Auditors’ Fees Give Clues to Bearish News for Investors
(Davis, CA) — Unexplained increases in a company’s auditor fees may foreshadow a future drop in stock prices, according to a new University of California, Davis, study.
“A rise in audit fees acts to deliver a precursory message about trouble within the company,” said Professor Paul Griffin from the Graduate School of Management.
“Auditors’ fees, which are reported to the Securities and Exchange Commission and are public, will go up if the auditors are worried about irregularities that can cause them to have legal exposure.”
The findings are reported in a paper, “Auditor Fees Around Dismissals and Resignations: Additional Evidence,” published in the December issue of the Journal of Contemporary Accounting and Economics. The paper is co-authored by David Lont, a professor at the University of Otago, New Zealand.
Public companies are required to have independent audits. When a company lacks adequate controls or shareholder protections, and perhaps has weak governance practices, the risk of legal exposure to the auditor rises. To stay in business, the auditor must charge a higher fee to cover this potential risk, the researchers explained. Eventually, the auditor may even resign.
“An auditor resignation and the attendant adverse publicity typically causes a significant drop in company stock,” Griffin said.
He said prior research has looked at how auditors’ fees behave after a resignation or dismissal, but not in the many months preceding that – before the auditor leaves.
Researchers also accounted for legitimate reasons auditors’ fees may rise, such as an increase in company size or complexity, or new regulations.
About the UC Davis Graduate School of Management
Established in 1981, the UC Davis Graduate School of Management is consistently ranked among the premier business schools in the United States and internationally. The school has nearly 600 MBA students enrolled in Daytime MBA and Working Professional MBA programs on the UC Davis campus, in Sacramento and in the San Francisco Bay Area. For 16 years consecutive years, U.S. News & World Report has ranked UC Davis among the top 10 percent of MBA programs in the nation. The Economist’s 2010 survey ranks the school’s faculty quality No. 3 in the world. For more information, visit: gsm.ucdavis.edu.