Earnings Management, Board Independence And Audit Fees Considering The Firm’s Profitability Level – Introduction

Earnings Management, Board Independence And Audit Fees Considering The Firm’s Profitability Level - IntroductionAudit fees have been examined by many researchers that result in contradictory findings. There have been many academic and market calls suggesting that professional fees increase the financial reliance of the auditor and auditing (Becker et al, 1988; Magee and Tseng, 1990). Different factors can have effect on audit fees, such as earnings management and board independence. It has been suggested that managers have incentives to manipulate earnings management. Prior researches have indicated that there is a significant relation between earnings management and audit fees (Magee and Tseng, 1990; Leventis and Dimitropoulos, 2010). There are some evidences suggesting that audit behavior related to tactics like “low balling” or “price cutting” is positively associated with audit pricing (see Barber et al., 1987; Francis and Simon, 1987; Simon and Francis, 1988).
On the other hand, discretionary accruals play an important role in earnings management.
Gul et al find a positive relation between discretionary accruals and audit fees. Discretionary accruals are related to accounting items that require judgment. As such, as discretionary accruals increases, inherent risk assessment increases that would lead to require more audit work, extensive reviews and close supervision of staff to achieve a desired level of audit assurance. Therefore, an increase in audit work is associated with increase in audit fees (Alali, 2011). electronic-loan.com

Board independence is a strong monitoring mechanism designed to mitigate agency problems. Beasley suggested that oversight by a higher quality of board is generally, associated with lower incidence of financial statement frauds. Dechow et al. provide evidence to show that certain elements of corporate governance structures are more commonly associated with earnings manipulations. They suggested that independent boards mitigate managerial fraud. Many prior papers have suggested positive association between better governance and high operating and stock market performance (Gompers et al., 2003; Masulis et al., 2007). Relatively little studies have focused on audit fees and corporate governance. Prior studies tend to point to a negative association between corporate governance characteristics and audit fees (Tsui et al., 2001; Griffin et al., 2007), because better governance reduces control risk and ensures higher quality reporting, which enables a reduction in audit risk and fees. Tsui et al. found a negative relation between board independence and audit fees. They argued that a weak internal control mechanism in a firm, as a result of CEO domination, is likely to have a negative impact on the reliability of the firms accounting system and this will result in higher control risk, in turn, it will result in higher audit effort and this will lead to higher audit fees. On the other hand, firms with independent corporate boards, which provide an effective monitoring system, are expected to be associated with lower control risk and audit fees.
Profitability is one of the important measures of valuating firm’s operation. Profitability is related to the operation of the firms and the efficient use of its assets and other resources. An efficient use of resources usually results in a high return on assets. Studies carried out by Simunic and Wallace found that profitability has a significant effect on the level of audit fees. Joshi and AL-Bastaki suggested that audit fees are significantly associated with profitability of the firms and highly profitable firms pay more audit fees.

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