THE MAIN DETERMINANTS OF AUDIT FEES: EVIDENCE FROM THE ALTERNATIVE INVESTMENT MARKET (2009-11) Nyerho Odje MSc, FCCA Faculty of Business Department of Accounting and Finance London South Bank University

Outline of the presentation Research background Aims and Objectives Literature review Theoretical and Philosophical consideration Research Question and Hypotheses Methodological consideration Statistical techniques employed Discussion of results

Research Background Management acts in stewardship and fiduciary roles Liable to shareholders (with full disclosure) Publish financial statements periodically Communicate inside information to stakeholders Allow informed economic decisions to be made Information asymmetry - ownership and management Need for external monitoring Role of External Audit Audit Quality Audit Fees

Aims and Objectives AIM: Gain an insight into the operation of the audit market . Data from a sample of 30 UK AIM firms Develop an Audit Fee model OBJECTIVES: Audit fee model - main determinants of audit fees in AIM firms Determine the significance factors which affect audit fees Impact of current economic factors on audit fees DELIMITATIONS Excludes small companies and charities

Literature review The determinants of audit fees have been much researched Taffler and Ramalinggam (1982) Brinn et al.(1994) in the UK; Simunic (1980), Palmrose (1986) in U.S; Francis (1984) in Australia; Cameran(2005) in Italy -- Kohler and Ratzinger-Sakel (2012) in Germany Developments in agency theory (Jensen and Meckling, 1976), Corporate Governance (Cadbury Committee, 1992) Size, complexity, and international presence of companies External verification through External Audit Invoked increased interest in auditing and hence audit fees Public opinion, policy makers and professional bodies impact on auditor public role due to: Ethical concerns Litigation Competition etc

Literature review High profile corporate collapses and role of external auditor: Enron (2001) WorldCom (2002) Parmalat (2003) Satyam – India (2009) Other major reasons for increase in external verification(and Audit Fees): Attempt by management to match performance with market expectations International nature of modern transactions – share purchase/disposal, mergers/acquisitions and cross-national ownership of property

Literature review Demand for external verification: Stewardship and accountability (Common Law of Agency) Legal requirement (Companies Act 2006) Corporate Governance (UK Corporate Governance Code 2012) Audit Quality : A joint determination of auditor expertise and auditor independence (DeAnglo,1981) Audit Product : Technical Audit/Value Added/Insurance Audit Market : Concentrated/ ‘Big4’ Premium & Oligopoly/OFT & Competition Commission Audit Fees: Provide objective, credible and outside opinion on financial reports Issue of audit quality due to expertise and independence Audit cost –Fixed /Variable (Direct (Time and Audit Expenses ) & Indirect) Audit profit Audit Premium (product differentiation)

Proxy (Independent Variable) Prior research Illustration of significant variables (and proxies) adopted by previous authors Significant Variable Proxy (Independent Variable) Author Year Sign of Coef Size Total Assets Simunic (Seminal research) 1980 +ve and stat sig Total Assets and Turnover Pong and Whittington 1994 + and SS Gonthier-Besacier & Schatt 2006 Risk Pre-tax profit Pong & Whittington (1994) -ve and not Stat Sig Total long term debt / by total assets. Taylor and Simon 1999 Loss (in two consecutive years) Abbott et al 2001 N and SS Complexity Trading subsidiaries/branches Beattie et al + and S Square root of no. of Consolidated Subsidiaries Ratio of total liabilities to equity

Theoretical and Philosophical considerations AGENCY THEORY: Corporate Governance Monitoring and Control External verification External Audit Audit Fee Limitations – Macro-economic factors ,Scope of Information Asymmetry, Assumptions about Owner/Agency relationship

Research Question and Hypotheses Main Research Question What factors determine audit fee level? Hypotheses: H1: Auditee’s Size has a positive and significant relationship with audit fees (AF). H2: Auditee’s risk has a positive and significant relationship with AF . H3: Auditee’s complexity has a positive and significant relationship with AF. H4: Fees for Non-Audit Services has a positive and significant relationship with AF. H5: Auditor’s size (‘Big4’) is positively associated with AF

Methodological consideration Adopted from Saunders et al (2012): Positivist Deductive Survey Experiment Mono-method Longitudinal Data Collection & Data Analysis

Statistical techniques employed Quantitative Research Design: Model Specification and Variable measurement- Log (AUDFEE) = α + β1NAS + β2TAS + β3TOV + β4COMP +B5PROF + β6BIG4 + e Variables: NAS = Non-Audit Services (Fees) TAS = Total Asset of client firm TOV = Turnover of client firm COMP = Client firm complexity PROF(RISK) = Profit/Loss of client firm BIG4 = Big4 or Non-Big4 Auditor

Std. Error of the Estimate Results summary SPSS results – Model summary: R R Sq. Adj R Sq Std. Error of the Estimate Change Statistics Durbin-Watson R Square Change F Change df1 df2 Sig. F Change 0.86 0.74 0.72 0.17 0.00 0.15 2 83.00 1.32

Results Quantitative Research Design: H1: (Two Proxies for ‘Size’ variable) Positive relationship between size (i.e. TAS) is a highly sig. determinant of AUDFEE. higher audit fees are associated with larger size ( i.e. increase in size leads to increased agency concerns (Fama and Jensen,1983) Positive relationship between TOV and AUDFEE but not Sig H2:Negative relationship between PROF and AUDFEE but not significant H3:Positive and sig relationship between COMP and AUDFEE. H4: Positive relationship between NAS and AUDFEE but not significant H5: Negative relationship between BIG4 and AUDFEE but not significant

Conclusions Limitations Recommendations for Further Research Firm complexity and Firm Size are still major factors in determination of Audit fees Independent Sample Test suggests no significant difference in audit fees based on auditor size. Limitations Sample size Period of study Types of variables Method Assumptions relating to Agency Theory and OLS analysis. Recommendations for Further Research Minimisation/Elimination of above Limitations Policy contributions Management and shareholders – Cost control including Benchmarking Auditors – Audit Pricing on the basis of significant factors affecting audit fee. Policy makers – e.g. Business Innovation and Skills and other relevant arms of Govt. Professional regulators-ICAEW,ACCA,OFT, Competition Commission

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