Audit fees-audit quality relationship: Does employee board representation matter?

We examine the effect of employee board representation on audit fees and whether the interplay between audit fees and employee board representation has an impact on audit quality, as measured by discretionary accruals. Using a sample of 3142 firm-year observations across seven European countries over the period of 2005–2019, we show that employee board representation is negatively associated with audit fees, and this association is primarily observed when the number of employee directors reaches two or more. In addition, we test the possible channels through which employee board representation affects audit fees and show that the effect is stronger in firms with weak corporate governance. We also document that audit committee effectiveness moderates the relationship. Finally, we show that the observed lower audit fees lead to an improvement in audit quality, probably due to a stronger control environment and reduced audit risk in the presence of employee directors. Our main results are unchanged when using alternative measures, additional controls, subsample analysis, alternative econometric techniques, and identification strategies.