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The Relationship Between Enterprise Risk Management and Audit Fees The relationship between enterprise risk management and audit fees Name: Tjalle de Fouw Student number: 11152273 Thesis supervisor: Georgios Georgakopoulos Date: 23 June 2017 Word count: 17,098 MSc Accountancy & Control, specialization Control Faculty of Economics and Business, University of Amsterdam The relationship between enterprise risk management and audit fees Statement of Originality This document is written by student Tjalle de Fouw who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents. Tjalle de Fouw Master Thesis 2 The relationship between enterprise risk management and audit fees Abstract Despite increased interest in enterprise risk management (ERM) by academics and practitioners, there is an absence of empirical evidence regarding the effect of the level of quality of the ERM system. This research examines the influence ERM quality has on the amount of audit fees paid. A database study of 708 North American companies from 2010 to 2016 is used to perform an assessment of multivariate linear regression analyses and bootstrapping tests to examine the impact of ERM quality on the amount of audit fees paid. In contrary to the expectations, a significant positive relation is found between ERM quality and audit fees, indicating that companies with higher ERM quality demand a higher audit quality causing the audit fees to rise. Keywords; Enterprise risk management, ERM, audit fees, internal control, risk management, CRO. Tjalle de Fouw Master Thesis 3 The relationship between enterprise risk management and audit fees Contents Abstract ....................................................................................................................................... 3 Contents ...................................................................................................................................... 4 1 Introduction ......................................................................................................................... 5 1.1 Motivation .............................................................................................................................. 5 1.2 Research question .................................................................................................................. 6 1.3 Contribution ........................................................................................................................... 6 1.4 Structure ................................................................................................................................. 6 2 Literature review and hypotheses development .................................................................... 7 2.1 Enterprise risk management .................................................................................................. 7 2.2 Audit fees ............................................................................................................................. 13 2.3 Audit fees and ERM quality .................................................................................................. 16 2.4 Earnings volatility and ERM quality ..................................................................................... 17 2.5 Environmental uncertainty and ERM quality ....................................................................... 18 2.6 Financial leverage and ERM quality ..................................................................................... 19 3 Research methodology ....................................................................................................... 21 3.1 Sample .................................................................................................................................. 21 3.2 Variables and measurement ................................................................................................ 23 4 Findings ............................................................................................................................. 29 4.1 Descriptive statistics............................................................................................................. 29 4.2 Correlation matrix ................................................................................................................ 31 4.3 Regression analysis .............................................................................................................. 34 4.4 Summary of main findings ................................................................................................... 40 5 Conclusion ......................................................................................................................... 41 6 Bibliography ....................................................................................................................... 43 7 Appendices ........................................................................................................................ 48 7.1 Appendix A, Table of articles ................................................................................................ 48 7.2 Appendix B, Homoscedasticity ............................................................................................. 53 Tjalle de Fouw Master Thesis 4 The relationship between enterprise risk management and audit fees 1 Introduction 1.1 Motivation There has been a continuing growth of interest in enterprise risk management (ERM). Since the early 2000’s an increasing number of organisations are considering the implementation of an ERM system or have implemented one. Since 2006 Standard & Poor (S&P) have developed an ERM rating for firms and began to consider ERM in their rating process (Hoyt & Liebenberg, 2011, pp. 795-796). Traditional risk management tends to separately manage risk in individual risk categories. ERM tends to go across these risk “silos” to manage risk in a holistic, integrated, enterprise-wide fashion. Advocates argue that ERM can increase risk awareness that improves strategic and operational making, which results in decrease earnings and stock price volatility, increase capital efficiency, reduce external capital costs, and create a more efficient risk management system (e.g., see Beasley, Pagach, & Warr, 2008; Cumming & Hirtle, 2001; Hoyt & Liebenberg, 2011; Lam J., 2001; Meulbroek, 2002; Miccolis & Shah, 2000). A substantial amount of research has been done focussing on the determinants of implementing an ERM system with inconclusive results (e.g., see Beasley, Clune, & Hermanson, 2005; Hoyt & Liebenberg, 2003; Kaplan & Mikes, 2014; Pagach & Warr, 2010). An increasing number of scholar’s view ERM as the fundamental paradigm for managing the portfolio of risks confronting organizations (Hoyt & Liebenberg, 2011; Hoyt & Liebenberg, 2003; Lam, 2014; Nocco & Stulz, 2006; Beasley, Pagach, & Warr, 2008) In contrary, opponents argue that ERM is not effective and it should not be implemented. Power (2009) argues that ERM decreases risk management quality due to it being flawed at the core elements such as risk appetite. He concludes that ERM can at its best provide limited security and in the worst case all of the security is illusory (Power, 2009). Others find that ERM does not increase firm value above traditional risk management (Lin, Wen, & Yu, 2012; McShane, Nair, & Rustambekov, 2011). In addition, Fraser et al. (2008) find that investors don’t see ERM as a value increasing aspect of the firm. Despite the increased interest in ERM by academics and practitioners, there is an absence of empirical evidence regarding the effect of the level of quality of the ERM system on certain company aspects. Hoyt and Liebenberg (2011) call for further research using a large sample, a more refined ERM measure to be able to measure the ERM quality, and identifying specific ways in which ERM contributes to firm value. In addition, Baxter et al. (2013) call for research that explores issues related to ERM quality in other industries Tjalle de Fouw Master Thesis 5 The relationship between enterprise risk management and audit fees apart from the insurance industry. Finally, Kaplan and Mikes (2004) encourage future research to refine the contingency variables of ERM. 1.2 Research question In this research, the relationship between ERM and the amount of audit fees is investigated. Prior research shows different results about the relationship between risk management tools and audit fees. Abbot et al. (2003) report a positive association between audit committee effectiveness and audit fees. This is because a more efficient audit committee demands more audit effort or a greater audit scope (Abbott, Parker, Peters, & Raghunandan, 2003, p. 29). However, Bell et al. (2001) find that the amount of audit fees increases when companies have a greater business risk (Bell, Landsman, & Shackelford, 2001, p. 43). This research aims to clarify this relationship. The research question that is to be answered in this study is; Does an increase in ERM quality mitigates the amount of audit fees paid? 1.3 Contribution As mentioned above there have been different results about the relationship between risk management tools and audit fees and the effect of ERM itself. There have been multiple studies
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