Monitoring function of the board and audit fees: contingent upon ownership concentration

• Date: 06 March 2017
• DOI: https://doi.org/10.1108/IJAIM-05-2016-0054
• Pages: 70-90
• Published date: 06 March 2017
• Author: Richard Bozec,Mohamed Dia
• Subject Matter: Accounting & Finance,Accounting/accountancy,Accounting methods/systems

Monitoring function of the board

and audit fees: contingent upon

ownership concentration

Richard Bozec

University of Ottawa, Telfer School of Management, Ottawa, Canada, and

Mohamed Dia

Department of Finance and Operations, Faculty of Management,

Laurentian University, Sudbury, Canada

Abstract

Purpose –The aim of this paper is to revisit the board independence–audit fees (BI–AF) relationship while

taking into account the ownership structure of the rm. Two effects are unfolding along the ownership

concentration spectrum: separation of ownership and control (principal–agent problems) and separation of

voting and cash ow rights (principal–principal problems).

Design/methodology/approach –The study is conducted over a seven-year period (2002-2008) using

panel regressions on a sample of Canadian publicly traded companies. The authors use a moderated

regression analysis incorporating two-way interactive terms (ownership ⫻BI) and a sub-group analysis.

Findings –The results show a positive and signicant relationship between BI and AF when ownership is

concentrated in the hands of a dominant/controlling shareholder. The higher the gap between voting and cash

ow rights of the ultimate owner, the stronger the relationship between BI and AF. Overall, evidence supports

both the demand-based perspective on AF and the expropriation effect argument.

Practical implications –Results support a one-size-ts-all approach to governance despite growing

concerns from academics and interest groups about the appropriateness of pursuing such strategy when

ownership is concentrated in the hands of a dominant/controlling shareholder.

Originality/value –By taking the excess voting rights into account (difference between voting rights and

cash-ow rights of the ultimate owner), the authors propose a rened classication of the sample rms along

the ownership concentration spectrum.

Keywords Audit fees, Ownership concentration, Board independence, Excess voting rights,

Interests misalignment, Private benets of control

Paper type Research paper

Introduction

The board of directors is generally seen as the backbone of corporate governance. Not

surprisingly, recommendations have been made to strengthen the disciplinary role of the

board by appointing a higher proportion of independent directors and separating the CEO

and Chairman positions. The independence of the board has become the cornerstone of “good

governance” because it allows the board to properly fulll its legal duty to oversee

management and to protect shareholders’ interests. Despite all the value placed on the

independent director by nancial market participants and regulators, empirical evidence on

the relation between board independence (BI) and rm performance is largely inconclusive

(Brown et al., 2011;Weisbach and Hermalin, 2003;Dalton et al., 1998).

Because rm performance is inuenced by a multitude of factors beyond the board

structure and composition, an alternative view is to analyze discrete board decisions instead.

Requests for external audit services fall into the realm of board strategic decisions. Empirical

The current issue and full text archive of this journal is available on Emerald Insight at:

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IJAIM

25,1

70

Received 13 May 2016

Revised 23 August 2016

Accepted 30 August 2016

InternationalJournal of

Accounting& Information

Management

Vol.25 No. 1, 2017

pp.70-90

©Emerald Publishing Limited

1834-7649

DOI 10.1108/IJAIM-05-2016-0054

studies generally support a positive relationship between BI and audit fees (AF) (Hay et al.,

2008;Abbott et al., 2003;Carcello et al., 2002;O’Sullivan, 2000). These results are consistent

with the demand-based perspective according to which more independent board is

concerned with discharging its monitoring role by increasing pressure to enhance the scope

of the audit. In other words, BI and AF are complementary.

Meanwhile, a growing number of researchers questioned the global policy of adhesion to

a one-size-ts-all approach to governance. Ownership structure is often referred to as a key

rm specicity in designing internal controls. For instance, Bebchuk and Hamdani (2009)

highlight the fact that rms with a dominant/controlling shareholder require different

governance arrangements than rms with dispersed ownership. In rms with concentrated

ownership, the fundamental concern is the risk that the dominant/controlling shareholder

may behave opportunistically at the expense of minority shareholders (risk of expropriation

or principal–principal problems), whereas in widely held rms the fundamental concern is

the risk that management may behave opportunistically at the expense of shareholders

(interest misalignment or principal–agent problems).

Despite increased attention devoted by academics and some interest groups to the

contrasting reality of corporate ownership outside the USA and the UK, only one study

analyzed the moderating impact of ownership concentration on the BI–AF relationship

(Desender et al., 2013). The results show that the relationship between BI and external AF in

Continental Europe is negatively affected by ownership concentration suggesting that board

composition and ownership concentration are substitutes in terms of monitoring

management. Controlling shareholders appear to be able to monitor managerial

misalignment beyond the board reducing the positive relationship between BI and AF.

However, the study only accounts for the potential interest misalignment between managers

and shareholders (principal–agent problem) and ignores the risk of expropriation (principal–

principal problem) usually associated with ownership concentration.

The objective of this paper is to revisit the BI–AF relationship in the context of publicly traded

companies while taking a closer look at the potential moderating impact of the ownership

structure. By taking the excess voting rights into account (difference between voting rights and

cash-ow rights of the ultimate owner), we propose a rened classication of the sample rms

along the ownership concentration spectrum. Accounting for the excess voting rights helps to

disentangle the two potentially offsetting effects that emanate from ownership concentration,

that is, the shareholders–managers misalignment (principal–agent problems) in the tradition of

Jensen and Meckling (1976) and the expropriation of minority shareholders (principal–principal

problems) in the footsteps of La Porta et al. (1999) and Claessens et al. (2002).

The study is conducted in Canada. The rms selected are all listed on the Toronto

Stock Exchange (TSX) and comprise Canada’s benchmark S&P composite index. Like

the USA, but contrary to most other non-US countries, Canada has a relatively good

reputation in terms of its legal and extra-legal institutions aimed at protecting investors.

Public equity markets are therefore relatively well developed. At the same time,

ownership may be highly concentrated. Canada features companies with a wide range of

ownership structures from widely held rms to family controlled businesses. This

provides an ideal setting to assess the potential moderating effect of ownership

concentration on the relationship between BI and AF.

The results show a positive and signicant relationship between BI and AF when

ownership is concentrated in the hands of a dominant/controlling shareholder. The highest

level of separation between voting and cash ow rights is also found in controlled entities.

The higher the gap between voting and cash ow rights, the stronger the relationship

between BI and the scope of audit. Overall, evidence supports both the demand-based

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Ownership

concentration