The Cost of Becoming Informed and Audit Fees

Kenneth W. Shaw and Lei Zhao ()
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Kenneth W. Shaw: School of Accountancy, Trulaske College of Business, University of Missouri, Columbia, MO 65211, USA
Lei Zhao: Department of Accounting, Richard A. Chaifetz School of Business, Saint Louis University, St. Louis, MO 63108, USA

Review of Pacific Basin Financial Markets and Policies (RPBFMP), 2023, vol. 26, issue 03, 1-36

Abstract: Auditing standards instruct external auditors to read public information to mitigate management’s information advantage in hiding earnings management and fraud. The transparency of this information, and thus the cost of becoming informed using public information, varies across firms. We argue this cost of becoming informed creates an opportunity for earnings management, increasing audit risk. This study finds that higher costs of becoming informed are related to higher audit fees. In addition, we show that executive equity risk-taking incentives and an attitude towards aggressive reporting exacerbate the effect of the cost of becoming informed on audit fees, suggesting complementary effects of these fraud dimensions on audit pricing. These results are more likely due to audit firms charging risk premiums rather than doing additional audit work. This paper contributes to recent research on the costs of becoming informed and to research on the relation between management compensation and auditor compensation.

Keywords: Audit fees; cost of becoming informed; fraud diamond; governance (search for similar items in EconPapers)
JEL-codes: G34 M41 M42 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1142/S0219091523500169

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