The results of ACEXPPERt suggest that there is no association between audit fees and audit committee financial expertise percentage. This result differs from Abbott et al. (2003) who find a positive and significant association, and Krishnan and Visvanathan (2006) that find a negative and significant association between audit fees and financial expertise of independent directors in the audit committee. Pre-SOX samples (2000 to 2002) and a sample of S&P 500 firms of the earlier studies could be the reason for different results. In the pre-SOX period, financial expertise of independent directors in the audit committee is optional. Audit firms at that time could have considered firms with audit committee financial expertise as a risk-mitigating factor and lowered their audit fees. In the post-SOX era, all firms have at least one audit committee director with financial expertise and the percentage of ACEXPPERt has increased from 9 per cent in 2004 to 40 per cent in 2008 (see Figure 4). Additionally, the percentile distribution of ACEXPPERt (Table 3, Panel A) shows that, except for 2004, almost all firms have at least one independent director with financial expertise. Based on these findings, it seems that the regulatory influence of SOX has reduced the signaling capacity of audit committee financial expertise.
While the data of this study do not support H1b, it is not a sufficient indication that audit committee financial expertise is not an important issue. A sensitivity analysis by audit firms shows a positive and significant association between expertise and audit fees (Table 22) for the Ernst & Young and PWC sub- samples. Further industry analyses show positive and significant associations between expertise and audit fees suggesting that financial experts on the audit committees of firms in the textiles, publishing and printing, extractive, and durable industries demand quality audits. The positive and significant association between
119 expertise and audit fees for firms audited by Ernst & Young and PWC suggest that firms audited by these two firms expect higher quality audits, resulting in higher audit fees.
Based on this analysis, I conclude that there is no evidence to support hypothesis 1b. An inference is that audit firms are aware that most audit committees have financial expertise and no longer consider audit committee financial expertise as a significant risk factor when regulatory influences are strong.
Overall, in the post-SOX era, audit committee independence and expertise lose their signalling capacity to the audit firms, and, perhaps, others who rely on such variables, e.g., investors and regulators.
7.2.2 Institutional Ownership
Earlier studies find inconclusive results for institutional ownership. Whisenant et al. (2003) find no significant association between audit fees and institutional ownership. Han et al. (2009) also find no association between audit fees and long-term institutional ownership. Kannan (2009) find a positive and significant association between institutional ownership percentage and audit fees. Kannan’s (2009) sample includes both S&P 1500 non S&P 1500 firms from the years 2003 to 2005. These inconsistent results could be due to the period (pre- SOX) of study, the sample size (e.g., S&P 500) or the institutional setting of the study.
This study has a sample of S&P 1500 firms from 2004 to 2008. The results for institutional ownership in this study are negative and significant for all firms, and for the subsamples of SmallCap and MidCap firms but not for Super firms. Super firms, being large firms, are under constant scrutiny and are considered less risky in most instances, whereas smaller firms are in greater need of risk reducing signals. It seems that institutional shareholdings are seen as risk mitigating signals by audit firms. Further sensitivity tests reveal that for the audit firms, Ernst &
120 Young and KPMG, the institutional ownership coefficient is negative and significant suggesting that these firms consider institutional ownership as a risk mitigating factor.
The results by industries are mixed. The coefficient of INSTt is positive and significant for the food industry, whereas it is negative and significant for the chemicals, extractive, transportation, utilities, and retail industries. Institutional shareholding in the food industry is positively associated with audit fees suggesting that institutional shareholders demand a better quality and costlier audit. The negative and significant results for the chemicals, extractive, transportation, utilities, and retail industries suggest that audit firms view institutional holdings as a risk-reducing factor, and reduce their audit fees for firms in those industries when institutional holdings are high.
Overall, the result for long-term institutional holdings is negative and significant which favours the supply-side hypothesis. This is despite the fact that there is a high percentage of institutional ownership in the US, who normally demand higher quality audit (average 81%).
7.2.3 Executive Compensation
In the area of executive compensation, mixed results are the norm. For example, Vafeas and Waegelein (2007) find that CEO long-term pay has a negative relation to audit fees. Wysocki (2010) finds that there is a positive and significant association between CEO total compensation and audit fees. I cover three common types of compensation, STIPt (short-term incentive plans), STOPt (stock options), and LTIPt (long-term incentive plans). I discuss the test results of these variables below.