Audit fees and discretionary accruals: compensation structure effect

Abstract

Purpose

The purpose of this paper is to examine the relationship between discretionary accruals (DAs) and audit fees and whether this relationship is affected by the chief financial officer's (CFO) compensation structure.

Design/methodology/approach

Using a large sample of cross‐sectional firms over the period 2000‐2006, multiple ordinary least square regression models are estimated.

Findings

The paper finds that there is a positive and significant association between DAs and audit fees. Evidence shows that this relationship is significantly higher as CFO's bonuses increase and that this relationship is moderated as CFO's salaries increase. It is also found that income‐increasing DAs are positively and significantly related with audit fees and that increase in CFO's bonuses signifies this positive relationship.

Research limitations/implications

Results may change during the current financial crisis (i.e. 2007‐present) due to the increased regulatory scrutiny of executive compensation.

Practical implications

The study has regulatory implications because of the recent calls to require a mandate regulating executive compensation practices. The results support these calls as data show that increased bonuses are associated with higher discretionary accruals and thus higher audit fees. There is also a call to limit executive compensation to fixed amounts and data support that increase in salaries moderates the positive association between discretionary accruals and audit fees. These results can also be used by independent auditors when assessing risks and thus the results have practical audit implications.

Originality/value

The paper uses a large sample of public firms in years leading to the current financial crisis and contributes to the literature in executive compensation and audit practice.

Citation

Alali, F. (2011), "Audit fees and discretionary accruals: compensation structure effect", Managerial Auditing Journal, Vol. 26 No. 2, pp. 90-113. https://doi.org/10.1108/02686901111094994