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Fees Paid to Audit Firms, Accrual Choices and Corporate Governance

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Fees Paid to Audit Firms, Accrual Choices and Corporate Governance

Research has shown that auditors’ tolerance for aggressive corporate accounting is correlated with the amount of fees the corporate client pays to the auditor for both audit and non-audit services.

In our pooled sample, we confirmed previous research findings that the ratio of non-audit fees to total fees has a positive relation with the absolute value of accruals.

However, using latent class mixture models to identify clusters of firms with a homogenous regression structure reveals that this positive association only occurs for a fraction of the sample.

In contrast to the fee ratio results, we find consistent evidence of a negative relation between the level of fees (both audit and non-audit) paid to auditors and accruals (i.e., higher fees are associated with smaller accruals). The latent class analysis also indicates that this negative relation is strongest for clients with weak governance.

Overall, our results are most consistent with auditor behavior being constrained by the reputation effects associated with allowing clients to engage in unusual accrual choices.

Published in

Journal of Accounting Research

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