Does Auditor Compensation Lower Market Liquidity?

Abstract

Previous studies have focused on accounting measures, such as earnings management and discretionary accruals, in evaluating the effects of auditor compensation on disclosure quality. In contrast, we investigate the impact of fees paid for audit and non-audit services on a market-based measure of disclosure quality and stock market liquidity. Based on a large sample of NYSE-traded S&P 1500 stocks, we find only weak evidence to support the argument that auditor compensation lowers disclosure quality and market liquidity. This finding is robust to alternative measures of bid-ask spreads and asymmetric information costs of trading. We do find, however, some evidence to suggest that corporate governance characteristics play a role in the relationship between auditor compensation and quoted liquidity. Our findings underscore the need to revisit the rationale behind restrictions on non-audit services imposed recently by the Sarbanes-Oxley Act.