Correlation Between CEO Age And Audit Fees In Australia

Discuss about the Impact of CEO age of Australian listed companies on the audit fees charged by the auditors.

This study is designed to highlight the correlation between the age of the CEOs of the listed companies in Australia and the audit fees that these companies incur. During the early 2000s several high-profile accounting scandals emerged which pushed the legislatures and several bodies concerned with regulating accounting activities to pass the Sarbanes-Oxley act in 2002. This act made it mandatory for the chief executives and the CFOs to approve their firm’s financial statements before they are filed with the SEC. This new requirement was meant to monitor unethical behaviours among the executives and make them professionally responsible for fraudulent accounting behaviours (Huang, et al., 2012). By doing this, the CEOs were given more supervisory role to the accounting statements creation and release process.

Following the research by (Sundaram & Yermack, 2007), it was found that people tend to develop more ethical behaviours and becomes more conservative as they grow old. Old managers portray less aggressiveness in their management approach. This makes them more likely to insist on the production of high-quality accounting records.

Further, researches which have been conducted in the recent times are supporting the theory that the personal traits of a CEO have an impact on their corporate policies, for example issues such as individual life experience, preference for leverage and overconfidence are what shapes CEO’s financial actions as well as their attitude towards risks (Cronqvist, et al., 2012). Even though the age of a CEO can easily be observed, little information still exists on how their age correlates to the quotation of accounting fees by the audit firms.

Past theories are under the impression that CEO’s age have an influence on their risk-taking decisions but these predictions give mixed illustrations. Models such as those concerned with career development predict that risk aversion behaviours are more portrayed in younger CEO’s due to their lack of reputation as high-quality executives. This makes the managers at risk of suffering heavy punishment for unfavourable performance through reduction of opportunities to advance their careers in future. As a result, they may end up being induced to incorporate more conservative investment decisions. Contrary to this, the model developed by (Prendergast & Stole, 1996) suggest that younger CEO are great risk takers and often get involved in aggressive investment decisions in their bid to signal superior abilities. This is further, associated with overweighing of personal beliefs and exaggeration of investment attitudes so as to appear talented making them to be classified as risk takers. These behaviours are supported by the actions of 30-year-old Michael Reger during his tenure as the chief executive of the Northern oil and Gas when he directed capital investment towards drilling oil in areas yet to be explored (Serfling, 2014). This action was heavily criticised and termed as beyond the risk tolerance of older generation CEOs.

The structure of this proposal will be as indicated below,

Evaluation of the literature review followed by hypothesis to be tested leading to the discussion on research methods and  will be ended with a conclusion.

Research Support for the Correlation

How CEO age could impact upon business operations.

Age impact on the price of company stocks

In their study on the association between the CEO’s age and the changes in the business stock prices, (Andreou, et al., 2016) concluded that younger CEO’s are strongly correlated to future stock prices crash which include crash generated by breaks in consecutive earning strings. The collected evidence is supported by the notion that younger CEO occasionally hide unfavourable news associated with poor performance in the business operations. Considering that strings of consecutive earnings increase are explained by large permanent CEO compensation increase which don’t dissipate with crashes, it can be viewed that the younger CEO do have financial incentives to hide unfavourable news at the initial stages of their career (Baik, et al., 2011). This gives an indication that the young CEOs do exploit opportunities arising from weak corporate governance to pursue their individual interests. The study gave a suggestion that CEO’s age is a factor to be considered in determination of stock price crash risk and goes on to widen our knowledge on how the CEO age is an agency problem (Carter & Lorsch, 2004).

The age of the CEO and the acquisition behaviour

From the study by (Yim, 2013), it was demonstrated that there is an association between acquisition and huge permanent increase on the compensation of the business CEO. This led to a declining incentive on the CEO’s incentive to pursue acquisitions as they age.  For this reason, the age of the CEO does play a vital role when evaluating a firm’s acquisition actions.

From the conclusions in the research CEO age is modelled to have an economical effect in the development and implementations of business corporate policies. This indicates that the board’s selection of a CEO matters a lot which in turn end up complicating the director’s duties. The board members are tasked with pursuing the objectives of the shareholders by examining the abilities of the CEO and providing them enough incentives to allow them adhere to the firm’s goal congruence.

Young CEOs may be optimally selected based on their role which demand diverse knowledge and skills. However, the research illustrates that when it comes to issues like acquisitions and the business compensation culture, the young CEO are accorded a stronger incentive which might lead to overinvestment and destructions of the firm’s value (Bebchuk, et al., 2011). Being that the compensation scheme can provide a different nature of incentive for different CEOs, its relevant for the board to review the compensation incentive to a person rather than the firm

Determination of the audit fees

Historically business managers were responsible for negotiating and determining the audit fees, this led to the auditors losing their independence to the managers. In 2003 the SEC made regulations which transferred the duties of negotiating and setting the audit fees to the audit committees. Despite the introduction of the Sarbanes Oxley Act of 2002, a number of auditors are reporting that management is still in control of the business relationship with the external auditors (Cohen, et al., 2010). As per the accounting regulations, the audit committee is the one tasked with negotiation and determination of the audit fees. The current revelations by some auditors is giving an idea that investors are given a false sense of security by the accounting standards  (Beck & Mauldin, 2014).

Theoretical Implications

The benefits of explicit consideration of the executive incentive scheme in the auditing tasks has been stressed by the regulating bodies as evident by their concern that compensation is the major contributor of the experienced accounting scandals (Billings, et al., 2014). Considering that the managers equity has a direct influence on the business risks, the managers are suggested to have an incentive to control the auditor’s risk assessment of the business. The demand by the auditing standards that the auditors assess the company’s executive compensation scheme and provide a report of the assessed risks is an evident of the case.

As per the research conducted by (Billings, et al., 2014), adequate evidence was found to indicate that auditors do raise the cost of their services as a response of CFO equity incentives. This gives an indication that the auditors do view heightened audit risks as a product of the CFO equity incentives.

It is therefore vital to consider the executive incentive schemes so as to improve the understanding of auditors’ behaviour when it comes to assessment of risks and making pricing decisions in accordance to the current auditing standards.

Following heightened regulations designed to control accounting standards due to the early 2000s scandal, there is a recognition of the CFOs as actors who are accountable for generation of quality financial statements (Alali, 2011). The firms thereby need to be more cautious when it comes to compensating the CFOs by means of equity-based tools.

Development of Hypothesis

1^st: CEOs overconfidence and the audit fees

H1: young managers are overconfidence

A number of CEOs are under the impression that their firms are is a better position to succeed than the other companies operating in the industry. This scenario is referred to as overconfident.

Two of the major conflicts affecting audit professionals are identification of the minimum audit fees as well as breaking down the rate by a number of audit institutions. These techniques are however only efficient in nations with economical competition where monopolies do not have to dictate the minimum wages.

Being that auditors’ financial interests are determined by the wage they obtain from their contacts with the corporations, they employ a number of factors so as to price the services they offer. A lot of studies have been put in place so as to assist highlight these factors. Some of the descriptive factors which have been considered in majority of the studies include; risks, volume and complexity of operations of the department being audited  (Rajabi, et al., 2008). From the previous studies it is indicated that the young CEO have motivations to keep their career at state by showing their career to be higher than in reality. This is in anticipation that the current unfavourable outcomes will be compensated by future better performance. One of the greatest contributors of this form of self-deception is the issue of overconfidence.

Overconfidence is a factor which auditors view as one of the contributors of risk to the firm. In case where the CEO is likely to have the overconfidence traits, auditors tend to increase the fees of their services to cater for this risk (Ebrahimpour & Sarouklaei, 2016). In this regard we thereby seek to highlight the relationship between the young managers and the overconfidence issue. This will assist us link the risk associated with the managers overconfidence to the age of the CEO.

Research Proposal Structure

2^nd: Age, strategic decisions and audit services prices

H2: Young CEOs attract higher audit fees

There are a number of research literature that predicts that the age of managers has a direct impact on their intensity of pursuing specific strategic decisions. In some cases, younger managers are suggested to portray aggression and risk aversion when dealing with riskier ventures. During their young age, CEO’s tend to be pressured to display their talent to the world with an intention of showcasing that they are capable of competing and even doing better than the old veterans for this they tend to be ready to make very risky but potentially profitable decisions. This way they try to convince themselves that they possess additional talent in relation to the aged CEOs. On the other hand, old CEOs are normally reluctant to shift their investment decision making as they are more confident on the techniques that their past experience have enabled them to excel in. while considering the roles of managers background in the organizational outcome it was discovered that the young managers are associated with unprecedented risk taking actions (Andreou, et al., 2016).

Aged CEOs are occasionally are in a situation where they tend to give more utility to the financial and career security and may not be willing to risk losing all for the sake of trying a riskier investment strategy (Huang, et al., 2012). Old age is also associated with reluctant to change and maintenance of the status quo. As the managers age they tend to lose the mental and physical stamina that can allow them learn new behaviours. In addition, their operation experience forces them to seek and evaluate information intensively before deciding.

The above identified behaviours tend to correlate with the firms’ risk status, a factor that auditors do consider when pricing their services. Thereby will test the second hypothesis that young CEO attract higher audit fees.

Sources of information to be used to gather relevant data

The information pertaining to the audit fees, auditors, non-audit fees as well as internal control will be obtained for the period between 2007 to 2017. The sample of interest will be the companies listed in Australia. The CompStat will be a valid source for extracting financial and segment information. This information will be in accordance to various regulatory and accounting rules.

The other variable of interest is the age of the CEOs, this will be derived from ExecuComp for a similar period as that of audit fees information. More information regarding the variables will be derived from the Australian securities exchange market to assist interpret and make conclusions regarding the study variables.

Sampling techniques

The companies of interest are those listed in the Australian securities exchange. When collecting the data regarding their CEOs and the associated audit fees expenses will apply random sampling to select the data. The data from the recent years, that is 2007-2017 will be used so as to ensure the study findings reflect the current trends in the market. The use of random sampling to select our data sample will assist come up with a data set which will give the best representation of the entire population.

The confounding auditor type effect rule will exclude non-big 4 accounting entities as well as joint audits as they are affected with complications of how the audit fees are determined. Under the joint audits two auditors from diverse firms are supposed to sign the audit report as jointly liable for the opinion issued. In addition, financial sectors and financial years which lack complete information will be disregarded from the sample data. The final sample will there after be computed and the information collected for purpose of analysis.

Definition of variables

In this study the focus is on the ways in which the age of the organisation CEO impact on the service fee charged by the auditing firms. For this purpose, our study dependent variable will be the audit fees. The age of the CEOs is the independent variable which will be affecting the relevant audit fee.

Variables to be controlled

Through the past studies several factors have been highlighted to be responsible for the audit fees. Some of this include size of the firm, complexity of operations, riskiness and other special instructions demanded by the clients.  The variables to be controlled will thereby be classified under four major categories. First category will be made of client financial factors that may interfere with the auditors pricing. Here will include size, segments, foreign, leverage level. The next category is concerned by the requirements of the Sarbanes-Oxley Act. In recent studies it has been observed that auditors are pricing the control risks that are generated by the material weaknesses of the internal control system (Hogan & Wilkins, 2008). In the third category we classify non-audit charges, this involves the quality of the audit, specialisation of the industry and the auditor tenure. The fourth category is included to account for agency as well as contractual issues which are concerned with pricing of audit services. This will control effects which rise from monitoring done by the board of directors which is evident by presence of external directors on the board. The external monitoring by the institutional investors also fall under this category.

Models to be used to examine the hypothesis

To test the hypothesis set, will apply a number of models. This will assist derive the necessary relations that can be applied in making the necessary conclusions.

One of the models that will be put in place will be the regression model.

This will assist test the correlation of the two variables i.e. the dependent and the independent variable. By testing the correlation and regression will be able to analyse if there exist any association between the two variables of interest.

Furthermore, will use the ANOVA test and t test to examine the inferential relationship between the variables.

Conclusion

Human development is a phenomenon that takes place with age, this development is normally accompanied by physical, emotional and spiritual changes that affect how we behave at each stage of life. CEO being part of the human race are affected by this change. Their age does have a lot of influence on how they approach management tasks. For instance, from past studies a lot of evidence have been acquired to indicate that the age of a CEO will determine how they perceive risk taking in business operations. Young CEO tend to possess a lot of physical and emotional stamina that makes them aggressive investors. They possess risk taking traits ready to pursue risky investments to optimise their performance.

Also, old age is characterised by experience, skills and knowledge that is developed with time along the career path. For this reason, the old CEO tend to take time to verify their steps and information before making investment decisions. This makes them averse to risks.

Having analysed the association between age and business risks, we are thereby interested in developing models which can assist expend on the knowledge regarding the association between the age of the CEOs and the auditor’s pricing of their services to the firms.

References

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