The conditional effects of abnormal audit fees on audit quality

This study investigates whether audit quality is associated with abnormal audit fees, and if so whether the association between the two is asymmetric in the Korean market. In particular, we focus on the specific situations that would influence the relationship between audit fees and audit quality. Our empirical results using the absolute value of discretionary accruals as a proxy for audit quality are as follows: First, the association between abnormal audit fees and audit quality is negative when the abnormal audit fees are positive (i.e., when actual audit fees are higher than the normal audit fees). Second, further investigation reveals that the negative association between the two is mainly observed in the firms with low stock returns, without analyst followings or with a low level of institutional investors’ influence. The evidence is consistent with the notion that the abnormal audit fees in Korea are indicative of economic rents rather than a measure of audit effort. Moreover, we show that the audit fees can be used to measure the level of economic bonding between the clients and the auditors, which is likely to increase in the firms with a relatively poor external monitoring mechanism and thus is also likely to impair the auditors’ independence.