Optimistic tone and audit fees: Some Australian evidence

• Author: Dessalegn Getie Mihret,Ferdinand A. Gul,Mohammad Badrul Muttakin,Vincent Bicudo de Castro
• DOI: http://doi.org/10.1111/ijau.12165
• Published date: 01 July 2019
• Date: 01 July 2019

ORIGINAL ARTICLE

Optimistic tone and audit fees: Some Australian evidence

Vincent Bicudo de Castro | Ferdinand A. Gul | Mohammad Badrul Muttakin |

Dessalegn Getie Mihret

Department of Accounting, Faculty of

Business and Law, Deakin University,

Burwood, Victoria, Australia

Correspondence

Dr. Mohammad Badrul Muttakin, Department

of Accounting, Faculty of Business and Law,

Deakin University, 221 Burwood Highway,

Burwood, Victoria 3125, Australia.

Email: m.muttakin@deakin.edu.au

We examine whether the tone of corporate annual reports is associated with audit

pricing decisions. A unique dataset drawn from annual reports of nonfinancial firms

listed on the Australian Stock Exchange for the period from 2002 to 2014 is gener-

ated using textual analysis. We find that annual reports that convey optimistic tone

are associated with lower audit fees, suggesting that annual report tone reflects fac-

tors that auditors consider in assessing audit risk. Consistent with the inverse associ-

ation between tone and audit fees, results of additional analysis show that annual

report tone is positively associated with earnings quality. Our results hold after con-

trolling for firm characteristics that influence audit pricing decisions and remain

robust to alternative variable measurement and test of endogeneity. Overall, the

findings suggest that auditors could enhance their audit risk assessment practices by

systematically considering linguistic attributes of qualitative corporate disclosures.

KEYWORDS

audit fees, audit pricing, audit risk, optimistic tone

1|INTRODUCTION

Qualitative information disclosures provided by management are

increasingly regarded as an important supplement to information

presented in financial statements (Huang, Teoh, & Zhang, 2014;

Kothari, Xu, & Short, 2009). Accordingly, recent accounting and

finance research has paid attention to the association of linguistic

attributes of corporate reports with corporate behavior and economic

outcomes (Biddle, Hilary, & Verdi, 2009; Davis, Piger, & Sedor, 2012;

Huang et al., 2014; Larcker & Zakolyukina, 2012; Li, 2008; Rogers,

Van Buskirk, & Zechman, 2011). The sentiment (i.e., tone) of messages

reflected in annual reports (Henry, 2008; Huang et al., 2014; Yekini,

Wisniewski, & Millo, 2016) tends to influence investors' and analysts'

views about firms. Similarly, one can argue that annual report tone

would be associated with audit risk assessment (see Lopatta, Gloger, &

Jaeschke, 2017; Yang, Yu, Liu, & Wu, 2018), as, for example, auditing

standards require auditors' perusal of information that accompanies

audited financial statements (International Federation of Accountants,

2012). Nevertheless, whether the overall tone reflected in the reports

is associated with auditor's decisions remains yet to be empirically

examined. Using Australian evidence, we investigate whether the tone

of corporate annual reports is associated with audit pricing decisions.

The motivation for this study originates from three sources. First,

auditors' considerations of information accompanying audited finan-

cial statements has gained increasing attention in recent times

(Simnett & Huggins, 2014). This trend is consistent with financial

statement users' needs for qualitative corporate disclosures as an

important source of information (Lang & Lundholm, 2000; Lawrence,

2013). In particular, the linguistic attribute of tone of messages con-

veyed in corporate annual reports tends to be associated with eco-

nomic outcomes (Henry, 2008; Huang et al., 2014; Yekini et al., 2016),

and it is thus likely to reflect audit risk factors. Second, current

auditing standards require auditors not only to review such informa-

tion as part of assessing the risk of misreporting—for instance, due to

fraud risk (International Federation of Accountants, 2009a)—but also

to evaluate consistency of the information with the audited informa-

tion and modify the audit report when material inconsistencies

between audited information and other accompanying reports are dis-

covered (Financial Reporting Council, 2016; International Federation

of Accountants, 2012; Public Company Oversight Board, 2013).

Received: 28 May 2018 Revised: 28 March 2019 Accepted: 2 May 2019

DOI: 10.1111/ijau.12165

352 © 2019 John Wiley & Sons Ltd Int J Audit. 2019;23:352–364.wileyonlinelibrary.com/journal/ijau