Better governance, lower fees

16/2/2009

Following high-profile corporate collapses, the rules regarding company governance have changed internationally.

The Sarbanes-Oxley (SOX) legislation affected major changes in the US, and in New Zealand companies have to meet tighter regulations imposed by the NZX and NZ IFRS (International Financial Reporting Standards).

Dr David Lont (1976-79)

How these changes interact with auditing fees raises significant issues for the accounting profession, says Dr David Lont (1976-79), an accountancy and business law lecturer at the University of Otago.

In post-SOX research undertaken with Yuan Sun and Professor Paul Griffin (University of California, Davis), David argues that, while SOX imposed substantial cost on companies, increased spending on governance can also result in savings.

He says theirs is the first research to reconcile a positive and negative effect – a fee-increasing relation because auditing services help attain better governance, partially offset by a fee-decreasing relation because auditors reduce the price of risk to reflect the benefits of better governance.

After controlling for the increased costs imposed by SOX, David finds better governance reduces the cost of auditing, because even though better governance is costly, it enhances the quality of financial statements and internal controls, enabling auditors to decrease audit and control risk, and therefore results in reduced fees.

“This moderates the price of audit risk for the average US company by about six per cent, which we calculate\ implies a dollar offset to the average company’s audit fees of approximately $180,000, and more than $500,000 for the larger companies in our sample. This suggests better governance and reporting in New Zealand might also lead to audit-fee offsets here.”

Reproduced with the kind permission of the University of Otago magazine