The Impact of SEC Disciplinary Actions on Audit Fees.

Abstract This paper examines the impact of Securities and Exchange Commission (SEC) disciplinary actions on the fees which affected accounting firms receive for their audit services. The impact of information with adverse implications for auditors' reputations is important because, to the extent that auditors suffer a financial loss, they are motivated not to engage in activities which may impair their reputation. Several studies (e.g., Francis and Simon 1987; Palmrose 1986; Rubin 1988; Francis and Wilson 1988) indicate that accounting firms who have established a reputation for relatively high quality service receive higher audit fees than firms who have not established such a reputation. However, researchers have only recently begun to examine the effects of auditors' loss of reputation (Wilson and Grimlund 1990; Firth 1990) and the findings of the only study examining auditor compensation following government criticism suggest that adverse information does not lead to lower audit fees (Firth 1990). This study combines survey data and publicly available information to compare new audit client fees received by auditors subject to SEC disciplinary actions versus those of unaffected auditors. After controlling for other factors shown to affect audit fees, new clients of sanctioned accounting firms were found to receive a fee discount over and above that normally received by clients switching auditors (for theory and evidence related to fee discounts on initial engagements see DeAngelo 1981 and Simon and Francis 1988). The implication of this result is that the impairment of reputation resulting from government disciplinary action leads to a reduction in audit fees and that accounting firms therefore have fee-related incentives to insure the performance of audits at a level of quality consistent with their reputation.