F.2. Audit Fees and Investor Perception

BEHAVIORAL RESEARCH IN ACCOUNTING American Accounting Association
Vol. 25, No. 2 DOI: 10.2308/bria-

50403
2013
pp. 71–95
Audit Fees and Investor Perceptions of

Audit Characteristics
Allison K. Beck
The Florida State University
Robert M. Fuller
Leah Muriel
The University of Tennessee
Colin D. Reid
Northeastern University
ABSTRACT: We investigate how audit fee disclosures affect investor perceptions of

audit characteristics. We find evidence that when audit fees are presented to investors
with supplementary contextual information indicating that the fees are low, average, or
high (as compared to industry averages), investors perceive audit quality and auditor
effort as being low, average, or high, respectively. When not provided with any
additional information concerning the audit fee (similar to the present state of
disclosures), investors assess audit quality and auditor effort as being average.
Surprisingly, we find that while investors perceive auditor independence as low,
average, and high when fees are presented as high, average, or low, respectively,
investors not provided with any relative fee information assess auditor independence
as low, similar to the investors who are presented with high relative fees. This latter
finding provides important insight regarding investors’ current perceptions of auditor
independence, particularly in the absence of relative or comparative audit fee
information.
Keywords: audit fees; disclosure; investor perception.
Data Availability: Contact the authors.
INTRODUCTION
I
nvestor reliance on audited financial information is so crucial that it garners substantial legal
liability for auditors under the 1933 and 1934 Securities Acts. However, very little
information is provided to the investor about the audits performed or the nature of the
relationship between
the auditor and client. Although potential investors can observe extreme instances of audit failures
We thank Jack Kiger for allowing us to survey his students. We also thank two anonymous referees and Theresa Libby
(editor) for helpful comments that have greatly improved the paper. All authors contributed equally to the paper and are
listed alphabetically according to last name.
Theresa Libby, Accepting Editor.
Published Online: January 2013

71
72 Beck, Fuller, Muriel, and Reid
characterized by financial restatements, such direct and strong evidence of inferior audit quality
would only be obtained ex post, after an audit opinion is issued and financial statements are filed
with the SEC. Unfortunately, financial statement users have little interim information at their
disposal to develop ex ante expectations about audit quality or other related aspects of an audit
engagement, whose levels typically lie somewhere within a continuum, rather than at an extreme
endpoint.
It is difficult for investors and other external constituents to observe important qualitative
aspects of an audit engagement such as the experience level, technical competence,
conscientiousness, or objectivity of audit personnel. These and similar attributes can be expected
to vary considerably across audit engagements and may ultimately have ramifications for audit
quality. A company’s audit quality may, in turn, impact its future riskiness as an investment. Yet,
despite having the potential to be quite heterogeneous, audit quality remains an opaque concept
that can be difficult for investors to assess in the absence of such information.
Currently, the only audit-related disclosures that are routinely made to investors include the
audit fees and the audit report. The typical information presented in the audit report is quite
limited and seldom distinguishes the audit report of one company from that of another. When
faced with decisions about how to allocate their funds across companies, potential investors
should know something about the quality of a company’s audit due to potential impacts on the
reliability of the company’s financial information(Hodge 2003)and its riskiness as an investment.
Lacking other meaningful information, we anticipate that audit fees can or should provide an
important basis upon which investors form perceptions about an audit.
Previous research affirms the importance of audit fee data, indicating that audit fee
disclosures confer incremental, forward-looking information about a company’s future risks and
also impact a company’s ex ante cost of capital(Khurana and Raman 2006; Stanley 2011;
Hackenbrack et al. 2011).Numerous archival studies explicitly use audit fees and ratios of audit
fees as surrogates for audit-related attributes such as auditor independence, auditor effort, and
financial reporting audit quality(Ahmed et al. 2006; Hribar et al. 2010; Bentley et al. 2011).Other
studies assert that the magnitude of a company’s audit fees is associated with auditor
independence, auditor reporting decisions, and a company’s ex post financial reporting
quality(Simunic 1984; Davis et al. 1993; Srinidhi and Gul 2007).Several studies conclude that
abnormally large fees impair auditor independence, thus adversely impacting auditor reporting
decisions and reducing the quality of reported financial information(Gunny et al. 2007; Hoitash et
al. 2007).Finally, some evidence indicates that unusually low audit fees are associated with
impaired audit quality(Hribar et al. 2010; Gupta et al. 2012; Brandon et al. 2012).However,
despite extensive empirical-archival research that imparts various characteristics to audit fees
and/or documents associations between audit fees and audit-related outcomes, it is unclear what
investors ascertain about an audit engagement based on a given audit fee, and we are unaware of
any prior behavioral research that investigates how investors perceive audit characteristics in
light of an individual company’s audit fee.
The objectives of this research are two-fold. First, we investigate whether the provision of
additional referent information about audit fees ( percentile rank data relative to other firms in the
industry that establish a comparative benchmark) alters user perceptions of audit characteristics.
This enables us to determine what investors perceive, based on audit fees, about the audit
characteristics, and whether their perceptions coincide with the audit fee–audit characteristic
relationships identified in previous archival research. Second, we contrast the perceptions of
investors who are merely supplied with the total dollar amount of the audit fees with the
perceptions of investors who are told that a company’s audit fee is approximately average in
comparison to the audit fees of other companies within the same industry. Making this latter
comparison offers insights as to how investors perceive audit and company characteristics when
lacking additional information, consistent with the current state of audit fee disclosures.
Behavioral Research In Accounting
Volume 25, Number 2, 2013
This study reports the results of an experiment designed to assess the impact of audit fee
disclosures on investor perceptions of audit characteristics. Specifically, we manipulate the
content of audit fee disclosures to examine how investors perceive audit characteristics under
various alternative scenarios—when the audit fee presented is approximately average, abnormally
high, or abnormally low compared to the industry average, or when no benchmark information is
provided. The five audit characteristics of interest consist of: (1) auditor independence, (2) auditor
effort, (3) financial statement error, (4) audit quality, and (5) business risk.
Study participants were provided with financial information and data indicating the audit fees
paid by a fictitious company. Some of the participants also received additional information that
indicated the relative size of the audit fees compared to similar organizations. This information
was designed to aid investors in assessing the ‘‘representativeness’’ of the organization’s audit
fee. This relative size was indicated as high (96th percentile), average (52nd percentile), or low
(6th percentile) in relation to other companies in the same industry. The dollar amount of the fee
presented to the participants was the same, regardless of the relative size specified to participants.
After reviewing the financial information, participants were then surveyed about their perceptions
of the company, the audit, and the firm performing the audit.
Overall, the results of our study suggest that investors do develop perceptions about a
company and its audit based on audit fees, as we find that providing supplemental audit fee
disclosures indicating the relative magnitude of a company’s audit fees significantly influences
investor perceptions of auditor independence, auditor effort, and audit quality. Specifically, we
present evidence that when fees are presented to investors as low, average, or high (as compared
to industry averages), investors commensurately perceive audit quality and auditor effort as being
low, average, or high, respectively. When not provided with any additional information
concerning the audit fee (similar to the present state of disclosures), investors assess audit quality
and auditor effort as being average. However, we find that while investors perceive auditor
independence as low, average, and high when fees are presented as high, average, or low,
respectively, investors not provided with any relative fee information assess auditor independence
as low.1 This latter finding provides important insight into investors’ current perceptions of
auditor independence, particularly in the absence of relative or comparative information, and
suggests that it might be useful for regulators, when contemplating additional disclosure
requirements, to allocate some attention to disclosures that have the potential to enhance investor
perceptions of auditor independence. The findings of our study contribute to the forum of debate
concerning the current state of audit-related disclosures and their value for investors.
The remainder of the paper is organized as follows. In the next section we discuss the
regulation of audit fee disclosures and other initiatives designed to enhance the information set
available to investors about public company audits. Next, we provide background information on
cognitive biases and magnitude perceptions that may influence investor perceptions of audit
characteristics, and we review the relevant literature about the information content of audit fee
disclosures and formulate our hypotheses. We describe the research undertaken to test the
hypotheses. We then present the results of our analysis, concluding with a discussion of the
implications of this research, its limitations, and opportunities for future research.
INSTITUTIONAL BACKGROUND
Audit Fee Disclosures
Effective in 2001, the SEC implemented a mandatory disclosure requirement for audit fees in
response to fears that the provision of large-scale consulting services, which generated sizeable
1
This is similar to investor perceptions of independence in the high relative fees scenario.
streams of revenue for audit firms, might impair auditor independence(Markelevich et al. 2005).
The typical consulting fees derived from a client were often considerably larger in magnitude than
the audit fee revenue an accounting firm generated from the same client, exacerbating concerns
that auditors might cave in to client pressure during an audit, out of fear of losing the consulting
relationship. In order to make the relative magnitudes of audit and non-audit fees more transparent
to investors, the SEC began requiring all registrants to disclose in the proxy statements the dollar
amounts of their audit and non-audit fees, with detailed breakouts of the amounts in specific
categories. The new rule was effective for proxy statements filed after February 5, 2001(SEC
2001).2 At present, companies must disclose the dollar magnitudes of their audit fees, subdivided
into four categories: audit fees, audit-related fees, tax fees, and all other fees.
Other Audit-Related Disclosures

While disclosure of the audit firm identity enables financial statement users to observe, at a
macro level, whether an auditor is a Big N auditor (an auditor characteristic commonly associated
with higher quality audits), this auditor attribute is not informative about idiosyncratic
engagement- level characteristics that may also have a bearing on audit quality. Moreover, prior
literature indicates that the quality of Big N audits is not homogeneous(Francis and Yu 2009; Choi
et al. 2010a; Reichelt and Wang 2010),albeit some evidence exists that Big N auditors generally
provide higher quality audits than non-Big N auditors (e.g.,Becker et al. 1998; Francis et al. 1999;
Francis and Krishnan 1999).Furthermore,Lawrence et al. (2011)conclude that previously
documented differences in audit quality may be largely attributable not to auditor type, but instead
to client characteristics that drive the selection of auditor type. Thus, the characterization of an
auditor as a Big N may or may not sufficiently inform investors about audit quality, to the extent
that other audit engagement attributes or client characteristics also concurrently influence audit
quality.
The audit opinions supplied to investors within the audit report are typically generic and
standard unless the audit report includes an explanatory paragraph or a form of modified opinion
indicating specific problems uncovered during the audit. Consequently, the typical audit report
verbiage seldom distinguishes one company’s audit report from another. Thus, audit fees, which
vary considerably in magnitude across organizations, serve as one of the few distinguishing
indicators of the auditor–client relationship that are quantifiable and visible to investors(DeFond
et al. 2002; Kinney et al. 2004; Khurana and Raman 2006; Li 2009),and therefore are the focal
point of our research that examines investor perceptions of audit characteristics.
Recent Regulatory Interventions and Other Initiatives

The SEC’s initial adoption of the audit fee disclosure rule marked the beginning of a series of
interventions by regulators and initiatives aimed at increasing the reliability of audited financial
data, augmenting the information set available to investors about public company audits, and
ultimately enhancing investor confidence in audited financial information.
In 2002, the Sarbanes-Oxley (SOX) Act established the Public Company Accounting
Oversight Board (PCAOB), an organization formed to provide oversight of public company audits,
‘‘to protect investors and further the public interest in the preparation of informative, accurate, and
independent audit reports’’ (U.S. House of Representatives 2002).Generally, all public accounting
firms that prepare or furnish audit reports for SEC registrants must register with the PCAOB.
Periodically, the PCAOB inspects a sample of audit engagements performed by its registrants.
2
Thus, for companies with December 31 year-ends, the 2001 proxy included fee disclosure information for the
fiscal year ending December 31, 2000 (the initial disclosure year).
During the inspection process, the PCAOB evaluates the adequacy of the audit tests performed
and, upon conclusion, issues inspection reports documenting any specific instances in which the
auditor failed to adhere to professional standards (e.g., lacked auditor independence, failed to
conduct appropriate or sufficient testing in the circumstances at hand, or arrived at improper
conclusions from the testing performed).Lennox and Pittman (2010)conclude that PCAOB reports
do not significantly impact a client’s choice of auditor because they lack disclosure of audit
quality control weaknesses and overall audit firm quality.3
In 2007, the AICPA voluntarily launched the Center for Audit Quality (CAQ)—a self-
contained, autonomous, nonprofit organization whose mission is to enhance investor confidence
and help fortify and stabilize the capital markets vis-a`-vis initiatives to enhance the reliability
of financial information. Recently, the CAQ wrote a letter to the International Auditing and
Assurance Standards Board expressing apprehension about the lack of publicly available
information pertaining to audits and the audit process. 4 Overall, these recent initiatives highlight
concerns from the public and regulators about audit quality, auditor independence, related audit
characteristics, and the need for supplemental and enhanced information to be made available to
investors.
BACKGROUND AND HYPOTHESES

Two streams of research are used to inform and derive the theoretical foundation for this
research. First, research and theory about cognitive biases and magnitude perceptions provide the
foundation for how investors perceive and make sense of data provided to them, particularly in the
absence of any referent data for comparison. Second, the extant literature on audit fees provides a
framework for understanding potential consequences of audit fees and a basis for anticipating how
audit fees might thereby influence investor beliefs about the organizations and the audits to which
they correspond. Together, these two streams of research can suggest how an investor might make
attributions about audit fee magnitudes and how these attributions might then influence other
beliefs about both the organizations providing the data and the audit work supporting the data. An
overview of the research on biases and perceptions follows. Relevant audit fee literature is
discussed in the hypothesis development subsections pertaining to the individual constructs.
Cognitive Bias and Magnitude Perceptions Theories

Prior research about cognitive biases indicates that, in the absence of specific data, individuals
tend to rely on heuristics to simplify, make sense of, and make decisions based on data that have
some level of associated uncertainty(Tversky and Kahneman 1974).The use of heuristics or the
existence of bias in human judgment is not a new phenomenon and helps to explain the lack of
rationality often exhibited by decision makers. Based on an extensive review of the bias literature
byArnott (2006),we identify two potential biases that can influence perceptions of data by
investors, particularly in the absence of additional data that explain the information.
First, representativeness(Arnott 2006)is a bias leading individuals to erroneously ascribe
certain characteristics or values to objects based on their apparent characteristics or similarity to
other groups. In this situation, individuals may mistakenly take an object (audit fee) and
inaccurately associate that data to another group because they believe the object to share
characteristics of the group. This occurs when there is inadequate information to ascertain that the
3
In response to more recent concerns about the lack of audit information available to investors, the PCAOB is
currently considering four potential modifications to the current format of the auditor’s report.
4
The letter was dated September 15, 2011, and is available at:http://thecaq.org/pub licpolicy/CommentLetter/
CAQCommentLetter-IAASBConsultationPaperonValueofAuditorReporting.pdf
object is in fact a member of that group, based on the limited data provided about the group
(Tversky and Kahneman 1974; Arnott 2006).Prior research demonstrates that the representative-
ness bias can significantly affect decision making, causing individuals to incorrectly base
perceptions on a limited data set and ascribe certain value to it(Uecker and Kinney 1977).Thus, in
the audit fee setting, if individuals perceive an audit fee as being ‘‘representative’’ of the audit fees
for similar organizations, they may incorrectly ascribe certain characteristics (e.g., average audit
quality) to the audit. In the absence of additional information to suggest that the size of an audit fee
is atypical, we conjecture that investors will, by default, assume that the audit fees presented and
their associated characteristics are about average. If users fail to identify ‘‘outlier’’ situations in
which a fee is abnormally high or low, they may also consequently fail to associate such an
unusually high or low audit fee with its related consequences, thus assuming that the levels of
various associated audit characteristics are about average.
Second, not only do individuals often unknowingly rely on limited information when
associating objects to groups, but prior research also indicates that individuals are frequently
overconfident in their ability to assess and estimate values due to their inability or unwillingness to
use all available information available to them(Joyce and Biddle 1981). Block and Harper (1991)
find that individuals frequently do not realistically assess their own ability to estimate, and thereby
make poor ascriptions about data. In the presence of information that helps identify the appropriate
base rate for comparison of a value, individuals can make better assessments of a value(Lim and
Benbasat 1997).However, in the absence of ad ditional information, individuals remain
overconfident in their estimates due to an unawareness of the gaps in their available information,
exacerbating the extent of any incorrect inferences about the magnitude of data. Thus, investors
who fail to recognize that they have significant gaps in their knowledge about audit characteristics
may tend to make even less accurate attributions of audit fee data.
Hypotheses
Investors develop perceptions of company and auditor attributes through disclosures provided
in the financial statements, including audit fee disclosures(Khurana and Raman 2006; Ghosh et al.
2009).At various times, supplementary disclosures have been suggested or mandated to increase
the information set available to investors, magnifying the importance of understanding how added
disclosures might impact investor decision making. The PCAOB recently requested public
comments on proposed modifications to the current audit report format. However, at times,
regulators have actually gravitated away from requirements to present additional disclosures (e.g.,
audit partner signatures). In these situations, it becomes imperative to understand investor
perceptions in the absence of additional information or disclosures. In this section, we develop
hypotheses about how investors will perceive various audit characteristics in light of audit fee
information, both with and without additional relative fee information. These hypothesized
relationships are explained next.
Perceived Auditor Independence

Auditor independence is one audit characteristic that is of utmost concern to both the investing
public and regulators. As Arthur Levitt, chairman of the SEC, stated, ‘‘It is not enough that the
accountant on an engagement act independently. For investors to have confidence in the quality of
the audit, the public must perceive the accountant as independent’’ (Levitt 2000).The SEC deems
that, ‘‘an auditor’s independence is impaired either when there is direct evidence of subjective bias
such as through a confession or some way of recording the auditor’s thoughts, or when, as in the
ordinary case, the facts and circumstances as externally observed demonstrate, under an objective
standard, that an auditor would not be capable of acting without bias’’ (SEC 2001).
Auditor independence is associated with the likelihood that the auditor will report a detected
misstatement.5 Investors cannot directly observe an auditor’s true state of independence (auditor
independence in fact), and neither can they observe audit failures unless they are made public vis-
a`- vis financial restatements. Therefore, we examine investor perceptions of auditor
independence.
Concerns exist that auditor independence can be impaired when audit fee values are either
extremely high or extremely low. Ex ante, it is difficult to anticipate whether users of the financial
statements will exhibit relatively greater concern about abnormally high fees versus unusually low
fees, or equal concern about both.
The theory of economic rents suggests that high audit fees create an economic bond between
the auditor and the client, thereby impairing auditor independence because the firm becomes less
willing to lose or dismiss clients(Simunic 1984; Davis et al. 1993).Economic bonding may lead
auditors to cave in to pressure from their clients, e.g., not require them to book correcting entries,
which can ultimately impair financial reporting quality(Simunic 1984; Beck et al. 1988). Brandon
and Mueller (2006)provide evidence that jurors perceive auditors to be less objective and more
deserving of blame and punishments in the presence of greater economic dependence on the client,
as measured by the ratio of a client’s audit fee to the total audit fees for the audit firm office.
Fortunately, two important factors counteract the incentives created by economic bonding.
First, an auditor must weigh such decisions against the potential reputational costs of being
associated with poor quality work and losing other clients(Weber et al. 2008).Second, auditors
may be subject to lawsuits for malpractice, as they are known for having ‘‘deep pockets’’
(DeAngelo 1981).
Archival studies provide mixed evidence concerning which set of objectives outweighs the
other. Hoitash et al. (2007)document a negative relation between abnormal fees and audit quality,
concluding that economic bonding effects outweigh auditor reputational concerns.Ghosh et al.
(2009) find that investor perceptions of auditor independence (measured by earnings response
coefficients) are negatively associated with client importance. However,Larcker and Richardson
(2004)find a negative association between abnormal accruals and audit fees, concluding that
reputational concerns prevail.Ashbaugh et al. (2003)find no association between positive
discretionary accruals and audit fees, total fees, or any fee ratio metric.Chung and Kallapur
(2003)draw a similar conclusion.
Reputational concerns notwithstanding, the existence of high audit fees visible in financial
statements suggests a strong economic relationship, which can serve as a cue to the investor that
auditor independence may be impaired. However, given that several archival studies fail to find
evidence that economic bonding outweighs reputational concerns, we hypothesize (in null form):
H1: There is no significant association between perceived auditor independence and audit fee
relative size.
Perceived Auditor Effort

The diligence of an auditor can influence the likelihood with which he/she detects any
financial statement errors present in the financial statements, thus having a substantial impact on
the quality of an audit. However, auditor effort is difficult to measure, particularly in the U.S.,
where audit hours are not publicly available information. In a service industry such as the audit
industry, costs are largely driven by the amount of time spent performing the services. Therefore,
perceptions of auditor effort may be strongly associated with audit fee size. As an audit service
firm will presumably price its engagements so as to earn a profit, it can be expected that audit
fees increase
5
‘‘The conditional probability of reporting a discovered breach is a measure of an auditor’s independence from a
given client’’ (DeAngelo 1981).
commensurately with auditor effort. A seminal paper bySimunic (1980)finds that audit hours (a
proxy for auditor effort) are the largest cost driver for audit services. More recent archival
research also affirms that audit fees are an increasing function of auditor effort.Schelleman and
Knechel (2010)demonstrate that firms with higher levels of short-term accruals require greater
auditor effort and that this incremental auditor effort is priced into audit fees.Prawitt et al.
(2011)demonstrate that in instances where the internal audit function provides greater assistance
to the external auditor, there is an accompanied reduction in audit fees. Thus, an implicit finding
of their study is that there is a positive structural relation between auditor effort and audit fees.
Consistent with this conclusion,Hammersley et al. (2012)show that firms that neglect to take
remedial action to address material weaknesses in internal controls pay higher audit fees in
subsequent periods. Naturally, the presence of internal control problems would necessitate greater
substantive audit testing efforts. Based on the these findings from previous research, we
hypothesize that:
H2: Perceived auditor effort is positively associated with audit fee relative size.
Perceived Financial Statement Error

A primary concern for investors is the possibility that a material financial statement error
remains undetected by the audit or withstands correction by the auditor, resulting in an eventual
financial restatement. As stated in United States v. Arthur Young & Co., 465 U.S. 805 (1984),
‘‘the SEC requires the filing of audited financial statements in order to obviate the fear of loss
from reliance on inaccurate information, thereby encouraging public investment in the Nation’s
industries. It is therefore not enough that financial statements be accurate; the public must also
perceive them as being accurate.’’ In order for a financial statement error to exist in the financial
statements after an audit, the following conditions must be met. First, a financial statement error
must be present in the financial statements prior to the audit, and second, the auditor must be
either unable to detect it or unwilling to require correction of the financial statement error. A lack
of auditor effort could prevent an auditor from detecting a misstatement, and a lack of auditor
independence could result in a detected financial statement error withstanding correction.
Therefore, the likelihood with which a financial statement error prevails in the financial
statements after an audit should be a joint outcome of (1) a company’s ex ante accounting quality,
(2) auditor effort, and (3) auditor independence, among other factors.
Earlier, we hypothesized that greater perceived auditor effort would be associated with larger
audit fees. However, based on economic bonding theory, we also hypothesized that investors
would meanwhile perceive reductions in auditor independence as audit fees increase. As these two
effects would appear to exert opposing influences on user perceptions of the level of remaining
financial statement error in a company’s financial statements subsequent to an audit, we appeal to
prior literature to develop a hypothesis as to how user perceptions of the level of ex post financial
statement error will vary with audit fees.
Prior archival research finds evidence that unexpectedly large audit fees are associated with
inferior audit quality(Choi et al. 2010b),and that abnormal values for audit fees and total fees are
associated with an increase in the likelihood of a PCAOB-identified audit deficiency or serious
deficiency(Gunny et al. 2007). Choi et al. (2010b)conclude that there is a significant positive
relation between abnormally positive (large) audit fees and the magnitude of companies’
discretionary accruals.Kinney et al. (2004)find a positive association between restatements and
fees related to information system design or internal audit, andFeldmann et al. (2009)find that
firms making restatements actually pay greater audit fees (due to increased audit risk). Finally,
Hribar et al. (2010)document a significant positive association between the magnitude of
unexplained audit fees and the likelihood of accounting restatements, indicating that abnormally
high audit fees are associated with undesirable financial reporting outcomes.
However, numerous studies provide evidence to refute these conclusions.Stanley and
DeZoort (2007)assert that larger audit fees are a ssociated with a reduced likelihood of a future
financial restatement.Keune and Johnstone (2012)find that in the presence of larger audit fees,
auditors become less likely to waive accounting adjustments for material misstatements.
Schneider (2010)finds no evidence that either audit fees or ‘‘revenue dependence’’ by the auditor
affects lending decisions, which suggests that external constituents do not perceive a reduction in
the reliability of financial information when there are high audit fees. Together, the findings of
this latter group of studies suggest that financial reporting quality is not impaired in the presence
of high audit fees.
Here, we attempt to measure the extent to which investors associate a perceived likelihood of
uncorrected errors in the financial statements with the size of a company’s audit fees. Given that
prior literature has provided mixed results regarding the association between audit fees and
financial statement errors, we do not make a specific directional hypothesis regarding the
association between the level of perceived financial statement error and the relative magnitude of
audit fees. Instead, we present the following null hypothesis:
H3: There is no significant association between perceived financial statement error and audit
fee relative size.
Perceived Audit Quality

Ultimately, audit quality is crucial because it can impact the reliability of a company’s
financial statements and its future business riskiness as an investment. As discussed previously,
audits are not performed with equal levels of quality, and we believe that audit fees convey an
important information content that can help or hinder the manner in which investors assess the
overall quality of an audit. Thus, we measure user perceptions of audit quality.
DeAngelo (1981)defines audit quality as the joint probability of detecting and reporting
material misstatements. It is related to audit risk, which is ‘‘the risk that an auditor may fail to
modify the opinion on financial statements that are materially misstated’’ (AICPA 1994; Watkins
et al. 2004).Audit quality is not directly observable, although prior research has developed a host
of surrogates for it including, but not limited to, a likelihood of receiving a going concern opinion,
abnormal discretionary accruals, meet or beat analysts’ forecasts, and likelihood of a restatement
(Reynolds and Francis 2000; Romanus et al. 2008; Francis and Yu 2009).
Audit quality may be regarded as an outcome of several inputs that include auditor
independence, auditor effort, and auditor willingness to mandate correction of any financial
statement errors that do exist, among other factors(Caramanis and Lennox 2008; Brandon et al.
2012).User perceptions of audit quality should be partially dependent upon these three attributes.
We previously conjectured that users’ perceptions of auditor effort would be an increasing
function of audit fees. However, we also presented evidence from prior literature indicating that
auditor independence could be impaired and financial statement error may increase in the presence
of larger audit fees. This could offset any perceived gains in audit quality attributable to increased
effort. Thus, depending on the extent to which individual investors perceive and weight these
issues, their conclusions about audit quality may diverge.
In addition, it is possible that perceptions of post-audit financial statement errors could be
uncorrelated with audit fees. For example, if users assume that a company has low levels of pre-
audit financial statement errors, they may not perceive audit fees to have any marginal impact on
auditors’ ability to detect or willingness to correct financial statement errors.
Accordingly, we present a non-directional hypothesis regarding the association between user
perceptions of audit quality and audit fees:
H4: There is no significant association between perceived audit quality and audit fee relative
size.
Perceived Business Risk

Finally, we anticipate that in addition to making inferences about the aforementioned audit
characteristics, investors may draw inferences from audit fees about future business risk.Mishra et
al. (2005)conclude that SEC-mandated audit fee disclosures provide important and useful
information to the market for assessing business risk and for making investment and voting
decisions. Therefore, we examine whether audit fee information influences investor perceptions of
business risk.
Prior research(Stanley 2011; Hackenbrack et al. 2011)indicates that audit fees provide a
forward-looking indication of the level of a company’s future business risks. Numerous studies
indicate that elevated company risk may be a precedent for higher audit fees.Hoitash et al. (2008)
andMunsif et al. (2011)both document that higher audit fees are charged to companies having
previous internal control problems. Similarly,Ashbaugh-Skaife et al. (2009)find that ‘‘firms with
internal control deficiencies have significantly higher idiosyncratic risk, systematic risk, and cost
of equity,’’ thereby concluding that higher audit fees could be associated with higher risk.Hay et
al. (2006)perform a literature review and meta-analysis, and find that systematic risk is positively
associated with audit fees in the literature. More recently,Hackenbrack et al. (2011)andStanley
(2011)provide empirical evidence that audit fees are a leading indicator of a company’s level of
future business risk. Specifically,Hackenbrack et al. (2011)find that changes in audit fees are
positively associated with various surrogates for a firm’s idiosyncratic risk, including negative
future stock returns, debt rating downgrades, and lawsuits.Stanley (2011)demonstrates that
changes in operating performance are negatively associated with audit fees over a window up to
five years into the future. Overall, these studies suggest that higher business risk should be
associated with higher audit fees. Thus, we propose the following hypothesis:
H5: Perceived business risk is positively associated with audit fee relative size.
Absence of Relative Size

As we are unaware of any prior behavioral research directly investigating investor
perceptions of audit fees, we hypothesize, based on the psychology literature previously
discussed, that when investors lack cues to suggest that a value is abnormally ‘‘high’’ or ‘‘low,’’
they will take a middle- of-the-road approach in their assessments, essentially perceiving each of
the audit characteristics as ‘‘average.’’ They have little basis for assessing the magnitude of an
audit fee value. This viewpoint is consistent with prior literature on cognitive biases which
indicates that, in the absence of relative indicators, individuals will likely assume that a target
company is fairly representative of all organizations and accordingly assume that their financial
information is representative of similar organizations, or ‘‘average’’ (Tversky and Kahneman
1974).Therefore, we hypothesize:
H6: In the absence of relative indicators, when investors are provided with audit fee data,
they perceive (H6a) auditor independence, (H6b) auditor effort, (H6c) financial
statement error, (H6d) audit quality, and (H6e) business risk as being average.
RESEARCH METHOD
To address our research questions, we utilized a 1 3 4 factorial design, randomly assigning
participants to one of three levels of audit fee relative size or to a control group receiving no
additional relative size indication other than the audit fee itself. The relative magnitude of the
audit fee differed among participants having the additional benchmark information. While one
treatment
group was presented with a company that had an average audit fee relative to its industry, the
second treatment group was assigned to a company with an abnormally low audit fee, and the
third treatment group was given a company that had an unusually high audit fee. We examine how
the perceptions of participants differ across the treatment groups (3) and also contrast perceptions
of the treatment group having the average relative fee with the perceptions of a control group (1)
that did not receive additional disclosures.
Participants
One hundred and fourteen accounting students were recruited to participate in the experiment.
These students were enrolled in an undergraduate auditing course and were therefore familiar with
the basic premises of auditing. The instrument was administered in two different semesters, but in
the same course. The participants were randomly assigned to groups, and an initial ANOVA
verified that there were no differences between the four groups in terms of age, gender, or
investing experience.
Task
The task performed by the participants required them to provide their perceptions about an
audit derived from viewing the financial statements of a fictitious company as part of information
presented in a case. Participants were provided with case materials that included basic financial
information about the company and an audit fee disclosure similar to that which would be found
in an annual financial statement. After reading the information in their case materials and
reviewing the audit fee disclosure, the participants were then surveyed regarding their perceptions
of the audit and the company. Through a series of specific questions, participants were asked to
provide their perceptions of auditor independence, auditor effort, financial statement error, audit
quality, and business risk.
Independent Variable
The independent variable is the audit fee relative size in the disclosure information that was
provided to the participants. Each of the four cases had the same financial information for the
scenario company, as well as the same audit fee. The audit fee paid and the financial information
provided about the company were taken from the most recent 10-K filing of a company traded on
the New York Stock Exchange. The relative size for each audit fee as compared to its industry
was arbitrarily created, with the low fee ranking in the 6th percentile, the average fee ranking in
the 52nd percentile, and the high fee ranking in the 96th percentile. 6 We selected percentiles that
were further from the center than the first and third quartiles for several reasons. First, this design
ensures that if there is no difference in perception between the average (52nd percentile) and the
tails (6th percentile and 96th percentile), we can be confident that we did not fail to detect a
change in perception simply because our rankings were too close together. Second, we
specifically designed our percentiles to be more extreme to force separation among the groups that
were given percentiles. This allows for a better comparison with the group that received no
additional information (no percentiles), which is the primary group of interest. Finally, the goal of
our study is to find differences in perceptions, not to identify the specific fee threshold where
differences in perceptions begin to emerge. Future research may seek to examine at what
percentiles investor perceptions begin to change. The audit fee was taken directly from the 10-K
filing so that it would be proportional to the size of the company that we described.7
6
The audit fee remained the same in all cases. The only change was the disclosed percentile ranking.
7
The company whose audit fee we selected is a Fortune 500 company. The average audit fee for Fortune 500 companies
is ‘‘almost $10M,’’ according to a report byAlvarez & Marsal (2007).The audit fee used of $9.8M is representative.
The manipulation of disclosure information was similar to that performed byDopuch et al.
(2003).While the audit fee dollar amount was the same for all participants, the indication
regarding the relative size of an audit fee in comparison to other companies in the same industry
differed across the treatments. Prior research indicates that the size and complexity of the client
are significant cost drivers in an audit, as they are the largest determinants of the number of hours
spent in the auditing process(Davis et al. 1993; Stein et al. 1994).Similarly,Hay et al. (2006)find
that company size alone explains more than 70 percent of the variation in audit fees. Accordingly,
we control for a company’s industry by supplying a percentile ranking for audit fees relative to
other firms in the industry whenever additional audit fee information is presented. We do not
explicitly state in our instrument that the auditor is independent in fact or appearance. The
Securities Act of 1933 requires financial statements to be certified by an independent accountant,
so we only explain that this is a Big 4 auditor auditing a company that is publicly traded on the
New York Stock Exchange (NYSE).
Dependent Variable
The hypotheses make predictions concerning investor perceptions of five characteristics
related to the audit and the company: auditor independence, auditor effort, financial statement
error, audit quality, and business risk. Investor perceptions of these attributes serve as the
dependent variables for our analysis. All variables were measured using items employing a seven-
point Likert scale (1 ¼ Strongly Disagree, 7 ¼ Strongly Agree).
Perceived auditor independence is defined as the perception that an auditor is objective and is
not willing to be persuaded by audit fees or a close relationship with the client(SEC 2001).After
viewing the various audit fee relative size indicators, participants were asked questions to
determine their perceived level of auditor independence. The literature often tests auditor
independence based on audit and/or non-audit fee measures(Chung and Kallapur 2003; Kinney et
al. 2004; Larcker and Richardson 2004).Five items were used to measure this perception. The
items focused on investor perceptions of auditor independence (auditor independence in
appearance). The items exhibited adequate reliability for a newly developed measure (alpha ¼
0.64)(DeVellis 1991).Appendix A contains the items for each construct.
Perceived auditor effort is defined as an investor’s perception of the energy and resources that
the auditor has expended on the execution of the audit. Audit fees are based on the time that the
auditors spend auditing the client. Generally, audit hours should be reflected in the audit fees, and
audit hours are correlated with auditor effort. Furthermore, research has also indicated that auditors
can increase auditor effort by elevating the experience level of the personnel assigned to an
engagement, which also increases fees(Schelleman and Knechel 2010).Fees have served as the
primary proxy for auditor effort in the literature(Liu and Wang 2006).Three items were used to
measure this variable. The items focused on investor perceptions of the amount of auditor effort
expended in the audit. The items exhibited acceptable reliability (alpha ¼ 0.86).
Perceived financial statement error is defined as the extent to which financial statement
errors are perceived by an investor to exist in the financial statements and withstand correction by
the auditor. Previous research has examined the relation between audit judgments and financial
statement errors(Kinney 1979; Butt 1988).While participants have no real indication of financial
statement error, they are able to develop perceptions of financial statement error based on the
audit fee relative size. Three items were used to measure participants’ perception that errors
existed in the financial statement information. The focus of the items was to assess participants’
perceptions of the financial statements after the audit has been performed and to assess what
impact various audit fee relative size indicators have on perceptions of error in the financial
statements. The items exhibited adequate reliability for a newly developed measure (alpha ¼
0.67)(DeVellis 1991).
Perceived audit quality is defined as the perception that the auditor will both discover a
material misstatement and report it(DeAngelo 1981).Audit quality has frequently been measured
using abnormal accruals, financial statement restatements, or other surrogates for accounting
‘‘irregularities’’ developed in the archival literature(Reynolds and Francis 2000; Romanus et al.
2008; Francis and Yu 2009).Four items were used to measure audit quality from a broad
perspective. The items focused on perceptions of the overall quality of the audit. The focus was
not the quality of the company or investment. The items exhibited acceptable reliability (alpha ¼
0.91).
Perceived business risk is defined as the perception that the company’s economic condition
will deteriorate in either the short or long term(Huss and Jacobs 1991).The impact of the external
audit function on business risk has been assessed previously(Johnstone 2000; Stanley 2011).
However, our focus is to measure investor perceptions of business risk based on the audit fee
relative size. Four items were used to measure investors’ perception of business risk. The items
exhibited acceptable reliability (alpha ¼ 0.84).
Control Variables
Data collection period was included as a control variable to factor out any differences due to
participants providing data during the two different collection periods. The factor was coded as
1,0, indicating whether the data were collected in the first or second time period.
Invests was also included as a control variable to account for the influence of participant
investing experience on outcomes. This factor was coded as 1,0, indicating whether the participant
had investing experience.
Procedures
Participants were recruited through announcements in an undergraduate auditing course.
While no monetary reward was provided, participants were incented to participate via bonus
points in the course. Participants were awarded points based on participation rather than monetary
incentives based on performance. Our focus is on participant perception, not performance. We did
not want to cloud perceptions by incentivizing some type of performance. Participants were
provided with brief instructions of the study process. They were then provided with an
information sheet, the case, and the corresponding questionnaire all clipped to the front of an
envelope. All participants were presented with the same questions to measure perceptions for each
of the five dependent variables. The participants were instructed that once the questionnaire was
completed, it should be placed in the envelope and not be referenced. Participants were observed
while completing the questionnaires to ensure that they did not deviate from the directive. After
reviewing the case and completing the questionnaire, participants were instructed to complete a
separate questionnaire. This second set of items included questions to determine the participants’
perceptions of the riskiness of the current stock market, their likelihood of investing in the market,
their perceptions about the role of audits and auditors, as well as a manipulation check for the
independent variable. Participants took approximately 20 minutes to complete both phases of the
study. A time limit was not imposed on the participants.
RESULTS
Descriptive Statistics
One hundred fourteen participants completed the experiment. To verify the success of the
treatment, participants were asked a manipulation check question to determine whether they had
accurately recognized their treatment group. Only two participants incorrectly identified their
treatment group and were subsequently dropped from the analysis, resulting in 112 cases for
analysis. Table 1 displays the number of participants (n) by data collection period, audit fee
relative
TABLE 1
Between-Subject Factors
n
Data collection period 1 49
2 63
Audit fee relative size None 30
Low 26
Average 28
High 28
Invests 0 64
1 48
size (treatment), and investing experience (invests). The average age of the participants was 22.8,
and 41.2 percent were female. The majority of the participants were accounting majors (89.4
percent), and 42 percent of the participants reported that they were currently or had been investors
in the stock market. Table 2 displays the descriptive statistics for the dependent variables by
treatment and construct.
The descriptive statistics for auditor independence show the most variation. The participants
assigned to the low relative audit fee group were neutral (mean ¼ 19.08, assuming a neutral score
of 20 [rating of 4 3 5 items]) when it came to their perceptions of auditor independence. They
neither agreed nor disagreed with the statements assessing auditor independence. However, all
other groups were skeptical of auditor independence. The group with the high relative audit fee
was most skeptical of auditor independence, as its participants indicated that they disagreed that
the auditor was independent (mean ¼ 12.00). The group with the average relative audit fee was
skeptical of
TABLE 2
Descriptive Statistics
Auditor Auditor Financial Audit Business
Independence Effort Statement Error Quality Risk
(5 Items) (3 Items) (3 Items) (4 Items) (4 Items)
Group Mean (SD) Mean (SD) Mean (SD) Mean (SD) Mean (SD)
No additional information 12.90 (3.3) 14.77 (3.1) 11.26 (3.1) 17.57 (4.2) 19.50 (3.9)
n ¼ 30
Low relative audit fee 19.08 (4.0) 10.77 (4.2) 10.73 (3.0) 14.35 (5.9) 18.54 (4.8)
n ¼ 26
Average relative audit fee 14.96 (4.3) 14.29 (3.0) 10.46 (2.6) 17.57 (4.1) 20.46 (3.2)
n ¼ 28
High relative audit fee 12.00 (3.6) 15.00 (3.3) 10.75 (3.5) 18.61 (5.1) 19.64 (4.7)
n ¼ 28
Descriptive statistics are displayed by group and construct. The audit fee for each group remained unchanged while the
relative range presented in addition to the fixed audit fee did change—no relative range (no additional information), low
relative audit fee, average relative audit fee, and high relative audit fee. The data were coded such that an increase in
magnitude for any construct would indicate an increase in perception of that construct. The mean is calculated by
summing the seven-point scale scores for all observations and dividing by the total observations.
TABLE 3
Multivariate ANOVA
Effect Value F Hypothesis df Error df Sig.
Intercept 0.994 3338.825 5 102 0.000
Group 0.498 4.137 15 312 0.000
Data collection period 0.129 3.013 5 102 0.014
Invests 0.126 2.947 5 102 0.016
Multivariate tests were performed to test for significance of the model and for significant differences between groups.
The measured perceptions of the constructs serve as the dependent variable. The independent variable is the fee-level
treatment. The model controls for data collection time as well as investing experience. Both control variables are binary
variables as data were collected only twice and investing experience is a yes or no answer. ‘‘Value’’ represents the test
statistic for each effect.
auditor independence, but not to the extent of the high relative audit fee group (mean ¼ 14.96).
Interestingly, the perceptions of the group that was given no additional information were similar
to those of the group with the high relative audit fee (mean
¼ 12.90). These participants indicated
that they disagreed with the statement regarding auditor independence.
Regarding perceptions of auditor effort, Table 2 indicates that the group with no additional
information ‘‘slightly agreed’’ with items indicating that the auditors exerted sufficient auditor
¼
effort on the engagement (mean 14.77, assuming a neutral score of 12 [rating of 4 3 3 items]).
The group with the low relative audit fee was most skeptical of auditor effort (mean ¼ 10.77). As the
relative audit fee levels increased, perceptions of auditor effort increased, as expected.
The statistics for financial statement error are fairly similar across all four groups. The
statistics for each group are just below the neutral value of 12.00 (rating of 4 3 3 items). This
indicates that they did not perceive financial statement error to change as a result of changes in
relative audit fee levels. All groups similarly perceived that the business risk of the company was
higher rather than lower regardless of relative audit fee (all above neutral value of 16.00 [rating of
4 3 4 items]). Finally, all groups other than the low relative audit fee group had a slightly positive
perception of audit quality (above the neutral value of 16.00 [rating of 4 3 4 items]). The low
relative audit fee group had a slightly negative perception of audit quality (mean ¼ 14.35).
Multivariate and Univariate Results

To assess the influence of the independent variable, relative fee size, on the dependent
variables (auditor independence, auditor effort, financial statement error, audit quality, and
business risk), we first performed multivariate analyses to test for significance of the model and
for significant differences between the treatment groups. We control for data collection period by
using a binary variable (data collection period) to assign a time to each participant in our sample
since the data were collected on two separate dates. We also control for investor experience by
including a binary variable equal to 1 if the participant had investing experience. Table 3 displays
the results for the multivariate analysis. Based on the multivariate tests, we find that the effect of
the treatment is significant
¼ (F(15, 312) 4.137, p 0.000). The significance of the group variable
indicates that there are significant differences between the treatment groups’ perceptions of the
constructs. Given the significance of the treatment variable, additional examination of the
univariate statistics was performed (see Table 4).
The results of the univariate analyses indicate that there are significant differences between
the treatment groups with respect to perceptions of auditor independence (F(3, 106) ¼ 18.352, p ¼
0.000),
TABLE 4
Univariate ANOVAs
Type III Sum Mean
Source Dependent Variable of Squares df Square F Sig.
Corrected model Auditor independence 821.973 5 164.395 11.328 0.000
Auditor effort 440.861 5 88.172 8.252 0.000
Financial statement error 49.702 5 9.94 1.078 0.377
Audit quality 312.552 5 62.51 2.653 0.027
Business risk 61.713 5 12.343 0.688 0.634
Data collection period Auditor independence 0.305 1 0.305 0.021 0.885
Auditor effort 89.219 1 89.219 8.35 0.005
Audit quality 9.437 1 9.437 0.401 0.528
Business risk 0.241 1 0.241 0.013 0.908
Group Auditor independence 798.966 3 266.322 18.352 0.000
Auditor effort 331.012 3 110.337 10.327 0.000
Audit quality 283.325 3 94.442 4.008 0.010
Business risk 42.642 3 14.214 0.792 0.501
Invests Auditor independence 20.676 1 20.676 1.425 0.235
Auditor effort 42.962 1 42.962 4.021 0.047
Audit quality 31.012 1 31.012 1.316 0.254
Business risk 11.268 1 11.268 0.628 0.430
Error Auditor independence 1538.277 106 14.512
Auditor effort 1132.559 106 10.685
Financial statement error 977.361 106 9.22
Audit quality 2497.724 106 23.563
Business risk 1901.965 106 17.943
Total Auditor independence 26316 112
Auditor effort 22831 112
Financial statement error 14121 112
Audit quality 35485 112
Business risk 44786 112
Corrected total Auditor independence 2360.25
Auditor effort 1573.42
Financial statement error 1027.063
Audit quality 2810.277
Business risk 1963.679
Univariate tests were performed to test for significant difference between groups by dependent variable. The measured
perceptions of the constructs serve as the dependent variable. The groups are defined by the fee-level treatment. The
ANOVA procedure tests the effect of the group and is based on the linearly independent pair-wise comparisons among
the estimated marginal means.

auditor effort (F(3, 106) ¼
10.327, p ¼ ¼ p 0.010). Given the
0.000), and audit quality (F(3, 106) 4.008,
¼ conditions, we continue hypothesis testing to evaluate the
significant influence of our treatment
differences between these constructs across the treatment groups.
Hypothesis Tests, Pair-Wise Comparisons

H1 states that there is no association between perceptions of auditor independence and audit
fee relative size. However, descriptive statistics in Table 2 indicate that as the relative size of audit
fees increases, participants perceive greater impairments in auditor independence. Pair-wise
comparisons in Table 5 are consistent with the descriptive statistics, as perceptions of auditor
independence were significantly different based on relative audit fee size. Participants presented
with the unusually low audit fees perceived the greatest impairment to independence, followed by
participants assigned the average audit fees and then participants given the high relative audit fees,
respectively. The differences in perceptions between the low and average fee groups and between
the average and high fee groups are both significant, ¼p 0.002 and p 0.017, respectively.
Furthermore, we find a significant difference between low and high fees, p¼0.000. As a result, we
reject H1 (null).
H2 states that audit fee relative size is positively associated with greater perceived auditor
effort. Descriptive statistics in Table 2 indicate that as the relative size of the audit fee increases,
participants perceive greater auditor effort. Mean differences support our hypothesis, and pair-
wise comparisons indicate that there is a significant difference in the perceptions between the low
and high relative audit fee groups ¼ (p 0.000), as well as the low and average relative audit fee
¼ (p 0.000). There was no significant difference between perceptions of investors assigned
groups
to the average and high relative audit fees. As a result, we find partial support for H2.
H3 states that there is no association between perceptions of financial statement error and
audit fee relative size. Given the lack of a significant treatment effect on perceptions of financial
statement error in the univariate tests, we do not reject H3.
H4 states that there is no association between perceptions of audit quality and audit fee
relative size. Descriptive statistics in Table 2 indicate that as the relative size of audit fees
increases, participants perceive higher audit quality. The pair-wise comparisons indicate that
significant differences exist between the low and average relative size ¼ groups ( p 0.064), as well
¼ (p 0.010). However, there is not a significant difference in
as the low and high relative size groups
perceptions of audit quality between the average and high audit fee relative size groups.
Therefore, we find partial support for H4.
H5 states that audit fee relative size is positively associated with greater perceived business
risk. Given the lack of significance in our model for treatment on business risk in the univariate
tests, we find no support for H5.
H6 states that in the absence of an audit fee relative size indicator, audit fees are associated
with average perceptions of auditor independence, auditor effort, financial statement error, audit
quality, and business risk.8 To test this hypothesis, we examine the pair-wise comparisons to see if
there are significant differences in perceptions of the dependent variables between participants
receiving no fee information and those receiving low or high audit fee relative size information.
Again referring to the pair-wise comparisons in Table 5, we see that perceptions of participants
not provided any audit fee relative size information were not significantly different from those
participants presented with higher or average audit fee relative size information for auditor
independence, auditor effort,
8
Table 5 only provides the pair-wise comparisons for auditor independence, auditor effort, and audit quality. We
have no reason to believe that pairwise comparisons would provide any insight for financial statement error and
business risk, given the lack of significance for these variables in our univariate tests.
TABLE 5
Pair-Wise Comparisons
Comparison Mean
Dependent Variable Treatment Group Group Difference Sig.
Auditor independence No additional information Low —6.119 0.000

Average —2.191 0.191
High 0.958 1.000
Low relative audit fee No addl. info 6.119 0.000
Average 3.928 0.002
High 7.078 0.000
Average relative audit fee No addl. info 2.191 0.191
Low —3.928 0.002
High 3.15 0.017
High relative audit fee No addl. info —0.958 1.000
Low —7.078 0.000
Average —3.15 0.017
Auditor effort No additional information Low 4.101 0.000
Average 0.237 1.000
High —0.14 1.000
Low relative audit fee No addl. info —4.101 0.000
Average —3.863 0.000
High —4.241 0.000
Average relative audit fee No addl. info —0.237 1.000
Low 3.863 0.000
High —0.377 1.000
High relative audit fee No addl. info 0.14 1.000
Low 4.241 0.000
Average 0.377 1.000
Audit quality No additional information Low 3.299 0.077
Average —0.182 1.000
High —0.966 1.000
Low relative audit fee No addl. info —3.299 0.077
Average —3.481 0.064
High —4.264 0.010
Average relative audit fee No addl. info 0.182 1.000
Low 3.481 0.064
High —0.783 1.000
High relative audit fee No addl. info 0.966 1.000
Low 4.264 0.010
Average 0.783 1.000
Pair-wise comparisons were performed for each dependent variable that was found to have significant differences within
groups from the univariate ANOVA analysis. The measured perceptions of independence, effort, and quality are presented
along with the groups defined by the fee-level treatment.
and audit quality. However, we find that perceptions by participants not provided the audit fee
relative size information were significantly different from those with lower audit fee relative size
for auditor independence (p ¼ 0.000), auditor effort ( p ¼ 0.000), and audit quality ( p ¼ 0.077).

Audit Fees and Investor Perceptions of Audit Characteristics 89
This provides partial support for our hypothesis, indicating that the participant perceptions of
auditor

independence, auditor effort, and audit quality in the absence of relative fee information are
similar to participant perceptions derived from viewing average fees. However, participant
perceptions of auditor independence, auditor effort, and audit quality, in the absence of relative
fee information, are also similar to the perceptions of participants who were provided higher-than-
average relative fees. We know from the descriptive statistics that as the audit fee relative size
increases, perceptions of auditor effort and audit quality increase. This indicates a practically
important relationship between perceptions of auditor effort and audit quality, given no additional
fee information. Both auditor effort and audit quality are perceived as average or high in the
absence of relative fee information. We also know from the descriptive statistics that as the audit
fee relative size increases, perceptions of auditor independence decrease. The pairwise
comparisons indicate that those with no additional fee information perceive auditor independence
as low or impaired. This is a critical finding with implications for investor perceptions of auditor
independence given current fee presentations.
Discussion
The results indicate that as the relative size of the audit fee increases from low to high,
perceived auditor effort and perceived audit quality increase, while perceived auditor
independence decreases. More importantly, in the absence of an indication of audit fee relative
size, investors perceive audit effort and audit quality similarly to investors who are told that the
audit fee relative size is average to high, but their perceptions of auditor independence are similar
to those of investors who are told that the audit fee relative size is low.
Participants who were not given any additional information concerning the audit fee
perceived auditor effort similarly to participants provided with the average audit fee size indicator.
In the absence of information, they perceived auditor effort as slightly greater than did the
participants provided with average audit fee relative sizes, but perceived effort as lower than did
participants provided with the high relative audit fee. The same pattern is found with the audit
quality construct. As the relative audit fee increases from low to high, perceptions of audit quality
increased from low to high. This also makes intuitive sense based on the same reasoning as
described for auditor effort. In the case of no information, the perception of audit quality is the
same as it was for participants receiving the average relative audit fee. Like auditor effort, audit
quality is perceived as somewhat average in the absence of additional audit fee information.
Auditor independence was perceived differently, however. Participants perceived the low
relative audit fee as indicating the highest level of auditor independence. Perceived auditor
independence decreased as the relative size of the audit fee increased. This is similar to the finding
ofDavis and Hollie (2008),who examine non-audit fee disclosures in an experimental market and
find that as the ratio of non-audit fees to audit fees increases, potential investors perceive less
auditor independence. Interestingly, in our study, in the absence of information, participants
perceive relatively low auditor independence. Based on the findings of the other constructs, we
would expect this group to look somewhat average in its perceptions. This finding helps
supplement our understanding of investor perceptions of auditor independence by showing that, in
the absence of any other data, investors tend to be skeptical of auditor independence.
The other two constructs, business risk and financial statement error, show no results. For the
business risk construct, the mean perceptions do not significantly differ based on the relative size
of the audit fee provided. Even as perceived auditor effort and audit quality increase with higher
relative sizes of audit fees, investors do not perceive similar decreases in business risk. This
suggests that investors only view audit-related risk as a small component of business risk. The
method used to measure perceptions of business risk was more focused on company than audit
risk or financial statement risk. Investors likely properly assessed that high audit quality does
not
necessarily reduce the inherent business risk faced by the company or the numerous risks that are
external to the company and unaffected by the audit.
The level of perceived financial statement error also did not vary based on the relative size of
the audit fee provided. Table 2 shows that perceptions of financial statement error were not
significantly different across the various relative sizes of audit fee treatments. Given that users,
meanwhile, perceived differences in audit quality, this suggests that users define audit quality in a
broader realm than as a mere absence of financial statement errors after an audit, recognizing that
there can be differences in the quality of companies’ accounting estimates, even absent accounting
treatments that are blatantly erroneous. Not surprisingly, it seems that other factors may more
strongly impact perceptions of financial statement accuracy than the relative size of audit fees.
Limitations
As in all research, there are some potential limitations to the generalizability of the study’s
findings that should be acknowledged. The first limitation is the use of students as subjects.
Although 42 percent of the students reported some investing experience, their experience is likely
limited and not representative of that of individuals with more investment experience. However,
these students are likely representative of non-professional investors, who have less time and less
knowledge about financial statements and the ramifications of the information provided through
these statements.Elliott et al. (2007)provide an analysis of the effects of the use of students
(M.B.A.) as proxies for non- professional investors. The analysis rests on the integrative
complexity of the task being performed. Our participants were merely asked to report their
perceptions of given constructs. Given the low level of integrative complexity of this task, we feel
that our participants were fully capable of performing the tasks. Furthermore, given our interest in
the manner in which non-professional investors develop perceptions about an organization and
audit work performed on the basis of financial statement information, these participants likely go
through similar assessment processes to develop these perceptions and are likely valid
representatives of that investing group. We have no reason to believe that using graduate students
or ‘‘professional’’ investors would have dramatically improved our external validity given our
focus on perceptions. While different groups such as M.B.A.s or analysts may have resulted in
different mean observations by construct, the variations between groups (our primary focus)
should remain unchanged. However, this is certainly an avenue for future research. As our control
variable for investing experience indicates that prior investment experience does influence results,
additional research is warranted to determine the nature of this influence and the extent to which it
is strengthened or weakened with varying degrees of investment experience.
Another limitation is that the participants were mostly accounting majors in an auditing
course. This may have caused them to overweight the importance of the audit fee because they
were more aware of its implications. Our subjects should be at least as informed, if not more so,
than the population to which this study strives to generalize. As a result, the results should be
considered tentatively in regard to generalization of specific portions of the results to the investing
public. However, we feel that the assessment and perceptual processes exhibited by our subjects
are likely similar to the population at large. Again, the participants’ heightened awareness of the
audit fees may have affected the magnitude of the means tabulated for each construct; however, it
is less likely to affect the differences between groups. Future research could examine the degree to
which various levels of experience with accounting constructs influences investor behavior and
perceptions about the organizations represented in the financial statements they examine.
A limitation of our study, compared toDopuch et al. (2003)andDavis and Hollie (2008),is
that we do not control for independence in fact. These studies manipulate independence in fact by
stating whether reports provided to participants are biased (unbiased reports indicate that the
auditor is independent in fact). We do not provide any such information because two of the

Audit Fees and Investor Perceptions of Audit Characteristics 91
constructs we

are examining are investor perceptions of financial statement error and audit quality. To provide
such information would impede our ability to examine these constructs. We do not make any
explicit claims in the instrument regarding independence in order not to bias the participants. We
state that it is a publicly traded company. This subtly implies that the auditor must meet minimum
requirements pertaining to the appearance of independence because the 1933 Securities Act
requires the financial statements to be certified by an independent auditor.
Finally, our task materials were not a complete set of financial statements that an investor
may consult when considering organizations for investment. Given our limited time and our focus
on audit fees, we wanted to ensure that the task could be performed in the time allotted for its
completion, and that there would be some awareness of the audit fee information provided in the
task materials. Although the financial information we presented to participants may have been
somewhat limited, we were interested in the effect that the audit fee relative size information
might have on perceptions of audit performance and organizational business risk. Given that all
participants received the same set of abbreviated financials, we feel confident that the abbreviated
task materials would not have a differential effect on any particular treatment group in the study.
CONCLUSION
This study analyzes investor perceptions of audit engagement attributes based on the
presentation of audit fee relative size. The results indicate that users of financial information make
different assessments of audit quality, auditor effort, and auditor independence based on the way
that an audit fee is presented. Investors perceive commensurate increases in both auditor effort
and audit quality as the relative magnitude of the audit fee increases. Perhaps most importantly,
our study indicates that when additional contextual information is presented to indicate that audit
fees are unusually high, investors exhibit concerns about auditor independence. Interestingly,
when audit fee data are presented in a format that follows current disclosure rules and does not
provide additional benchmark information, investors also appear to exhibit similar concerns about
auditor independence.
This study also contributes to the literature in three primary ways. First, this study adds
breadth to the extant disclosure literature. While some would argue that more disclosure is better,
we should continue to investigate the quality of disclosures and investor perceptions of or
reactions to those disclosures. While we do not necessarily propose a superior framework for
disclosure, this issue should be studied further. Additionally, this paper contributes to existing
literature about the information contained in audit fees. An important conclusion emerges from
our study, which is that investors do appear to make a distinction between overall audit quality
and a mere absence of specific financial statement errors. Audit fees are one of the few proxies
that researchers and investors have for various audit characteristics. The results indicate that
investors can use audit fees to gather information about audit characteristics. Finally, this paper
contributes to the auditor independence literature. Auditor independence is one of the fundamental
requirements of a quality audit. Based on the results, when no additional benchmark data are
provided about the magnitude of the audit fee, we find that investors are skeptical of auditor
independence, perceiving it as low. Auditors may want to work with regulators to provide
information to investors that can be more useful for evaluating auditor performance and help
eliminate this bias.
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APPENDIX A
CONSTRUCT QUESTIONS
Construct Item
Auditor independence I believe that this client is economically important to the audit firm.
I believe that the audit firm would be willing to end its relationship with this
client.
I believe the auditors are independent evaluators of the financial information
for Company X.
The audit firm is reliant upon having Company X as a client.
I believe that the auditor’s work was not inappropriately impacted by pressure
from the client.
Auditor effort The auditors put forth sufficient effort to properly audit this client.
Based on the fee information, I believe the auditors spent the sufficient
number of hours to audit this client.
The company is receiving the proper amount of attention from its auditor.
Financial statement error I believe that the financial information presented for Company X is accurate.
Based on the audit fee information, I believe this company’s financial
information did not contain errors subsequent to the audit.
Based on the audit fee information, the company’s financial information
presented is a fair representation of the company’s actual financial
condition.
Audit quality I believe the company received a quality audit.
The company received an audit that can be relied upon.
The audit of Company X was performed thoroughly.
The audit should have been performed better for the company.
Business risk This investment is a risky investment.
I feel confident in the continued performance of this investment.
I would keep this stock in my portfolio.
This stock provides a stable return.
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BEHAVIORAL RESEARCH IN ACCOUNTING American Accounting Association

Vol. 25, No. 2 DOI: 10.2308/bria-

Audit Fees and Investor Perceptions of

ABSTRACT: We investigate how audit fee disclosures affect investor perceptions of

Published Online: January 2013

Other Audit-Related Disclosures

Recent Regulatory Interventions and Other Initiatives

BACKGROUND AND HYPOTHESES

Cognitive Bias and Magnitude Perceptions Theories

Perceived Auditor Independence

Perceived Auditor Effort

Perceived Financial Statement Error

Perceived Audit Quality

Perceived Business Risk

Absence of Relative Size

Multivariate and Univariate Results

Behavioral Research In Accounting

Hypothesis Tests, Pair-Wise Comparisons

Auditor independence No additional information Low —6.119 0.000

Behavioral Research In Accounting

Behavioral Research In Accounting

Behavioral Research In Accounting

Behavioral Research In Accounting

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