Transformations  in
Business & Economics

EXECUTIVE PAY GAP AND AUDIT FEES: EVIDENCE FROM CHINA⁶
Yi Xiong, Sicheng Li, Yang Gao

ABSTRACT. As the executive pay gap widens, its effects on enterprises are receiving more attention. However, conclusions are inconsistent regarding whether the executive pay gap affects auditors' engagement risks and pricing decisions. To fill the above gap, using a large sample of listed A-share nonfinancial firms in China from 2007 to 2019, the executive pay gap was measured and the effect of promotion-based tournament incentives caused by executive pay gap on auditors' risk assessment processes and pricing decisions was examined. Results show that the executive pay gap is positively associated with audit fees. This association is attenuated for firms with recent CEO turnover, in highly homogeneous industries, and non-state-owned enterprises. The relationship also shows nonlinear characteristics. To mitigate the engagement risk caused by widened executive pay gap, auditors usually invest more in audit costs and charge a risk premium, leading to increased audit fees. Overall, the promotion-based tournament incentives caused by the executive pay gap are the main reason for increased fees - a phenomenon that should arouse the interest of both investors and regulatory authorities. These findings can provide a reference for firms that want to design more reasonable compensation contracts and for auditors who want to modify their audit pricing strategies .

KEYWORDS:  executive pay, pay gap, audit fees, promotion-based tournament incentives.

JEL classification:  C52, E52, G21.

⁶Acknowledgments:  This study was supported by the National Social Science Foundation of China (No. 20CJY008), and the Fundamental Research Funds for the Central Universities (No. 2662019QD027).