Do Firms Pay for Audit Risk? Evidence on Risk Premiums in Audit Fees after Direct Control for Audit Effort

Posted: 28 Jun 2002

See all articles by Lasse Niemi

Lasse Niemi

Aalto University - School of Business

Abstract

Previous audit fee research assumes that audit fee bears a premium for client-specific business risk. However, empirical evidence on the risk premiums is scarce and mixed. In general, it seems that recommended, or proposed fees are found to bear a premium for risk, but evidence based on actual audit fees and hours suggest that an auditor's client-specific business risk is reflected in audit effort, but not in billing rates. This study documents the existence of risk premiums in actual audit fees after direct control of audit effort thought audit hours. Audit fee and hour data were obtained from the internal archives of four Big Six audit firms. The other sources of data are the client's financial statements and questionnaires sent to the partners of the audit firms.

The findings suggest that when an auditor's client-specific business risk is higher than average, or a client is a listed company, the fee contains a premium. Also, the new clients were found to pay higher fees after controlling for the audit work involved. However, no evidence supporting the risk premiums due to the client's financial distress could be found. On the contrary, the results provide some evidence suggesting that the loss-making clients pay lower fees than their better performing counterparts.

The findings reported in this paper supporting the notion that firms do pay for audit risk, are based on data from an institutional setting (Finland) not as litigious as those examined in related prior literature. Therefore, it could be expected that risk premiums in actual fees would also be observed in those more litigious settings if the effect of the audit effort could be controlled directly in the empirical tests.

Note: This is a description of the paper and not the actual abstract.

Keywords: risk premium, audit pricing, audit fees, audit risk, business risk, auditor litigation, audit effort

JEL Classification: L84, M40, M49

Suggested Citation

Niemi, Lasse, Do Firms Pay for Audit Risk? Evidence on Risk Premiums in Audit Fees after Direct Control for Audit Effort. Available at SSRN: https://ssrn.com/abstract=310979

Lasse Niemi (Contact Author)

Aalto University - School of Business ( email )

P.O. Box 21210
Helsinki, 00101
Finland

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