok Hwang, Sanjay Kallapur, Jay Junghun Lee, Ling Lei, Clive Lennox, Annie Qiu, Srini Sankaraguruswamy, Haina Shi, Byron Song, Michael Stein, Stephen Taylor, Ross Watts, T. J. Wong, Cheong H. Yi, participants at the 2006 American Accounting Association AAA Auditing Section Midyear Meeting, the 2006 AAA Annual Meeting, the 2006 Annual Conference of the Korean Accounting Association, Chinese University of Hong Kong, City University of Hong Kong, The Hong Kong University of Science and Technology, The Hong Kong Polytechnic University, Seoul National University, Singapore Management University, and, in particular, Dan Simunic the editor and two anonymous referees for their helpful comments and suggestions. Professor Choi acknowledges financial support from Samil PwC Faculty Fellowship and Management Development Center of Seoul National University. Professor Kim acknowledges financial support from the new faculty research grant of City University of Hong Kong Project # 72000167 . Editor’s note: Processed by Dan Simunic, final acceptance by Ken Trotman.

Submitted: July 2007 Accepted: March 2010 Published Online: October 2010 115

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Choi, Kim, and Zang

effort costs, litigation risk, and normal profits Simunic 1980; Choi et al. 2008, 2009 , and 2 abnormal fees that are specific to an auditor-client relationship Higgs and Skantz 2006 . Normal fees are mainly determined by factors that are common across different clients, such as client size, client complexity, and client-specific risk, while abnormal fees are determined by factors that are idiosyncratic to a specific auditor-client relationship. As noted by Kinney and Libby 2002, 109 , abnormal fees “may more accurately be likened to attempted bribes” and can better capture economic rents associated with audit services or an auditor’s economic bond to a client than normal fees or actual fees. We expect that the association between abnormal audit fees i.e., a...
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