The Impact of Executive Pay Gap on Audit Pricing in China

This study aims to test the economic consequences of the tournament incentive. First, we investigate the impact of the pay gap among top executives and the pay gap between executives and employees on audit pricing using a large sample of Chinese listed firms from 2008 to 2019. Then, we test the moderating role of ownership property, technological complexity and corporate governance in the association between the executive pay gap and audit fees. Findings indicate that the executive pay gap is positively associated with audit fees. The positive association between the executive pay gap and audit fees is more pronounced in private firms, firms with fewer R&D expenditures, and firms with smaller proportion of independent directors. Further studies suggest that large executive pay gap motivates managerial opportunistic behaviors, resulting in more accrual-based earnings management and real activities manipulation. Our results, consistent with managerial power theory, show that auditors assess firms with large executive pay gap as high risk and incorporate the audit risk and audit business risk associated with the executive pay gap into audit pricing. The results provide further evidence for regulators to strengthen supervision on the executive compensation, especially the executive compensation of state-owned enterprises and firms with weak corporate governance.