Pricing firms’ biodiversity risk exposure: Empirical evidence from audit fees

Abstract

Our study explores whether and how financial auditors—one of the most important information intermediaries of financial markets—consider firms’ (i.e., their clients’) exposure to biodiversity risks when making audit pricing decisions. Based on the risk-oriented audit approach, we hypothesize that auditors price firms’ exposure to biodiversity risks if these risks have an impact on firms’ future economic conditions. Using a firm-specific biodiversity risk measure based on textual analyses of firms’ 10-K statements, we find that firms’ biodiversity risk exposure is associated with higher audit fees. However, this positive association is concentrated among firms operating in industries with high physical and transition biodiversity risks. Further tests reveal that auditors do not increase their audit efforts due to firms’ higher biodiversity risk exposure but rather charge an audit fee risk premium. We also find that this audit fee risk premium is only charged (i) by auditors located in US counties with heightened environmental awareness, (ii) when public attention to biodiversity is high, and (iii) after the implementation of a biodiversity policy initiative. Overall, our findings suggest that auditors have started to charge a biodiversity risk premium. Therefore, our study not only contributes to the academic (industrial ecology) literature but also has important implications for biodiversity advocates, policymakers, regulators, auditors, and managers.