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Investors deserve earlier notification of corporate audit fees

by Dec. 18, 2014, 11:31 AM

The fees charged by independent auditors should be released to the public as soon as they are negotiated instead of waiting a year until a firm’s annual proxy statement is issued as is the custom now, new research argues.

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Karl Hackenbrack (Daniel Dubois / Vanderbilt University)

“Our results suggest that accelerating the mandated corporate disclosure of the audit fee would provide useful information to investors, reducing the severity of negative market reactions when companies announce bad news,” researchers from three universities write in their article “Relevant but Delayed Information in Negotiated Audit Fees.”

The study, published in the November issue of Auditing: A Journal of Practice & Theory, is the work of Karl E. Hackenbrack, associate professor of management at Vanderbilt’s Owen Graduate School of Management; Nicole Thorne Jenkins, associate professor of accounting at University of Kentucky College of Law; and Mikhail Pevzner, associate professor of accounting at the Merrick School of Business at the University of Baltimore.

The trio of scholars sampled 4,859 public company annual audits from 2001 to 2011 and found that a 2 to 3 percentage-point increase in the negotiated audit fee was positively associated with subsequent stock price dives of up to 18 percent over the 12 months between when the audit fee was first negotiated and when it was ultimately disclosed to the public.

Auditors “have access to a broad array of client-specific information well in advance of investors,” the researchers write. “(They) appear to be aware of the buildup of company-specific bad news before a ‘tipping-point’ is reached and adjust audit fees accordingly.”

A 2 to 3 percentage-point increase in auditing fees could signal a major lawsuit in the near future, a longtime customer soon to be lost or some other bad news. Although investors wouldn’t necessarily know the specifics if they were notified of an auditing fee increase, they would at least be warned to expect some negative news.

Reporting the auditor’s fee increase earlier could be beneficial to the company as well as its investors, the authors say. If word and explanations of negative developments get out early on rather than festering as rumors over a longer period of time, the dramatic stock price decrease might be partially deflected or even avoided.

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