Are Audit Firms’ Compensation Policies Associated With Audit Quality?

52 Pages Posted: 9 Aug 2021

See all articles by Jürgen Ernstberger

Jürgen Ernstberger

Technische Universität München

Christopher Koch

Johannes Gutenberg University Mainz - Gutenberg School of Economics and Management

Eva Maria Schreiber

Independent

Greg Trompeter

University of Central Florida

Multiple version iconThere are 2 versions of this paper

Date Written: April 12, 2019

Abstract

We examine how compensation policies of audit firms are associated with audit quality. Specifically, we investigate the effects of the ratio of variable to fixed compensation and the size of the basis for profit sharing (i.e., whether partners share profits in a small or in a large profit pool). For our analyses, we use detailed mandatory disclosure of the compensation policies in German audit firms. We document that compensation policies vary considerably across audit firms. We find that profit sharing in a small profit pool and high variable compensation are two characteristics of auditor compensation associated with lower audit quality. We also find some evidence suggesting that audit quality may be most at risk in cases where partners rely more heavily on variable compensation to divide a relative small profit pool. In additional analyses, we find that these associations are more pronounced in medium-sized audit firms. We argue that this finding may result from these firms being too large for audit partners to directly monitor each other effectively, yet simultaneously too small to have sophisticated centralized monitoring systems in place. Finally, we find that integrating partner-specific, non-profit-related performance metrics into the compensation structure mitigates the adverse effects of small profit pools and high variable compensation.

Keywords: audit partner compensation; variable pay; small profit pool; audit quality

JEL Classification: M40

Suggested Citation

Ernstberger, Jürgen and Koch, Christopher and Schreiber, Eva Maria and Trompeter, Gregory, Are Audit Firms’ Compensation Policies Associated With Audit Quality? (April 12, 2019). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3875762 or http://dx.doi.org/10.2139/ssrn.3875762

Jürgen Ernstberger

Technische Universität München ( email )

Arcisstraße 21
Munich, 80333
Germany

Christopher Koch

Johannes Gutenberg University Mainz - Gutenberg School of Economics and Management ( email )

Mainz
Germany
+49 (6131) 3929990 (Phone)

HOME PAGE: http://https://www.cg.bwl.uni-mainz.de/

Eva Maria Schreiber

Independent ( email )

Gregory Trompeter (Contact Author)

University of Central Florida ( email )

PO Box 161400
Orlando, FL 32816
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
23
Abstract Views
142
PlumX Metrics