A nonlinear association between positive abnormal audit fees and financial reporting quality: empirical evidence from the banking industry

Purpose This study aims to investigate the association between positive abnormal audit fees (PAAFs) and financial reporting quality (FRQ). Design/methodology/approach This study uses a multivariate regression analysis to examine a sample consisting of 2,200 bank-year observations from the United States (US) over the 2010–2020 period. Consistent with prior literature, PAAFs are derived using an audit fee estimation model and FRQ is derived using a loan loss provision estimation model. Findings This study provides strong evidence that PAAFs affect FRQ. Findings show an inverted U-shaped association. For lower levels of PAAFs, additional audit fees increase FRQ. By contrast, for higher levels of PAAFs, additional audit fees decrease FRQ. Research limitations/implications The focus on US banks may constrain the generalizability of findings. For this reason, further research exploring other contexts beyond the US setting may be particularly beneficial. Practical implications This study is of interest for regulators, auditors, and investors who are particularly concerned with FRQ determinants. Findings reveal that audit fees are key antecedents of FRQ and, overall, suggest the need for better monitoring and greater caution when interpreting banks’ financial reporting. Originality/value The significance of this study lies in its aim to enhance the understanding about the effects of PAAFs on FRQ by providing a plausible explanation for previous mixed results in the field, as well as novel insights for the banking industry. For banks with lower (higher) PAAFs, additional audit fees are beneficial (detrimental) as the audit effort effect (economic bond effect) prevails over the economic bond effect (audit effort effect).