Do Auditors Price Audit Committee's Expertise? The Case of Accounting versus Nonaccounting Financial Experts

Abstract

The issue of whether audit pricing reflects the effectiveness of the audit committee is of fundamental interest to auditors, managers, and others. Auditors are expected to price the effectiveness of the audit committee because it relates to the control risk and thus, the overall audit risk. This study examines the relation between audit fees and a key determinant of the audit committee's effectiveness—that is, the financial expertise of the audit committee. Though the Sarbanes-Oxley Act mandates the disclosure of a financial expert, the Securities and Exchange Commission (SEC) broadly defined experts to include accounting or nonaccounting financial experts. Does audit pricing differentiate between accounting and nonaccounting financial expertise? For a sample of Standard & Poor's (S&P) 500 firms for the years 2000 through 2002, we find that after controlling for several board and audit committee characteristics and firm characteristics, audit pricing is negatively related to accounting financial expertise. However, this finding is conditional upon the strength of the overall governance structure. We do not find a significant relation between audit fees and accounting financial expertise for observations with weak governance structure. Overall, our evidence is consistent with the SEC's initial narrow definition to include only the accounting financial experts. The lack of a significant relationship between nonaccounting financial expertise and audit fees suggests that auditors perceive that only accounting financial expertise contributes to audit committee's effectiveness.