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“A rise in audit fees acts to deliver a precursory message about trouble within the company,” says one of the study’s authors, Paul Griffin, a professor at the University of California, Davis.

“Auditors’ fees, which are reported to the Securities and Exchange Commission and are public, will go up if the auditors are worried about irregularities that can cause them to have legal exposure.”

Public companies are required to have independent audits. When a company lacks adequate controls or shareholder protections, and perhaps has weak governance practices, the risk of legal exposure to the auditor rises.

To stay in business, the auditor must charge a higher fee to cover this potential risk, the researchers explained. Eventually, the auditor may even resign.

“An auditor resignation and the attendant adverse publicity typically causes a significant drop in company stock,” Griffin says. He and co-author David Lont, a professor at the University of Otago, New Zealand, report their findings in the Journal of Contemporary Accounting and Economics.

He says prior research has looked at how auditors’ fees behave after a resignation or dismissal, but not in the many months preceding that—before the auditor leaves.
Researchers also accounted for legitimate reasons auditors’ fees may rise, such as an increase in company size or complexity, or new regulations.

More news from UC Davis: www.news.ucdavis.edu/