Research On The Association Between Internal Control Quality And Audit Pricing:Evidence From Growth Enterprises Market

As a paid labor provided by a CPA, audit services should be priced to reflect not only the supply-and-demand condition but also the rules and characteristics in their production. An economic bridge between the accounting firm and the audited entity, justifiable and regulative audit pricing determines the healthy development of the audit market. Consequently, audit pricing, particularly factors that affect audit pricing, has been a focus for many domestic and overseas scholars.In theory, there are two basic factors that influence audit service pricing-audit costs and audit risks. Development in relevant research areas leads to further extension of specifications of both factors. More influencing factors are discovered concerning audit markets in various nations and of various types. It is a useful approach to studying audit pricing from the perspective of internal control quality because effective internal control not only decreases the audit costs but also reduces the audit risks a CPA has to bear. In the West, the issue of Sarbanes-Oxley Act marked a watershed in the study of the association between internal control and audit pricing.In China, meanwhile, existing literature pays more attention to internal control disclosure than to the association between internal control quality and audit pricing, as rules of internal control were issued later than the West and relevant research has not yet become mature.As a series of laws and regulations about internal control were enacted in Shenzhen Stock Exchange and Shanghai Stock Exchange, it means that regulators have put forward new requirements to the construction and disclosure of internal control of listed companies. It provides a good opportunity to study internal control of listed companies.This article put the perspective on the Growth Enterprise Market (GEM) that emerged in2009.The GEM builds a platform where the high growth, innovative companies could obtained financing channels. Not only it provides more audit engagements for CPA, but also brings a new challenge. First of all, as the investors’ awareness of the GEM market is not comprehensive and accurate, it will rely more on the auditing reports issued by the CPA. Second, as the GEM’s characteristics of disclosure, risk and operation are special, it also determines that when choosing way of auditing CPA should conform to the characteristic of the GEM. So, in the face of the GEM brings new challenges to auditors, it’s a new problem for CPA need to solve that how to formulate a reasonable audit pricing mechanism and reduce the risks of audit failure. This makes the study of this paper has more practical significance and theoretical significance.After reviewing related literatures about audit pricing, connection of internal control and audit fees, this paper analyzed their inner link in detail based on the theory of cost-benefit and risk premium. On the one hand, the quality of internal control affects audit pricing by influencing the audit cost and audit risk. On the other hand, CPA will charge higher audit fees of listed companies with internal control defects compared with the companies without defects, and charge higher audit fees of the companies with serious defects compared with companies with the general defects.In this paper, the data of listed companies in the GEM during2009-2011were chosen for empirical testing. The quality of internal control was measured according to how many defects disclosed in the internal control reports issued by the companies in public. If there is a problem it was defined that the company had an internal control defect. First of all, the sample was divided according to the presence of internal control defects in internal control report on, to explore whether the internal control defects would lead to audit fees’rising. Then the sample with defects was tested further. If a company disclosed more than3problems, it was defined that had a terrible internal control defect to study whether worse internal control quality would result in higher audit fees.Empirical results show that whether listed companies have the internal control defects, internal control quality has no significant influence on audit pricing. However, serious internal control defects have a significant positive effect on audit pricing. In general, the CPA needs to pay more attention to the quality of internal control when auditing, and evaluate the quality of internal control more accurately when pricing audit services. The contributions of the paper are as follows:Firstly, researching of association between internal control quality and audit pricing enriches the existing related literatures and provides data support for future research.Secondly, the conclusion of this paper is innovative. Through to study on the data of the GEM, it’s found that CPA’s attention to internal control deficiencies have a difference in degree. Only the substantial and serious internal control defects will obviously lead to a change of audit fee.Thirdly, this article expands the path of research on the GEM’s audit pricing. According to the characteristics of the gem listed companies, this article introduced a new indicator, innovation, which will have an influence on audit pricing. It’s proved that the higher innovative listed companies own on the GEM board, the lower audit fees they will pay. This conclusion expands the research on the impacting factors of audit pricing.