The fees that publicly-traded companies agree to pay auditors should be disclosed at the time they are negotiated, a new research paper recommends, saying investors and markets could benefit substantially from accelerated disclosure.
Audit fee negotiations conclude with the signing of an engagement letter, typically during the first quarter of the year of the company’s being audited. But under current disclosure practice, the audit fee paid isn’t made public until the following year’s definitive proxy statement.
Increases in audit fees frequently signal trouble ahead for a company, and accelerating the disclosure of fees could “reduce the severity of negative market reactions when companies announce bad news,” according to an article published by the American Accounting Association.
“Our results suggest that negotiated audit fees contain information meaningful to investors and that if disclosed proximate to the signing of the engagement letter instead of the following year, information asymmetry between managers and investors would be reduced,” the study says.
To compile those results, researchers analyzed data from 4,859 companies over a 12-year period beginning in 2000, focusing on the relationship between two principal variables — increases in audit fees from one year to the next and crashes in company stock that occurred in the year following negotiation of fees.
Stock crashes were significantly associated with increased audit fees, the study found, with a less-than-5% likelihood that the association was due to chance.
Auditors, the researchers noted, have access to vast amounts of private information from clients, which they use to price their services. On average, companies expect “their auditor to have negotiated a 2 to 3 percentage-point increase in the audit fee in advance of a crash event over and above changes necessitated by operational or structural changes in the client.”
“Investors and markets could benefit considerably if audit fees became public at the time they are negotiated, since this would likely avert the crashes in company stock that can occur when undisclosed bad news is allowed to build up over time,” Nicole Thorne Jenkins of the University of Kentucky, a co-author of the study, said in a news release.
Image by Pixabay