The Role of Risk Management and Governance in Determining Audit Demand

• Published in: Journal of business finance & accounting 2006-11, Vol.33 (9-10), p.1344-1367
• Main Authors: Knechel, W. Robert, Willekens, Marleen
• Format: Article
• Language: English
• Subjects: Audit committees; audit demand; audit fee; Audit fees; Auditing; Audits; Corporate governance; Disclosure; governance; Professional fees; Risk management; Studies
• ISSN: 0306-686X; 1468-5957
• DOI: 10.1111/j.1468-5957.2006.01238.x

:  Most prior research into audit fees has been based on a theoretical model which treats audit fees as the by‐product of a production function ignoring potential demand forces that may drive the level of the audit fee. Inspired by prior ‘anomalous’ results, we take a different perspective by focusing on demand factors that may affect the level of the audit fee. Using data collected from a sample of listed companies in Belgium, we consider both disclosures about risk and risk management and actual decisions about corporate governance to examine whether audit fees are higher when these demand forces exist. In general, we expect that external auditing will increase in situations where there are multiple stakeholders with individual risk profiles who can shift some of the cost of monitoring to other stakeholders. Consistent with our theory and expectations, our results indicate that audit fees are higher when a company has an audit committee, discloses a relatively high level of financial risk management, and has a larger proportion of independent Board Members. Audit fees are lower when a company discloses a relatively high level of compliance risk management. The latter result indicates that controls are only complementary as long as they are voluntary, as mandated controls act as substitutes for non‐mandated controls.