The association between firm litigation risk and audit fees

: an analysis of the role of directors' indemnity insurance and directors' share ownership

Abstract

This dissertation provides empirical evidence to show that auditors charge higher audit fees for firms with director indemnity insurance ("DII") for their senior management than for firms without DII, after controlling for the traditional determinants associated with audit fees. The association is based on the theory that firms with DII are associated with higher litigation risks. Thus, auditors are expected to assess higher levels of risk for these firms that, in turn, will result in higher audit effort and higher audit fees. Using Australian data regression analysis for 394 Australian companies shows that the existence of DII (as measured by a dummy variable) is significantly and positively associated with audit fees. This relationship is further examined after taking into account the governance structure of a firm. Governance attributes such as the presence of an audit committee, proportion of non-executive directors on the audit committee and CEO duality are included and tested in the model. The corresponding results still provide evidence of a significant association between audit fees and DII although the magnitude is reduced. These results suggest that an effective governance structure does mitigate litigation risk to an extent. An additional test to evaluate the role of director share ownership shows that this association is moderated by directors' share ownership since the association between DII and audit fees is positive and significant for firms with low director ownership (< 5% ownership) but not significant for firms with high director ownership.

Date of Award	15 Jul 2005
Original language	English
Awarding Institution	City University of Hong Kong
Supervisor	Stephen G LYNN (Supervisor) & Ferdinand Akthar GUL (Supervisor)