Overconfident management and the audit fee demand-side perspective

Abstract

The issue of managerial overconfidence in managers has been studied in relation to audit pricing. Previous studies examined the relationship between managerial overconfidence and audit fees from the supply side. This study investigates the association of managerial overconfidence and audit fees from the demand side. We found a significant negative relationship between managerial overconfidence and audit fees. This finding supports the demand side perspective of audit pricing, specifically that overconfident management demands low quality audit services and subsequently low audit fees. In addition, we also investigated the role of the audit committee in the relationship between managerial overconfidence and audit fees, and found that a negative and significant relationship between managerial overconfidence and audit fees only occurred in companies with a strong audit committee. These findings suggest that a strong audit committee is able to offset the negative effect of managerial overconfidence by increasing monitoring of the financial reporting process, and auditors responds to this by reducing the level of risk of financial reporting and subsequently the audit fee.