Auditor Liability and Excess Cash Holdings: Evidence from Audit Fees of Foreign Incorporated Firms

Auditors face greater liability in some countries than others due to the nature of the institutional monitoring framework of legal claims that can potentially be brought against the auditor. This paper is the first to document the relationship between auditor liability and auditor pricing of excess cash holdings for clients across national borders, using a sample of foreign incorporated firms traded in the US. Our findings indicate that auditors demand a fee premium for foreign incorporated clients with greater excess cash holdings, consistent with that auditors recognizing the potential for legal exposure to agency conflict arising from foreign listed US traded clients. Furthermore, we examine aspects of foreign capital market protections, such as disclosure requirements, the strength of legal enforcement, and the strength of shareholder rights to better understand auditor perception of the liability they incur due to the agency costs associated with excess cash holdings. We find that there is a positive association between audit fees and excess cash holdings for firms where the country of incorporation permits greater liability of auditors in criminal and civil litigation. In addition, auditors assign higher audit fees to firms holding greater excess cash incorporated in countries with greater required accounting disclosure and stronger legal enforcement. Keywords: Auditor liability, excess cash, agency theory, audit fees, international accounting