CEO tenure and audit pricing

Abstract

We examine the relationship between CEO tenure and audit fees. After controlling for client and auditor attributes in the analyses, we find that audit fees are higher in the initial 3 years of CEOs’ service, suggesting that CEOs in their early career are more likely to show high risk-taking behavior and manage earnings that increases the probability of financial misreporting. Auditors incorporate this risk in their audit pricing decisions resulting in higher audit fees. We also find that audit fees are higher in the final year of CEOs’ service, supporting the argument for departing CEOs’ horizon problem that CEOs in their final year are more likely to manage earnings, and auditors perceive this action as increasing reporting risk in their audit pricing decisions, resulting in higher audit fees. However, the firms with more effective audit committees pay relatively lower audit fees in initial years of CEOs’ service indicating that effective audit committees reduce auditors’ assessed risk during this time-period resulting in lower audit fees. We do not find any evidence on the effect of firms’ CFO power and corporate social responsibility performance on audit fees in these two time-periods of CEOs’ service. The main results hold in a battery of supplemental tests that include the effect of several CEO characteristics, client bargaining power and the effect of SOX. Our study extends CEO characteristics and audit fee literature, and have implications for auditors in their client acceptance and audit pricing decisions, and for regulators to identify the filers with higher financial reporting and audit engagement risk.