Moderating Effects of Agency Problems and Monitoring Systems on the Relationship between Executive Stock Option and Audit Fees: Evidence from Korea

Abstract

Since executive stock options may give rent-seeking incentives to CEOs, CEOs with stock options are likely to misallocate corporate resources to seek personal gains, which in turn may lead to a decrease in firm value. High-quality audit services can reduce the negative impacts of executive stock options on firm value and help firms to ensure sustainable growth. However, while most of the existing accounting literature related to executive stock options (ESO) is mainly focused on earnings management, there are relatively few studies that investigate the relation between ESO and audit fees. At the same time, while previous studies on ESO have been conducted in advanced countries, few studies have identified the relationship between ESO and audit fees in emerging markets. Therefore, it is necessary to examine the effect of ESO under circumstances different from those of developed countries. To fill this gap, we investigated the association between executive stock options and audit fees and examine the moderating effects of agency problems and monitoring systems on the relationship. Using 462 observations from 110 nonfinancial Korean listed companies, for the period of 2000 to 2005, we found that executive stock options are positively related to audit fees. In addition, we found that the effects of executive stock options on audit fees are even higher in firms with high agency problems, effective internal monitoring systems, and major accounting firms. This study can help regulatory agencies to validate audit fee regulations, such as the International Standard on Auditing, that consider ESO a significant risk factor. In addition, these results can help external auditors to set up the specific guidelines for pricing audit fees. Furthermore, the results of this study will contribute to the construction of more desirable corporate governance structure in Korean companies, which in turn would not only enhance firm value but also strengthen the sustainability of companies belonging to the emerging markets.