Corporate Corruption Culture and Audit Pricing in the U.S.

Abstract

Using a firm-level corruption culture measure constructed using cultural background information on key company insiders, we analyze how auditors price clients’ corporate corruption culture to understand its role in auditors’ risk judgment. We show that firms with a high-corruption culture are less likely to have Big 4 auditors and industry specialist auditors. Given auditor choice, firms with a high-corruption culture incur higher audit fees and have a longer audit report lag. Moreover, 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 systems. The effect on audit fees declined after the implementation of Section 404 of the Sarbanes–Oxley Act requiring auditor attestation to the quality of companies’ internal controls. Using the staggered adoption of universal demand laws as a natural experiment, we find that the reduction in audit fees in response to raising obstacles for shareholder lawsuits is smaller for firms with a high-corruption culture. Overall, we provide large sample evidence that auditors exercise professional skepticism regarding the ex-ante audit risk captured by corruption culture and show that corruption culture interacts with fraud opportunity and the legal environment in affecting auditors’ risk assessment.