Improved Corporate Governance Reduces Auditing Fees

Professor Paul Griffin and his coauthors David Lont and Yuan Sun of the School of Business, University Otago, Dunedin, recently presented their article “Corporate Governance and Audit Fees: Evidence of Countervailing Relations” at a joint symposium hosted by the Journal of Contemporary Accounting and Economics and Auditing: A Journal of Practice & Theory at The Hong Kong Polytechnic University on January 4-5, 2008.

Griffin and his co-authors contend that increased spending on governance—including auditing—enhances the quality of financial statements and internal controls for a company. They found that the increased spending on governance has an opposite effect on auditing costs (via fees) in the long term—it reduces auditing costs to below what would be a much higher fee.

In their study, Griffin, Lont and Sun derive and test an economic framework that describes the relation between corporate governance and auditing fees paid by companies. The framework shows that auditing and governance are co-determined by a fee-increasing relation because auditing services provide a means to attain better governance, and a fee-decreasing relation because auditors incorporate the benefits of better governance in pricing their services, passing savings onto the companies that must be audited.

The authors have tested their framework in the wake of Sarbanes-Oxley legislation, which imposed substantial cost on many companies to strengthen governance, including increased spending on auditing and internal control. After controlling for this increased spending, the researchers conclude that better governance reduces the cost of auditing.

Their framework explains that this offset occurs because even though better governance (including auditing) is costly, it also enhances the quality of financial statements and internal controls, which enables auditors to decrease audit and control risk resulting in reduced fees. The audit fee offset for the typical large company is more than $500,000.

Professor Griffin and his colleagues also presented their research at the Annual Academic Seminar on Corporate Reporting & Governance last September in Irvine, California; at INSEAD in France last October; and at the Israeli Institute of Technology in Haifa in January.