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Audit Journal
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



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Auditor conservatism, asymmetric monitoring, and earnings Auditing: A Journal of Practice & Theory November 2010 American Accounting Association 140 Choi, Kim, and Zang management. Contemporary Accounting Research 20: 323–360. Kinney, W. R., Jr., and R. Libby. 2002. Discussion of the relation between auditors’ fees for nonaudit services and earnings management. The Accounting Review 77 Supplement : 107–114. ——–, Z.-V. Palmrose, and S. Scholz. 2004. Auditor independence, nonaudit services, and earnings restatements: Was the U.S. government right? Journal of Accounting Research 42 3 : 561–588. Kothari, S. P., A. J. Leone, and C. E. Wasley. 2005. Performance matched discretionary accrual measures. Journal of Accounting and Economics 39 1 : 163–197. Krishnan, J., H. Sami, and Y. Zhang. 2005. Does the provision of nonaudit services affect investor perceptions of auditor independence? Auditing: A Journal of Practice & Theory 24 2 : 111–135. Larcker, D. F., and S. A. Richardson. 2004. Fees paid to audit firms, accrual choices, and corporate governance. Journal of Accounting Research 42 3 : 625–658. Myers, J., L. Myers, and T. Omer. 2003. Exploring the term of the auditor-client relationship and the quality of earnings: A case for mandatory auditor rotation? The Accounting Review 78 3 : 779–799. Petersen, M. A. 2009. Estimating standard errors in finance panel data sets: Comparing approaches. Review of Financial Studies 22 1 : 435–480. Raghunandan, K., and D. V. Rama. 2006. SOX Section 404 material weakness disclosures and audit fees. Auditing: A Journal of Practice & Theory 25 1 : 99–114. ——–, J. Read, and S. Whisenant. 2003. Initial evidence on the association between nonaudit fees and restated financial statements. Accounting Horizons 17 3 : 223–234. Reynolds, J. L., D. Deis, and J. R. Francis. 2004. Professional service fees and auditor objectivity. Auditing: A Journal of Practice & Theory 23 1 : 29–52. Ruddock, C., S. Taylor, and S. Taylor. 2006. Nonaudit services and earnings conservatism: Is auditor independence impaired? Contemporary Accounting Research 23 3 : 701–746. Sankaraguruswamy, S., and S. Whisenant. 2005. Pricing initial audit engagements: Empirical evidence following public disclosure of audit fees. Working paper, University of Houston. Simunic, D. A. 1980. The pricing of audit services: Theory and evidence. Journal of Accounting Research 18 1 : 161–190. ——–, and M. T. Stein. 1996. The impact of litigation risk on audit pricing: A review of the economics and the evidence. Auditing: A Journal of Practice & Theory 15 Supplement : 119–133. Whisenant, S., S. Sankaraguruswamy, and K. Raghunandan. 2003. Evidence on the joint determination of audit and nonaudit fees. Journal of Accounting Research 41 4 : 721–744. Zmijewski, M. E. 1984. Methodological issues related to the estimation of financial distress prediction models. Journal of Accounting Research 22 Supplement : 59–82. Auditing: A Journal of Practice & Theory American Accounting Association November 2010 Copyright of Auditing is the property of American Accounting Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder 's express written permission. However, users may print, download, or email articles for individual use.

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