Allameh Tabataba’i UniversityEmpirical Studies in Financial Accounting2821-0166208020240121The Role of Litigation Risk, Information Asymmetry and Economic Uncertainty in Explaining Audit FeeThe Role of Litigation Risk, Information Asymmetry and Economic Uncertainty in Explaining Audit Fee1331660110.22054/qjma.2023.74951.2479FAMandanaTaheriAssistant Professor, Faculty of management & accounting, University of Allameh Tabataba'i,Tehran,Iran0000-0001-7741-7208GhasemBlueAssociated Professor of Accounting, Management & Accounting Faculty, Allameh Tabataba'i University, Tehran, Iran0000-0002-6984-6368RaminParvarpourMaster of Accounting, Allameh Tabataba'i University, Tehran, Iran.0009-0009-6978-1734Journal Article20230721Information asymmetry and economic uncertainty are features of the capital market in today's complex business environment, which increase audit risk and litigation risk, and can be effective in explaining audit fees. The purpose of this research is to investigate the role of legal claims risk, information asymmetry and economic uncertainty in explaining audit fees. The time domain of the research is the period from 2013 to 2021 and the research sample includes 120 companies listed on the Tehran Stock Exchange. Research findings, based on analysis using multivariable regression models on combined data, show that among the macroeconomic variables investigated (including economic growth rate, inflation rate, exchange rate, and interest rate), both economic growth rate and inflation rate have a direct and significant relationship with the audit fee. Additionally, there is a direct and significant relationship between the risk of lawsuits and information asymmetry with the audit fee. The results indicate that the risk of lawsuits, economic uncertainty and information asymmetry play an effective role in explaining auditors' fees.<br /> <br /><br />Introduction<br /><br />Audit fees indicate the amount of auditors' effort to reduce the audit risk to the reasonable level. It is a measure to control financial risk and some legal claims that are threatening audit firms. According to litigation risk, auditors try to control this risk by increasing their efforts and audit fees. Chen (2019) and Frino et al. (2022) state that information asymmetry and economic uncertainty increase audit risk and litigation risk, and can influence audit fees. In other words, audit services are necessitated by the conflict between shareholders and managers. Information asymmetry and economic uncertainty increase agency costs, thereby heightening the necessity for auditing to control and manage these costs. Consequently, auditors increase audit fees to manage audit risks and ensure the thoroughness of their audit work. Therefore, this research aims to explain the effect of litigation risk, information asymmetry, and economic uncertainty on audit fees.<br /><br /><strong> Methodology</strong><br /><br />Our data were collected using financial statements, notes, and audit reports in CODAL<sup>[1]</sup> database and Rahavard-e-Novin<sup>[2]</sup> software. The final sample for a period of 2013-2021 consists of 1080 firm-year observations. In addition, the GARCH models were employed to measure the independent variables. To test the first and second hypotheses of this research, model 1 is used:<br />Afee<sub>t</sub>= litig risk<sub>t</sub>+ Asymmetry<sub>t</sub>+ Size<sub>t</sub>+ INVREC<sub>t</sub> +Lev<sub>t</sub> + ROA<sub>t</sub>+ loss<sub>t</sub>+ CHANGE<sub>t</sub> +Adu size<sub>t</sub> + Specialist<sub>t</sub>+ LIQUID<sub>t</sub> + SALE<sub>t</sub> +Year Effects+ Industry Effects (1)<br />To test the third hypothesis of research, model 2 is used:<br />Afee<sub>t</sub>= Economic Growth<sub>t-1</sub>+ Inflation Rate<sub>t-1</sub>+ Exchange Rate<sub>t-1</sub>+ Interest Rate<sub>t-1</sub>+ Size<sub>t</sub>+ INVREC<sub>t</sub> +Lev<sub>t</sub> + ROA<sub>t</sub>+ loss<sub>t</sub>+ CHANGE<sub>t</sub> +Adu size<sub>t</sub> + Specialist<sub>t</sub>+ LIQUID<sub>t</sub> + SALE<sub>t</sub> +Year Effects+ Industry Effects (2)<br />Where, SIZE represents the natural logarithm of total assets; INVREC denotes the amount of inventory and receivables divided by total assets; Lev indicates total liabilities divided by total assets; ROA signifies net profit divided by total assets; LOSS is assigned 1 if a firm has experienced a loss in any of the last three years, and 0 otherwise; CHANGE is assigned 1 if a firm has changed its auditor, and 0 otherwise; LIQUID represents current assets divided by total assets; SALE represents the ratio of sales to assets; Adu size is a dummy variable that equals 1 if the audit firm was either the Iran Audit Organization (IAO) or Mofid Rahbar (an audit firm belonging to IACPA), and 0 otherwise. SPECIALISR is assigned 1 if the auditor is an industry specialist, and 0 otherwise. Audit Fee (AFEE): is the natural logarithm of the audit fee.<br />Information Asymmetry (Asymmetry): According to the model of Venkatesh and Chiang (1986).<br />Economic Uncertainty (RM): Economic uncertainty is the inability of agents to accurately predict the outcomes of decisions. In this research, it has been measured by four indicators, including the fluctuation of economic growth, inflation rate, exchange rate, and interest rate. In addition, a GARCH model was used to index these criteria. For this purpose, a volatile measure of changes in the Gross National Product (GNP) index was considered to be an indicator of the risk of macroeconomic factors that the firm faces in its financial and production decisions. The results of the estimation of the GARCH model led to conditional variances, which ultimately lead to the standard deviation or the concept of uncertainty upon taking the square root.<br />Litigation Risk (Litig risk): We measure this variable based on Lowry and Shu (2002), Krishnan and Zhang (2005), and Sun and Liu (2011).<br /><br /><strong> Conclusion</strong><br /><br />The results of testing the first and second hypotheses indicate that the risk of lawsuits and information asymmetry have a positive and significant relationship with audit fees. In the third hypothesis, the effect of lack of economy on remuneration was investigated. In this research, four indicators including economic growth, inflation rate, exchange rate, and interest rate have been used to measure the economic uncertainty of macroeconomic variables. In this regard, the results of the hypothesis testing show that economic uncertainty based on inflation and economic growth criteria has a positive and significant relationship with audit fees. Additionally, economic uncertainty based on interest rate criterion has a negative and significant relationship with audit fees. However, the exchange rate indicator does not have a significant effect on audit fees. Therefore, it can be seen that audit risk as an indicator of determining audit fees is influenced by some economic variables such as inflation and economic growth.<br />In order to strengthen the results and address potential endogeneity in the research models, we redefined the dependent variable as imaginary (bivariate) and re-estimated the initial models of all three hypotheses. The results of these re-estimations confirmed the findings of the least squares regression in the first model for the first and second hypotheses. In the third hypothesis regarding economic uncertainty, economic growth and inflation rate criteria, as well as exchange rate, lead to an increase in the audit fee, while interest rate causes a decrease in the audit fee. Additionally, new control variables were added to the initial models based on the information provided in previous sections. The results of these additions confirm the findings of the initial estimation of the hypotheses.<br /> <br /> <br /> <br /> Information asymmetry and economic uncertainty are features of the capital market in today's complex business environment, which increase audit risk and litigation risk, and can be effective in explaining audit fees. The purpose of this research is to investigate the role of legal claims risk, information asymmetry and economic uncertainty in explaining audit fees. The time domain of the research is the period from 2013 to 2021 and the research sample includes 120 companies listed on the Tehran Stock Exchange. Research findings, based on analysis using multivariable regression models on combined data, show that among the macroeconomic variables investigated (including economic growth rate, inflation rate, exchange rate, and interest rate), both economic growth rate and inflation rate have a direct and significant relationship with the audit fee. Additionally, there is a direct and significant relationship between the risk of lawsuits and information asymmetry with the audit fee. The results indicate that the risk of lawsuits, economic uncertainty and information asymmetry play an effective role in explaining auditors' fees.<br /> <br /><br />Introduction<br /><br />Audit fees indicate the amount of auditors' effort to reduce the audit risk to the reasonable level. It is a measure to control financial risk and some legal claims that are threatening audit firms. According to litigation risk, auditors try to control this risk by increasing their efforts and audit fees. Chen (2019) and Frino et al. (2022) state that information asymmetry and economic uncertainty increase audit risk and litigation risk, and can influence audit fees. In other words, audit services are necessitated by the conflict between shareholders and managers. Information asymmetry and economic uncertainty increase agency costs, thereby heightening the necessity for auditing to control and manage these costs. Consequently, auditors increase audit fees to manage audit risks and ensure the thoroughness of their audit work. Therefore, this research aims to explain the effect of litigation risk, information asymmetry, and economic uncertainty on audit fees.<br /><br /><strong> Methodology</strong><br /><br />Our data were collected using financial statements, notes, and audit reports in CODAL<sup>[1]</sup> database and Rahavard-e-Novin<sup>[2]</sup> software. The final sample for a period of 2013-2021 consists of 1080 firm-year observations. In addition, the GARCH models were employed to measure the independent variables. To test the first and second hypotheses of this research, model 1 is used:<br />Afee<sub>t</sub>= litig risk<sub>t</sub>+ Asymmetry<sub>t</sub>+ Size<sub>t</sub>+ INVREC<sub>t</sub> +Lev<sub>t</sub> + ROA<sub>t</sub>+ loss<sub>t</sub>+ CHANGE<sub>t</sub> +Adu size<sub>t</sub> + Specialist<sub>t</sub>+ LIQUID<sub>t</sub> + SALE<sub>t</sub> +Year Effects+ Industry Effects (1)<br />To test the third hypothesis of research, model 2 is used:<br />Afee<sub>t</sub>= Economic Growth<sub>t-1</sub>+ Inflation Rate<sub>t-1</sub>+ Exchange Rate<sub>t-1</sub>+ Interest Rate<sub>t-1</sub>+ Size<sub>t</sub>+ INVREC<sub>t</sub> +Lev<sub>t</sub> + ROA<sub>t</sub>+ loss<sub>t</sub>+ CHANGE<sub>t</sub> +Adu size<sub>t</sub> + Specialist<sub>t</sub>+ LIQUID<sub>t</sub> + SALE<sub>t</sub> +Year Effects+ Industry Effects (2)<br />Where, SIZE represents the natural logarithm of total assets; INVREC denotes the amount of inventory and receivables divided by total assets; Lev indicates total liabilities divided by total assets; ROA signifies net profit divided by total assets; LOSS is assigned 1 if a firm has experienced a loss in any of the last three years, and 0 otherwise; CHANGE is assigned 1 if a firm has changed its auditor, and 0 otherwise; LIQUID represents current assets divided by total assets; SALE represents the ratio of sales to assets; Adu size is a dummy variable that equals 1 if the audit firm was either the Iran Audit Organization (IAO) or Mofid Rahbar (an audit firm belonging to IACPA), and 0 otherwise. SPECIALISR is assigned 1 if the auditor is an industry specialist, and 0 otherwise. Audit Fee (AFEE): is the natural logarithm of the audit fee.<br />Information Asymmetry (Asymmetry): According to the model of Venkatesh and Chiang (1986).<br />Economic Uncertainty (RM): Economic uncertainty is the inability of agents to accurately predict the outcomes of decisions. In this research, it has been measured by four indicators, including the fluctuation of economic growth, inflation rate, exchange rate, and interest rate. In addition, a GARCH model was used to index these criteria. For this purpose, a volatile measure of changes in the Gross National Product (GNP) index was considered to be an indicator of the risk of macroeconomic factors that the firm faces in its financial and production decisions. The results of the estimation of the GARCH model led to conditional variances, which ultimately lead to the standard deviation or the concept of uncertainty upon taking the square root.<br />Litigation Risk (Litig risk): We measure this variable based on Lowry and Shu (2002), Krishnan and Zhang (2005), and Sun and Liu (2011).<br /><br /><strong> Conclusion</strong><br /><br />The results of testing the first and second hypotheses indicate that the risk of lawsuits and information asymmetry have a positive and significant relationship with audit fees. In the third hypothesis, the effect of lack of economy on remuneration was investigated. In this research, four indicators including economic growth, inflation rate, exchange rate, and interest rate have been used to measure the economic uncertainty of macroeconomic variables. In this regard, the results of the hypothesis testing show that economic uncertainty based on inflation and economic growth criteria has a positive and significant relationship with audit fees. Additionally, economic uncertainty based on interest rate criterion has a negative and significant relationship with audit fees. However, the exchange rate indicator does not have a significant effect on audit fees. Therefore, it can be seen that audit risk as an indicator of determining audit fees is influenced by some economic variables such as inflation and economic growth.<br />In order to strengthen the results and address potential endogeneity in the research models, we redefined the dependent variable as imaginary (bivariate) and re-estimated the initial models of all three hypotheses. The results of these re-estimations confirmed the findings of the least squares regression in the first model for the first and second hypotheses. In the third hypothesis regarding economic uncertainty, economic growth and inflation rate criteria, as well as exchange rate, lead to an increase in the audit fee, while interest rate causes a decrease in the audit fee. Additionally, new control variables were added to the initial models based on the information provided in previous sections. The results of these additions confirm the findings of the initial estimation of the hypotheses.<br /> <br /> <br /> <br /> https://qjma.atu.ac.ir/article_16601_81ab5a99e63794587f4b1e7cbabbf8aa.pdf