Journal of Accounting Review  2017/07
Vol.65   83-116
DOI:10.6552/JOAR.2017.65.3

Financial Restatements and Audit Fees

Abstract

In this study we investigate the association between audit fees and the likelihood and characteristics of financial restatements, as well as whether audit fees increase subsequent to financial restatements. Using a sample of Taiwanese listed companies that restate their financial statements and a matched sample of nonrestating companies from the period 2002–2008, we document several findings. First, positive unexpected audit fees are associated with restatement likelihood, consistent with prior studies’ assertion that unexpected audit fees form economic bonding that may impair auditor independence and lead to decreased audit quality. However, this result cannot rule out the possibility that auditors of companies with weak internal controls charge higher audit fees to conduct more extensive audit testing but still fail to detect all material misstatements that may result in future financial restatements. Second, restatements involving downward income adjustments and transactions prone to earnings management are positively associated with audit fees. Finally, the subsequent increase in audit fees is greater for firms with restatements than for firms without restatements. Our results indicate that future audit fee increase is an economic consequence borne by restating companies in Taiwan.