Corruption Culture, Auditor Choice, and Audit Pricing

Abstract

We examine the external auditors’ response to firms’ corruption culture for a large sample of U.S. firms. Using a firm-level corruption culture measure constructed using cultural background information on key company insiders, we show that firms with a high-corruption culture are less likely to have Big 4 auditors and industry specialist auditors, incur higher audit fees, and have longer audit report lag. In further analysis, we find that the effect of corruption culture on audit fees is more pronounced for companies with Big 4 auditors and for those with material weaknesses in their internal control system. The effect declined after the implementation of Section 404 of the Sarbanes–Oxley Act requiring auditor attestation to the quality of company internal controls. In addition, from 2001 to 2005, 5 states had a staggered adoption of universal demand (UD) laws, which increase the obstacles for shareholders to initiate lawsuits alleging breach of fiduciary duty by directors or officers. Using a difference-in-differences analysis, we show that the changes in audit fees are more positive for firms with a high-corruption culture in the 5-state treatment group relative to the matched control group. Overall, our findings provide insights into the important role firms’ corruption culture plays in audit production.